IMF Resident Representative in Ukraine: The single most important thing to unleash Ukraine’s growth potential is to strengthen the rule of law and root out corruption
An exclusive interview of IMF Resident Representative in Ukraine Goesta Ljungman with Interfax-Ukraine agency
-- What stage are talks between Ukraine and IMF at regarding the completion of the first review? In which areas is there any progress and where there is no movement at all and even reversals? Any indications about the date for the new mission, SLA and disbursement?
-- As we have communicated earlier, the discussions on the first review are still ongoing. There are a number of outstanding issues that need to be resolved. What I am talking about are both the conditions and commitments in the program, and issues that have come up subsequently, including some that undo achievements of past programs. At this stage it is not possible to make any predictions about when the review can be completed. This depends on how quickly there is progress on outstanding issues.
-- IMF in its recent communications is incessant in reminding about unsolved problems in the NBU. Would you elaborate where those problems are concentrated: appointments, distribution of powers, independence, or monetary and exchange policies?
-- Our communications have focused on the importance of preserving the significant progress made under past IMF-supported programs. With respect to the NBU, these key achievements include the reorientation of monetary and exchange rate policy, the clean-up of the banking sector, the modernization of banking regulation and supervision, strengthening of the anti-money laundering framework, and the reforms of the organization and governance of the National Bank. These reforms have been central in stabilizing the economy and creating preconditions for economic growth starting in 2016. Preservation of these reforms and continued progress in strengthening the National Bank is a key part of the current Stand-By Arrangement with Ukraine. Specifically, on the economic policy front, this means preserving the inflation targeting framework and the flexible exchange rate regime. This framework has served Ukraine well over the past five years. It is also important to continue strengthening banking regulation and supervision in the interest of keeping the banking system safe and able to continue providing credit to household and firms. But even policies that are unequivocally good for economic stability and well-being of the Ukrainian people are not always going to be popular with everyone. And for that reason, it is critically important to protect the NBU and its staff from undue external pressure when they conduct their work in good faith.
-- Anticorruption legislation and judicial system. IMF’s frenemies accuse the Fund in imposing conditionalities which run opposite to Ukraine’s Constitution and its sovereignty. How justified are those accusations? Any compromise which could be attained?
-- Let’s start with what is important. Ukraine’s economic development is being held back by a lack of trust in the judiciary and high levels of corruption. The single most important thing to unleash Ukraine’s growth potential is to strengthen the rule of law and root out corruption. The creation of an institutional infrastructure to fight against corruption has therefore been a key element in all IMF-supported programs since 2014. We are talking about NABU, SAPO, the High Anti-Corruption Court, asset declaration requirement for high-level officials, criminal responsibility for illicit enrichment, etc. Some key elements of the judicial reform were also included in the current Stand-By Arrangement, recognizing the importance of establishing the public’s and investors’ confidence in the rule of law. Legislation needs to support judicial integrity and an even-handed application and enforcement of the rule of law, in a manner consistent with Ukraine’s constitution. On the integrity of anti-corruption agencies and the judiciary, we trust that the Ukrainian authorities see these principles as fundamental.
-- Budget-2022. Aside its deficit, any other issues which may be deemed controversial? Could a fiscal consolidation be postponed on the back of arguments of worsening situation with COVID-19 and belated vaccination?
-- I would first like to clarify why fiscal sustainability is important. In 2020, when the world was hit by a nasty combination of a pandemic—with far-reaching health consequences—and a very severe recession, it was logical to allow the fiscal deficit and debt to increase substantially in order to meet urgent spending needs. This was indeed the policy response advocated by the IMF, and the reason for the IMF’s unprecedented financial response. The IMF mobilized loans of more than US$100 billion to member countries, including disbursing US$2.1 billion to Ukraine in June under the current Stand-By Arrangement. Once the pandemic dissipates and the economy recovers, the fiscal deficit will need to return to pre-pandemic levels. This is important to instill confidence in Ukraine’s economy and reduce Ukraine’s borrowing needs. A strong fiscal position also gives Ukraine room to provide fiscal stimulus in the case of a future downturn. So the question should not be if Ukraine should reduce the fiscal deficit, but when. And in order to do so, there needs to be already a good plan for how that would happen, including through well-designed tax measures.
-- New issues on the plate: tax amnesty, the law on 14 pc VAT rate for agrarians, “investment nannies”, and we may count on. Are those issues detrimental for the program?
-- As I tried to explain in the previous question, a key objective of the IMF-supported program is to re-establish a fiscally sustainable position. This will require spending restraint and maintaining government revenue. While we can discuss changes to the composition of revenue and expenditure, it is important that the overall fiscal position is not undermined. A second point is that the tax system should be fair, stable and predictable. While preferential tax rates for specific groups of taxpayers will obviously be welcomed with open arms by those who see their taxes go down as a result, this does not necessarily make it good policy. We are skeptical about tax amnesties in general. The international evidence on whether they bring in revenue and change taxpayer behavior is mixed. Tax amnesties often hurt tax collection in the long run because they discourage people from paying their future taxes by making them think there will be yet another future amnesty. But if there is a tax amnesty, public officials and their close relatives and associates should not be allowed to participate. It is also absolutely crucial that the amnesty is not allowed to be used as a vehicle to launder proceeds from crime and corruption, and that it is not abused to grant amnesty from criminal activity.
-- Next two questions deal with the energy sector. We witness developments in its gas segment such as the institutionalization of an annual retail gas contact. Have they assuaged IMF concerns about the perils to the gas market reform?
-- I will start with the issue of protecting poor households, who are unable to pay for their energy consumption. There is—and there will be—a substantial part of the Ukrainian population who cannot cover the cost of gas, heat, hot water and electricity. The most efficient way to support those households is to identify them and provide them with financial support through the budget so that they can pay their utility bills. This instrument for support exists in the form of the Household Utility Subsidy program. We support this program. The other issue is structural – about what is the most efficient way organize the gas market. Since 2015, there has been a concerted effort to move towards an open and competitive gas market, both at the wholesale and retail levels. Important progress has been made, but a fully functioning market for household gas has not yet been established. Giving households the choice between a wide range of products—including fixed price contracts—is one of many developments that are needed. What is not needed is the return to price controls for gas. Not only is this a highly inefficient way of subsidizing households, with much of the subsidy going to households that do not need the support, but it also leads to a misuse of resources, though corruption and by discouraging energy efficiency.
-- Disbalances in Ukraine’s electricity sector continue accumulating and hence their fiscal costs. Do you see a long -term viable solution to this conundrum beyond bailing the sector out at taxpayers’ expense?
-- I agree that financial imbalances in the electricity sector are a source of concern. But it may be worthwhile to separate the issue into two: the immediate financial imbalance on the one hand, and Ukraine’s long-term energy security, on the other hand. It is obvious that there is an urgent need to identify additional financial resources for the electricity sector. The important part of this is that actual revenue sources are mobilized. Simply borrowing more is not a viable solution to current imbalances. But there is also a broader issue of Ukraine’s long-term electricity model. Ukraine currently relies on its legacy electricity production infrastructure, much of which dates back to Soviet times. Reorienting and modernizing electricity production is necessary and possible. But it requires planning to ensure that Ukraine can strengthen its energy supply and security.
-- The current SBA expires this December, does not it? Could it be continued? Could disbursements be merged? Which options for a potential future program are on the table and which of them in your opinion would be most viable beyond 2021? -- Let’s focus on what’s important: IMF wants to support economic development and prosperity of Ukraine. We have demonstrated this through a series of IMF-supported programs continuously since early 2014. And we will continue to support good economic policy and the transformation of the economy.