Sovereign Analysis /

Ukraine: Notes from virtual IMF Spring meetings

  • Little tangible progress to report on the status of the ongoing IMF first review

  • Four broad areas of focus for the review remain the same, namely the NBU, fiscal, energy, anti corruption and judiciary

  • Timing for completing the review still uncertain, although short-term financing picture is manageable; maintain Hold

Ukraine: Notes from virtual IMF Spring meetings
Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
16 April 2021
Published byTellimer Research

We set out our thoughts on Ukraine following our discussions with the IMF team during the recent virtual IMF/WB Spring Meetings. We would like to thank IMF staff for their time. The views we set out here are our own. We retain our Hold recommendation on the US$ bonds, with a yield of 7.2% (z-spread 572bps) on the 2032s on a mid-price basis as of cob 15 April on Bloomberg.

There seems little tangible progress to report on the status of the IMF review at the Spring Meetings after the Fund announced in February that it had put the first review of the SBA on pause. Discussions continue at all levels, and remain constructive, and these are set to continue until they can find a resolution, at which point the Fund can proceed with the review. But the issues are difficult; it is hard to build political and popular support for them.

That said, the recent build-up of Russian military forces on Ukraine’s borders and in illegally occupied Crimea may have overshadowed the programme discussions, shifting investor attention and opening up another area of uncertainty, although it is too early to say what the impact will be.

Programme issues

The four broad areas of focus in this review remain the same as they were at the time of the virtual Annual Meetings in October; namely: i) the central bank (NBU), ii) fiscal, iii) energy, iv) anti corruption and judiciary.

We discuss the issues within each one below (for background, see also here):

  1. NBU. This includes legislation on the Deposit Guarantee Fund (DGF), and governance issues within the NBU, which is maybe a catch-all for “central bank independence”. On the latter, one issue to be addressed concerns legislation to clarify the role of the NBU Council vs that of the NBU Board, as the Council (the NBU’s supervisory body) has indicated its ambitions to become more involved in operational decisions on monetary and financial sector policy.

  2. Fiscal. The discussion is about when to reduce the deficit, the pace of consolidation and the mix of measures. It distinguishes the short-term (2021) from the medium-term outlook (2022 and beyond). Regarding 2021, Q1 performance was encouraging due in part to good revenue collection, although this needs to be monitored due to risks from underbudgeting of utility subsidies and more Covid-related measures (eg health spending and financial support for households and companies). Over the medium term, the focus is on bringing the overall deficit to a sustainable position. This means returning the consolidated deficit to pre-Covid levels, of around 2.2-2.5% of GDP, compared to the budget and programme target of 5.3% this year and the 2020 outturn of 6.2% (2020 was a little wider than the 5.5% expected by the IMF last year as the government was able to mobilise more domestic financing), and an intermediary target of 3.5% in 2022. The 2.2-2.5% target is consistent with a cyclically neutral position, implying a primary surplus that will reduce public debt. Staff are discussing with the authorities the revenue and expenditure measures to achieve this. And while Covid looks challenging (the surge in cases in a second wave shows signs of easing, although Kiev’s lockdown measures have recently been extended to end-April and the vaccination roll out is still at an early stage – covering 377,000 (0.9%) of the population), there is no compelling argument to loosen fiscal targets this year.

  3. Energy – two areas: gas and electricity

    i) On gas, the objective is clear, to establish a fully functioning wholesale and retail market, moving from price control to an open and competitive market at the retail level, with support for poor households. While the reimposition of a price cap in January was a set back (it implied a 30% cut in the average price of households according to reports), it was lifted at the end of March (although it continues at UAH6.99 per cubic metre at Naftogas). Discussions continue on what a market-based solution is going to look like, including how much regulation there will be of retail suppliers, as it also highlighted shortcomings in the gas market through market concentration at a regional level, with monopolistic behaviour and risks of market abuse.

    ii) In the electricity sector, the accumulation of large financial imbalances pose risks to taxpayers. The sources of these imbalances need to be addressed.

  4. Anti corruption and judiciary. Two key areas: on NABU (the Anti-corruption framework) and on the HCJ (judiciary)

    i) The first area is dealing with the constitutional court (CC) ruling in September against the National Anti-Corruption Bureau (NABU), that the previous president did not have constitutional powers to appoint the director and establish the agency. This raises three sub-issues: a) the proposal is to move the bureau to the Cabinet, with a new procedure for appointing the director, but it is important that the criteria for dismissing the director are set out clearly in legislation, so that the director cannot by dismissed by parliament on a whim. b) the IMF are also of the view that the process for appointing the director should give a decisive role to independent experts with international experience (the IMF had insisted on this in the HACC too). This requires looking at the composition of the nominating committee and voting arrangements; there is no agreement on this as yet. c) there is also a question about what happens to the existing director. The CC ruling did not appear to question the legitimacy of the director, just that the president did not have the constitutional power to make the appointment, although any legal ambiguity needs to be addressed in order to reduce risks of any future challenge to its decisions.

    ii) The second area is ensuring the integrity of the High Council of Justice (HCJ), the judiciary body responsible for disciplinary cases against judges. The IMF focus is on the integrity assessment of members of the HCJ, both existing ones and new or proposed ones. The issue here is the composition of the integrity council. The IMF view is that independent members with international experience should have a decisive role (same as for NABU and HACC). This is the Fund’s priority amongst the Venice Commission’s longer list of recommendations for judicial reform.

    Crucially, in both these areas (NABU and HCJ), legislation is necessary, which Staff are discussing with their counterparts. But some very fundamental issues remain unresolved.


Timing for completion of the review is therefore still unclear to us. The government remains optimistic, with reports suggesting that relevant legislation could be passed in coming weeks (as always), and that it expects two disbursements this year (we assume, US$0.7bn each), or even implying that reviews could be merged (ie combining the first and second). But this sounds optimistic.

While we do think things could move pretty quickly when ready, it still seems some way off. Energy and the judiciary are particularly challenging. Market expectations may therefore slip from Q2 to Q3, if they haven’t already. The programme is also due to expire in December, so time is also now beginning to run out. But it is premature to talk about what happens then and any extension or successor arrangement.

Economic developments

The economy surprised on the upside last year with not-as-deep a contraction as expected. Real GDP fell by only 4% (on official figures) compared to initial expectations of -7.4% (April 2020 WEO). This was due to the better-than-expected performance of the household sector and stronger net external demand. It also provides a bit of momentum coming into this year, with the IMF revising upwards its 2021 growth forecast by c1ppts from its October WEO to 4% in the latest WEO, although this only brings the Fund more in-line with the NBU’s forecast of 4.2% and the Bloomberg consensus of 4.4%. However, Covid restrictions and the slow vaccine roll out could weigh on the economy.

The central bank embarked on the beginning of a tightening cycle last month, responding to inflation rising above its target and higher inflation expectations. The NBU raised its policy rate by 50bps to 6.5% on 4 March, as CPI inflation rose to 7.5% yoy in February from 6.1% in January (since the Spring Meetings, the NBU hiked rates again on 15 April by 100bps to 7.5% as inflation rose further in March to 8.5%). But real rates are still negative.

The current account balance is expected to see a big swing this year, from a surplus of 4.3% of GDP in 2020 to a deficit of a 2.5% in 2021 (based on latest WEO projections). However this shouldn’t be a surprise, as the same kind of move was expected in the October WEO. International reserves have eased a bit this year, to US$27.0bn (end-March) compared to US$28.8bn at end-January, but remain strong, while the hryvnia (UAH) has depreciated modestly since mid-March modestly, reversing some of its earlier strength this year.

Implications for financing

There are opposing forces. Despite delays to completing the review, the short-term financing picture seems reasonably manageable. Reserves remain healthy, eurobond yields suggest Ukraine still has market access at generally favourable rates (and the government recognises this), and an SDR allocation amounts to a potential windfall of US$2.7bn (subject to IMF Board approval, although it isn’t expected to hit the NBU balance sheet until August). This may provide a bit of respite, although investors may also be concerned that the SDR allocation – and market access – may reduce the authorities’ incentive to press ahead with what is required to complete the IMF review.

However, overall public sector gross financing needs (GFN) remain large, becoming heavier in the second half. The government’s financing programme projects GFN this year at US$23.7bn (similar to last year), and relies on IFI financing (with access to Fund disbursements unlocking other IFI money) and market access, through a combination of eurobonds, local currency issuance and non-resident inflows. It targets US$6.2bn from external markets and US$17.1bn (equivalent) from domestic markets.

Hence, continuing delays to the IMF review may complicate the financing outlook. We think the external target may be difficult to achieve if the IMF review continues to be delayed, holding up Fund disbursements and other multilateral funding behind it, and potentially with implications for market access. We think the government may have anticipated US$2-3bn from official money this year, plus a contribution from eurobonds (eurobond issuance did amount to US$4bn last year). But even with still favourable yields, Ukraine hasn’t issued since July, after the programme was agreed, only succeeding with a small tap in December, while this year’s market volatility shows market access cannot always be relied upon – Ukraine yields ('31s) are up c100bps this year. It is not clear how the authorities will cover any external shortfall. Meanwhile, the domestic funding target may also be challenging. The government funding target already anticipates a 25% increase in domestic financing this year compared to what was already a bumper 2020. Any external funding shortfall that sees a substitution towards domestic funding may put even more pressure on domestic sources and upward pressure on domestic yields.

Implications of the Russia situation

Russia's recent escalation of tensions presents another more imminent source of concern for bondholders. On the one hand, it increases perceptions of Ukraine country risk, even if it doesn’t lead to outright war. Ukraine ‘32 yields seemed to rise about 40bps in reaction to the news (perhaps a mild response in itself). It might also weaken the currency and knock non-resident inflows into the government debt market, on which the government’s domestic funding target partly depends.

But on the other, the rallying of international support for Ukraine may lead to more optimism about donor support, although we are not sure it weakens IMF lending conditions. Indeed, yields have fallen since the IMF meetings, with the bonds reversing their losses this month, buoyed also by positive news this week about a possible Biden-Putin Summit.

Yield on Ukraine 2032 US$ bond (%)