15:45 01.05.2023

We have planned high frequency reviews of the EFF program: one in the summer and one in the fall -- IMF Resident Representative in Ukraine

11 min read
We have planned high frequency reviews of the EFF program: one in the summer and one in the fall -- IMF Resident Representative in Ukraine

Exclusive interview with Vahram Stepanyan, International Monetary Fund Resident Representative in Ukraine, to the Interfax-Ukraine news agency

Text: Dmytro Koshovyy


 

- What are the main differences between this EFF program and the usual one? How important are the guarantees provided by individual members of the IMF, what is the mechanism for confirming them during the program and the actions of the IMF in case these guarantees are broken?

-- Ukraine’s new EFF is the first program to be approved since changes to the IMF’s Financing Assurances policy designed to enable lending under exceptionally high uncertainty including for cases of active conflict such as Ukraine. It is also important to note that, with about US$15.6 billion in size, the EFF has catalyzed substantial additional funding for Ukraine bringing the overall support package to about US$115 billion for the next four years in the baseline scenario. Moreover, the program is designed to work also in a downside scenario.

These changes allow the IMF to support Ukraine in its current circumstances of exceptionally high uncertainty in a manner consistent with the IMF’s legal and policy frameworks and with adequate safeguards for the repayment of IMF’s resources. In terms of the mechanism, at the time of the EFF approval by the IMF Executive Board, a significant group of IMF shareholders, including the G7 countries, reaffirmed their recognition of the IMF’s preferred creditor status and committed to provide adequate financial support to secure Ukraine’s ability to service all of its obligations to the Fund.

- As for the new program, there is a widespread opinion in Ukraine that it requires raising taxes and prohibits tax liberalization reform, and, therefore, restricts the economic growth or even makes it impossible. How true is that? What kind of tax reform is discussed in the paragraph on the National Revenue Strategy?

-- The short answer to your first question is that the Fund program aims to foster sustainable and robust economic growth. In Ukraine’s current circumstances, fostering economic growth depends on multiple policy instruments. One of these is tax, as efficient and fair tax policies allow redistribution of public resources to meet a country’s social and infrastructure needs, while enhancing the competitiveness by leveling the playing field for businesses. These important functions of tax policy help foster economic growth in general and specifically in Ukraine. 

Looking further ahead, Ukraine’s recovery and reconstruction will require enormous financial resources, as illustrated by the recent Damage and Needs Assessment. The international community is willing to share part of the burden, but Ukraine needs to continue to play its part by strengthening its domestic revenue mobilization to finance increasing social and infrastructure needs. For post-war Ukraine, this will be a core prerequisite for sustained and robust economic growth. It follows logically that measures that reduce tax collection or erode the existing tax base would limit Ukraine’s ability to meet its reconstruction and development goals, thus affecting negatively long-term economic growth.   

Turning now to the National Revenue Strategy (NRS): in practical terms, it will help to align revenue mobilization with government development priorities and medium-term spending needs, including reconstruction and social needs. To maintain the revenue base in the short-term, the focus will be on lifting measures introduced under Martial Law, and on reforms in tax and customs. The NRS will become a comprehensive roadmap including clear revenue and other policy targets covering both policy and administrative reforms. It will include: (i) measures to strengthen tax and customs services; (ii) a revised simplified tax regime to address the erosion of labor taxes; (iii) alignment of VAT and excise duties with the EU acquis; (iv) strengthened anti-corruption measures and governance procedures to address integrity risks; and (v) tax reforms for post-war reconstruction and investment.

- The program includes a benchmark regarding the impossibility of ad hoc changes to the budget, but before its implementation the Verkhovna Rada has already managed to adopt a law that can significantly affect the budget balance. What is your assessment of this situation, what is your advice on the process of increasing military spending if necessary, and what do you think are other additional sources of internal budget revenues or spending cuts to balance such changes?

-- Fiscal financing needs during wartime are both large and volatile. At the same time, under the EFF-supported program Ukraine aims to ensure fiscal sustainability, and predictability of budget policies that were altered during COVID and due to war. In this context, the authorities have committed to restore and strengthen Article 52 of the Budget Code, which defines and governs the framework and circumstances when the budget can be amended both on revenue and expenditure side. 

The recently adopted law that you refer to would, as I understand it, entail additional expenditures equivalent to more than $4 billion. However, it is not funded, and thus could open up a financing gap in the budget for 2023. Finding resources of this magnitude would likely imply abrupt short-term tax measures or large borrowing in domestic financial market—but such measures are in practical terms impossible without having a very negative impact on economy and financial market. Moreover, borrowing to fund such spending may further jeopardize Ukraine’s debt sustainability, which is already under pressure. This underscores the importance of solid tax policies that allow mobilizing domestic revenue and protecting the tax base from erosion. 

The war causes a significant increase in the state's share in the economy. What safeguards does the IMF offer, which of them are part of the program? How important is the part on anti-corruption and rule of law in this EFF program?

-- The role of the government in the economy during the war naturally increases and will likely remain elevated for some time given the huge spending needs on defense, social and reconstruction. The combination of very large financing needs and limited resources calls for an even stronger focus, both domestically and internationally, on transparent and efficient governance and expectations of continuous anti-corruption efforts. 

Under the EFF-supported program, the authorities have committed to safeguarding and continuing reforms to strengthen governance and anti-corruption frameworks, including through legislative changes. This area is an important part of the program. 

Overall, about one third of measures under the program conditionality explicitly relate to governance and/or anti-corruption efforts. Examples include the targeted restoration of asset declarations, and work on AML/CFT. Many measures in the fiscal and financial sectors also have a transparency and governance angle, including enhancing transparency in reporting and management of risks in public finances, strengthening public investment management, improving revenue administration, and strengthening governance in SOEs and the financial sector. 

 - One of the benchmarks of the program is the development by the end of June of a strategy for the transition to a more flexible exchange rate and easing the FX control. But business is already asking the Government and the National Bank to partially remove FX restrictions. What do you see as the prerequisites for the possible gradual removal of FX restrictions and the rejection of a fixed exchange rate?

-- First, I’d like to mention that we regularly talk to representatives of Ukrainian businesses to hear their views about the economic situation as well as their concerns. At the same time, we know that the war is still ongoing, the uncertainty is very high, unprecedented, and economic management under such circumstances is very challenging. So certain restrictions were introduced at the onset of the war to help the authorities manage the economy in an extremely challenging situation. And I’d like to say that from the first days of the war I have been in continuous contact with our counterparts at the NBU and Ministry of Finance and have been impressed how skillfully they have managed wartime economy.

Now about the benchmark you mentioned. Under the program, the authorities intend to carefully adjust foreign exchange controls to support economic recovery while maintaining exchange rate stability and national security. The NBU, in consultation with the IMF staff, is currently preparing a conditions-based strategy to move to a more flexible exchange rate, ease foreign exchange controls and transition back to the inflation targeting framework. This strategy will help establish and assess the prerequisites for such a move and guide the policy measures needed to support this transition. The NBU has a professional and experienced team to implement the needed measures in due course, and the IMF staff stand ready to help with advice and technical assistance as needed. 

- The negative scenario in the program is described in sufficient detail, while the positive one is very brief. Why? How often is it planned to review the macro scenarios for program calibration, including when can it be done for the first time?

-- We call the scenarios downside and upside scenarios. The detailed discussion of the downside scenario is a required feature of this EFF arrangement. The program has been designed to resolve Ukraine’s balance of payments problem and restore medium-term external viability in both a baseline and downside scenario, and financing assurances to support debt sustainability are provided also for both baseline and downside scenarios. These are requirements under the Fund’s policy on lending under exceptionally high uncertainty.

Regarding the upside scenario, we recognize in our assessment that Ukraine’s economic outlook could be more favorable than expected should there be a swifter cessation of hostilities. To illustrate this upside risk, we discuss a scenario that involves a more pronounced reconstruction effort and stronger reform implementation. And, of course, we all hope for better economic outlook.

Fund programs are assessed through regular reviews, which involve IMF staff updating its macroeconomic forecasts and frameworks based on the most recent data and developments as well as policy discussions with the authorities. In this case we have planned high frequency reviews: one in the summer and one in the fall.

- Could you comment on the need to add quantitative performance criteria (QPC) to the program, such as the floor on social spending and the floor on nominal tax revenues?

-- These targets are designed to help the authorities, in particular Ministry of Finance, to manage the fiscal accounts under extremely difficult circumstances of scarce resources and growing spending needs. A floor on social spending (indicative target under the program) is established to ensure that social spending is safeguarded in times when the authorities have had no alternative but to streamline most of the non-defense spending. 

Tax revenues are subject to several risks stemming from the war, as well as potential policy choices that could erode the tax base. A floor on nominal tax revenues (quantitative performance criteria under the program) is a measure to protect tax revenues that are embedded in 2023 budget, including through adoption of legal amendments that should help mobilize projected revenues. This quantitative target will help safeguarding revenues from measures eroding tax base. In the short-term this may help alleviate financing constraints while supporting reconstruction and social spending in medium-term. I’d like to add that the Ministry of Finance has a particularly challenging task in managing a wartime economy. What I have seen at the Ministry is a team of dedicated professionals working hard to achieve the program objectives, and our experts stand ready to help in this by providing policy advice and capacity development as needed.

- Energy Sector. In this program, much less attention is paid to this sector than in the previous ones, the issue of tariffs approximation to the market level is absent at the first stage of the program. At the same time, if I understand correctly, there is a 60 billion UAH limit on PSO compensation to the state energy companies from the budget, but, according to the companies, the deficit is already measured in hundreds of billion UAH. How dangerous, in your opinion, is the situation in the energy sector with regards to quasi-fiscal risks and what can be the solution?

-- Energy sector reforms and measures have indeed featured prominently in several previous Fund programs. The EFF-supported program will also keep this important area in focus, but major reform measures are expected to take shape in the second phase of the program, once the war winds down. The authorities have expressed a commitment to implementing a timely and ambitious reform agenda aimed at tackling the longstanding structural challenges in the energy sector that have been compounded by the war. They are cognizant that this will involve restoring and enhancing competition in wholesale and retail gas markets. Furthermore, ensuring sustainability of the system and reducing quasi-fiscal liabilities will necessitate a gradual increase in energy tariffs to cost recovery. At the same time, it will be important to allocate adequate and well-targeted resources to protect vulnerable households.

Regarding the UAH 60 billion number, I’d like to clarify that it is not a rigid cap which would limit the authorities' ability to use public money to import gas if an acute need arose. This number should be viewed as an adjustor to the fiscal balance target that would give the authorities space to accommodate potential spending pressures including from gas purchases or PSO compensation, but conditional upon availability of financing.

 

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