Young job seeker is interviewed at a job fair in Barcelona. Spain's youth unemployment remains among the highest in the European Union. (Photo: Gustau Nacarino/Reuters/Newscom)


IMF Survey: IMF Urges Ukraine To Stick With Recovery Policies

November 4, 2009

  • IMF says Ukraine has stabilized difficult economic situation
  • Presses policymakers to avoid actions that could undermine recovery
  • Says all authorities in Ukraine need to work together

The IMF is urging Ukrainian policymakers to try to forge a consensus to support economic recovery and avoid measures that would fuel inflation and unemployment.

IMF Urges Ukraine To Stick With Recovery Policies

Metalworker at a steel plant in Ukraine, which has overcome the worst of the crisis but now faces new challenges (photo: Alexander Khudoteply/AFP)

Ukraine Stand-By Arrangement

An IMF Mission recently returned from Kyiv after discussions with the authorities on the third review under Ukraine’s $16.4 billion Stand-By Arrangement with the Fund. The IMF Survey magazine spoke with Mission Chief Ceyla Pazarbasioglu about the trip and the outcome of discussions.

IMF Survey online: What is the current status of the Ukrainian program?

Pazarbasioglu: Ukraine’s economic program—which the Fund has been supporting since last year—has managed to stabilize an extremely difficult economic situation. This stability is critical for the well-being of the Ukrainian people. However, our recent mission to Ukraine found that policies in some areas, including the submission of an expansionary 2010 budget and the new social standards law, threaten these gains. So we are concerned.

We stand ready to continue our help, of course, should Ukraine choose to go on with the program and implement the policies needed now to build on the early gains. But there is serious disagreement among the authorities on how to proceed. We hope that they can shortly reach consensus—even with a looming election—in the interests of a stable and strong Ukraine economy.

IMF Survey online: How has Ukraine's economy performed under the economic program that was supported by the Fund?

Pazarbasioglu: The program has helped the country to overcome the worst of the crisis, while protecting social stability. This is critical. Remember, the situation in Ukraine was grave. The economy was in freefall. Real GDP fell by 20 percent in the first quarter of this year. Indeed, Ukraine was one of the hardest hit among the countries affected by the global crisis, with the deepest drop in output and sharpest decline in the exchange rate. This largely reflected the vulnerable state of the economy at the onset of the global crisis. The program aimed to address key problems immediately. In many ways it has succeeded, so that credit goes to the authorities’ policies.

IMF Survey online: What did the economic program achieve so far?

Pazarbasioglu: Just look at the latest trends. The contraction in industrial output and retail sales slowed down in August, and production has already started to pick up, albeit from a very depressed level. At the same time, inflation has fallen, risks to the banking sector have been reduced, and the exchange rate has steadied.

Ukraine still has a long way to go, of course, which is why it is crucial to continue with sound policies. In particular, the deep recession has created large pressures on the public finances—something that needs to be watched closely so that recovery is not threatened.

IMF Survey online: Is the IMF opposed to wage and pension increases in Ukraine?

Pazarbasioglu: Protecting the poor, the unemployed, and the most vulnerable is a priority for us. In Ukraine, protecting wages and pensions has been particularly important. A sizable part of our funding has been directed toward ensuring timely payment of wages and pensions by the government.

But we need to face reality—the availability of financing places clear limits on spending increases. In 2010, the government committed to raise wages and pensions in line with expected inflation. This would imply a 10 percent increase.

The IMF supports this increase: it balances the need to protect purchasing power against the need to live within financing constraints. A larger increase cannot be financed without resorting to inflation or significant downsizing of the public sector workforce. Ukraine’s inflation is already among the highest in the world. Higher inflation hurts everyone. But it is particularly painful for those on low incomes. To really protect the poor, we need to preserve the gains already made. That means keeping the sound policies on track.

IMF Survey online: Why are you so concerned about the social standards law that was recently passed?

Pazarbasioglu: As I said, it is simply not possible to increase wages and pensions too rapidly without leading to higher unemployment or higher inflation. This is a high price to pay, especially for the poor.

If the social standards law is implemented as voted, it could cost as much as 7 percent of GDP in 2010, which is totally unsustainable. Even with a change in the law as suggested by the President—which would limit indexation to low-wage workers—we estimate a cost of as much as 2½ percent of GDP, a very large addition to Ukraine’s budget deficit. However you calculate it, the country simply cannot afford this.

The measure would be counter-productive, as a soaring budget deficit would threaten economic stability and the poor and vulnerable will end up paying the price. We therefore have communicated to the President that the Ukrainian authorities need to stick with their earlier commitments in this area.

IMF Survey online: Is modifying the 2010 draft budget part of what needs to be done?

Pazarbasioglu: Yes, the Government has submitted a draft 2010 budget that would lead to a deficit of almost 8 percent of GDP, far above program commitments. In addition to pushing up interest rates, a deficit of this size would be very difficult to finance without resorting to inflation. Measures to reduce this are under discussion, but require consensus.

IMF Survey online: What about monetary policy? The hryvnia has come under renewed pressure recently.

Pazarbasioglu: Further improving the functioning of the foreign exchange market should remain a priority for the National Bank of Ukraine (NBU). As agreed, the discrepancy between the official exchange rate and the interbank rate will be further limited, to reduce the distortions that arise from parallel exchange rates.

Reducing the excess liquidity in the banking system is key to stem exchange rate pressures. Raising interest rates on NBU certificate of deposits—currently highly negative in real terms—would be an important step in this regard.

IMF Survey online: What is the biggest obstacle to the implementation of the economic program?

Pazarbasioglu: One word—ownership. For any economic program to be successful, there must be a minimum level of consensus. When the economic program was designed a year ago, there was a broad consensus in Ukraine on the underlying policies. All branches of executive authority, civil society, and even the opposition expressed strong support for this program. The severity of the situation had the effect of really focusing minds on what needed to be done.

But the pressure of events and political developments means that consensus is now much harder to achieve. Without this, progress will stall, the recovery could be jeopardized, and people may lose confidence in the ability of policymakers to improve the economy.

IMF Survey online: What are the risks and challenges for Ukraine’s economy in the coming months?

Pazarbasioglu: Of course, a lot depends on the global economy. But domestic factors are as important. To sum up: Ukraine is still in a highly fragile position. The policies under the program have stopped the bleeding, but recovery will take a long time. Lingering uncertainty is damaging for confidence and could derail recovery.

We do believe that the policy measures pledged by the authorities under the program are the right ones to secure Ukraine’s economic recovery, and improve the living standards of the Ukrainian people. But the new budget and social standards law threaten the gains made so far: they cannot be financed without higher inflation or unemployment.

The success of any program depends critically on ownership—getting the appropriate degree of buy-in for the difficult decisions that may need to be taken. The hopes for recovery for the Ukrainian people should not be undermined by policy uncertainty ahead of January’s election. Against this background, the leadership of all authorities is needed. We stand ready to support them.

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