Ukraine’s IMF Program Sets Stage for Debt Restructuring

The IMF yesterday approved a four-year, $17.5 billion arrangement for Ukraine, their contribution to a $40 billion financing gap that they have identified over that period. A further $15 billion is to come from a restructuring of private debt, with formal negotiations expected to begin soon. The rest is expected to come from governments and other multilateral agencies. An ambitious array of reforms—including to fiscal and energy policy, bank reform, and strengthening the rule of law—are laid out, signaling a dramatic break from past governments. These measures are expected to set the stage for recovery: output falls 5 ½ percent this year before 2 percent growth returns in 2016, inflation will average 27 percent this year and then decline, while the current account deficit falls to 1 ½ percent and the currency stabilizes around current levels. Public sector debt will peak at 94 percent of GDP in 2015 as the program takes hold. All this depends on an end to the current hostilities, which as the IMF notes remains a considerable risk to the program.

These numbers have little meaning. The odds of this program surviving intact for four years, or even through the end of 2015, are not much higher than for the original 2014 program which was junked yesterday. Private forecasters predict a deeper recession (as much as a 10 percent decline this year and a further fall next year). Consider the IMF’s program a vision for where it would like to see Ukraine go, and focus on the cash flows that Ukraine will get in 2015 and the near term policy reforms they will need to implement to receive the money (many of which were passed recently by the parliament). From that perspective, yesterday’s deal provides critical near-term financial support, but is not enough to grow the economy while the war continues.

The judgment that the program will not last is not a rejection of the effort. The Fund deserves a great deal of credit for getting the program to the finish line in extraordinarily difficult conditions, and the $5 billion first disbursement from the Fund provides critical cash to the budget ($2.7 billion, with the remainder going to bolster international reserves), and should catalyze other official money. Ukraine can expect an additional $5 billion of IMF money in three equal tranches if the program stays on track through 2015, as well as $6.3 billion in other official funding.

IMF Board approval triggers the start of negotiations with Ukraine’s private creditors on a debt restructuring. The IMF has set a target of $15 billion for the operation in cash flow relief over the four years. There are a lot of ways to get to that number, and the Fund is purposely vague on what it is looking for. The public debate has focused on whether the deal will be a “reprofiling” (a moderate extension of maturities with little or no cut in interest rates, a sort of stand-still to keep creditors engaged until uncertainty is resolved) or a deep restructuring. The outcome is likely to be somewhere in between, with substantial interest rate cuts (at least for the first few years) required to meet the Fund’s target. That means substantial uncertainty will persist about whether further debt reduction will be needed, a problem for a program that optimistically assumes a return to markets by Ukraine in the next three years.

Publicly, the negotiations will be left to Ukraine, its financial advisors, and its private creditors. But don’t be surprised to see that the IMF and the major creditor governments call the shots in these negotiations, and the Fund’s next disbursement scheduled for June is dependent on the expected conclusion of a successful debt operation with high participation.

The report is more realistic in a number of respects than the program it replaced. I have been quite critical of the Fund for its rosy economic and political assumptions, and its view that the program had a “high probability” of success, all of which contributed to the underfunding of Ukraine over the past year. Such optimism was driven more by the Fund’s internal rules for lending than a clear-eyed assessment of the situation. Instead, this time the Fund acknowledges “exceptional risks” and IMF Managing Director Christine Lagarde simply suggests that “with continued firm implementation, there is a reasonably strong prospect of success.” Perhaps we have a new standard for Fund programs in the future.