IMF in Ukraine: shock therapy in times of armed conflict

Thursday 10 December 2015, by Tiago Stichelmans

Ukraine has been forced by the IMF to adopt extremely harsh austerity measures in order to pay back its lenders.

Last week, the IMF announced that the disbursement of the third tranche, or portion, of the IMF programme in Ukraine was dependent on the adoption by Ukrainian authorities of the 2016 budget and a tax reform agreed as part of the IMF bailout. This budget must contain austerity measures additional to previous ones imposed by the IMF in a country suffering from political and security instability.

Despite the unstable political situation in Kiev and the armed conflict in the east of the country, Ukraine had numerous conditions imposed as part of a 17.5 billion dollar IMF-led bailout programme last year. This programme contains conditions, categorised as either prior actions - measures to be adopted before the programme takes place - or structural benchmarks - measures to be adopted during the programme in order to receive the different tranches.

The economic situation of Ukraine is worrisome, which poses the question of the timing of adopting conditions that will impact the Ukrainian population. While the World Bank expects a 12% contraction of the economy in 2015, the programme the authorities signed with the IMF demands a very ambitious reduction of public deficit of 3.75% of Gross Domestic Product (GDP) in 2016 while the budget deficit (including the Ukrainian gas company Naftogaz deficit) in 2014 reached 10.3%. Reducing the budget deficit as measured in percentage of GDP while the economy is in recession implies even greater efforts.

The conditions attached to the programme aim to reach this target in addition to drastic socioeconomic reforms to the economy. The overall programme recalls older shock therapy imposed on Ukraine when it desperately needed a bailout from the IMF. The reforms include a VAT increase in the agricultural sector, increased taxation of natural resources, an education reform that requires closure of 5% of schools, redundancies in the public administration, the adoption of a deregulation plan, and a restructuring and privatisation plan for State Owned Enterprises (SOEs), plus cuts in energy subsidies and an increase in court fees.

The IMF continues to call for further pension reform despite measures already adopted throughout the year. The 2015 budget made savings in pension expenditures by freezing them (delay of indexation despite the 46% inflation), by reducing special pensions and by tightening eligibility for early retirement. The government will now have to adopt reforms to reduce expenditure on pensions measured in per cent of GDP, as it currently represents 18% of GDP. According to the letter of intent presented by the Ukrainian authorities to the IMF, this will be done through the termination of special pensions, and further tightening of early retirement options.

Regarding the privatisation of state-owned enterprises (SOEs), the government was forced by its creditors to establish a list of 350 state entities subject to privatisations in 2015 and a privatisation strategy for ten SOEs. Ukrainian energy companies are particularly targeted by this privatisation strategy. Ukraine had already privatised several energy companies in the last couple of years. Four of those privatisations are now challenged in court. The urgent need for liquidity justified those privatisations that brought strategic assets into the hands of oligarchs who managed to make a bargain out of an unstable political situation. If Ukraine is forced to rush into privatisation again, it might be forced to sell pubic assets in a weak bargaining position. And to make matters worse, the IMF programme forced the government to cut energy subsidies and increase energy prices by between 240% and 425% over the next four years!

While the Ukrainian population is shouldering the burden of adjustment, Ukraine’s creditors are well off. The IMF lauded that “Ukraine at the moment remains current on all its debt.” In a recent debt restructuring negotiation, they accepted only a minimal and rather symbolic haircut. Each euro from the public budget that Ukraine is paying to creditors is increasing the burden of fiscal adjustment for Ukrainian citizens.

This summer, the UN adopted new debt restructuring principles that clearly state economic and social costs must be minimised, and human rights must be respected. But rather than reforming in that direction, the Ukrainian case inspired the IMF to reform its ‘lending into arrears’ policy, to scrap the rule that the IMF cannot lend to countries that have payment arrears to official creditors. This done, the IMF can load even more debt on a bankrupt country, without requiring that its creditors share the burden and write off their loans.