David Lipton, IMF: Ukraine risks reversing

Ukraine has never been so far - over the past two years, the country has received four tranches of lending 8.7 billion dollars total from the IMF.

From 1994 to 2013, Ukraine participated in five programs of an international creditor, but none was completed. Each time Ukrainian authorities received several tranches in the beginning, and it all ended, because the authorities did not want or were not able to fulfill their obligations.

Despite some delays in providing funds, the latest Extended Funding Program (EFF) is still operational. However, the next - the fifth tranche - Ukraine risks not getting.

Key issues are pension reform, steps to accelerate privatization, concrete results in the fight against corruption. Only after completing this "homework", government will be able to rely on the next tranche of the Fund.

In general, there are great doubts whether the current authorities need cooperation with an international creditor. Two years ago, when this program only started to work, the country was in a difficult situation: the war, the rapid drop in GDP, devaluation of the hryvnia and high inflation. The situation is now stabilizing, and the exit from the program does not seem so risky.

Can Ukraine count on the next tranche, what is important for the IMF now, and what is wrong with the Ukrainian reforms – those are the matters the UP have discussed with the IMF's first deputy chairman David Lipton, who came to Ukraine with an important mission.

— What brings you to Ukraine this time?

— The reason for my visit now is to get an update on the economic situation in Ukraine and the progress of reforms. I came at the time when we are preparing the next World Economic Outlook – our fresh assessment of the global economy, which is very relevant for Ukraine.

We also discussed the progress of reform program, supported by the IMF. There have been some delays in this program. At the same time, it's a critical moment for Ukraine to move forward with the reform agenda.

— What can you say about World Economic Outlook? I know it will be announced in October, but can you tell us more now? What is the projection of economic growth?

—  The global economy is strengthening, and recovery is gathering momentum. And this recovery is becoming very broad-based. Most advanced economies and most emerging market countries are in recovery. Europe is also recovering.

All of that creates an opportunity for countries around the world to lift each other's economies and to  take advantage of stronger demand. But this recovery is not only led by consumption, but also investment, which is very trade and import intensive. It's for the first time since the global financial crisis that we see investment growing faster than GDP in the world.

All of that creates an opportunity for countries to export more and to increase growth further. Countries around the world are going to be judged in the future by how they took advantage of this opportunity – whether they address existing problems to grow faster, or whether they simply decide to take advantage of better conditions to relax on reforms.

This particularly applies to Ukraine. It obviously has a significant opportunity stemming from the strengthening of the global economy, from the strengthening of the European economy. Ukraine has done a very good job of stabilizing the situation in the last few years. The authorities and people of Ukraine deserve credit for having achieved that.

— What about further growth?

— Stabilization should set the stage for a resumption of rapid growth – Ukraine clearly has an opportunity to transition from stabilization to growth. You could of course argue that the economy of Ukraine is growing already. But the country needs much more rapid growth to catch up with its European peers.

More rapid growth depends on carrying reforms forward, not on pausing them. It depends on maintaining the progress that has already been achieved, rather than taking steps that would undo or reverse reforms. That's why this moment is critical.

If you look at the history of Ukraine, it has been here before: it has had problems, reacted to them by stabilizing the situation, but what was never done is to continue to push forward and become a dynamic country with sustained growth. Ukraine always allowed for pausing and interrupting reforms. In consequence, while most of the region was driving forward, Ukraine was drifting back.

— When should we expect the next tranche?

—  It's too soon to make any predictions about that. First, we need to see the reforms that are needed for this review to be implemented. Ultimately, it’s the IMF’s Executive Board that must be convinced that Ukraine is progressing with the reform agenda.

— How do you rate the implementation of the current program? There are rumors that you are not happy with it...

— Let's take a big picture: Ukraine has done a giant job of stabilization: bringing the budget under control, dealing with the deficits of the gas system, restoring competitiveness, or dealing with the problems in the banking system. These are all very important accomplishments that put Ukraine on the path toward sustained growth. But there are risks of going backwards.

Wage growth in the public sector and some parts of the private sector have been very high compared to inflation. If this situation is maintained, it will erase profitability and competitiveness, and ultimately threaten to put Ukraine where it was three years ago, unable to compete internationally. Similarly, many initiatives could raise the budget deficit and endanger the stability.

On the path toward a sustained rapid growth Ukraine also has to make steps forward as planned. For example, the pension reform is very important to all people. It makes no sense for Ukrainians to retire at earlier age, while the pensions are so small that they cannot provide deсent, stable living. There is a need to address that through the pension reform.

— There are various other important reforms. Improving the government, state-owned enterprises, land reform, continuing of cleaning of the banking system…

— If all these things move forward, including fulfilling the commitment on anti-corruption court, Ukraine has good prospects for more rapidly growing economy, and seeing living standards converge to advanced economies. Ukraine is way behind in the convergence process when compared with many of its neighbors. It’s important not to rest because growth is positive and because global recovery makes it easier. Ukraine needs to press ahead to improve the situation in the future.

The focus of this review is on pension reform, and on measures to speed up privatization and ensure concrete results in anticorruption efforts. It is equally important that the fiscal and energy sector policies remain consistent with program commitments.

— The Prime Minister of Ukraine has refused the idea of increases in gas prices from October 1. It wasn't agreed with IMF and you seem to have been against this. Are you now ready to accept that?

— The decision to de-politicize the process through the automatic formula is critical and we expect the government to stick to this commitment. Allowing for automatic increases in gas tariffs in line with market developments was one of the major achievements of this reform program. It is important to let gas prices be determined by market developments and avoid the re-emergence of untargeted implicit subsidies.

Poorest households are shielded from the increases by utility subsidies. For others, there were broad wage increases that are much higher than the gas price increase foreseen by the by-law. Gas prices in Ukraine are very low compared to its peers.

And finally, if Ukraine wants to dream about energy independence, it must invest in the infrastructure, which is only possible if gas prices reflect market development.

— Deputies have defended the idea of "The pension reform of the government plus the old-age pension saving scheme from 2019". The change was proposed by the parliamentary committee. Is the option of retirement saving system with fully funded pillar acceptable? Formerly IMF was against this.

—  There is a government’s proposal for pension reform that was discussed with IMF team, and we have agreed with the government on several principal objectives for the reform, such us decent pension level or later retirement. We need to understand where the legislative process is going.

— Land reform. What is the decision?

— Land reform remains an important element of the program. What was agreed is that more time is needed to get the right decision on this important topic.

For the last quarter of the century I’m being told by various politicians that land reform in Ukraine is impossible. It is true that it takes time and benefits come over time. But it shouldn't take 25 years!

We see the revival of agriculture, which is clearly among Ukraine’s strengths. Even agriculture that had been oriented on export to Russia has been very effectively reoriented toward the West. And this potential is far greater. It is important that there are incentives to invest in agriculture, which means that land should be available for the use as collateral when raising investment capital. Equally important is that farmers have the certainty of access to land over time, so that they are farming the land sustainably.

The reform can be done in different ways, and there are different models and examples from different countries. What’s important is that there is land reform rather than no land reform. This is not a requirement for the next program review.

But the idea that Ukraine should go another long period without land reform is very counter-productive. Ukraine must and can find a way for a public debate and consensus to get past rejection, shelving and blocking the reform. Again, it's important to act rather than not act.

—  Anti-corruption reform.  Anti-corruption chambers vs anti-corruption courts? Will these chambers ensure the quality of the reform?

—  Anti-corruption requires a very comprehensive approach, something that can’t be done by a single institution. One needs strong prosecution, right judges, enforcement of judgements. It’s not a simple process. NABU was an important accomplishment. We certainly agree that the creation of an anti-corruption court is an important next step. We encourage the government to do that.

—  Budget 2018. Is it balanced enough from the IMF point of view?

— We didn’t have the opportunity to go into the details, as the proposal hasn’t been endorsed by the cabinet yet. Of course, it is important that the budget remains consistent with the program commitments. We’ll have a close look at it once there is a draft.

 — You were talking about cleaning the bank system. And we know IMF has very good opinion of the former central bank governor. Who will be the best candidate, what are the requirements for the head of the central bank now?

—  Valeriya Gontareva has done an excellent titanic job, improving the efficiency of the central bank as an institution, improving the monetary and exchange rate policy, addressing banks with serious problems, including the need to nationalize, like Privat. And this was done during difficult times!

But there are still many challenges, and as I said in my meeting with NBU management, for a good central bank the work is never done. It's important for the next governor to have the capability to carry on the work of the central bank independently, to set monetary and exchange rate policy and to preserve the health of banking system.

So, we have views about the job requirements, but not about the job applicants.

— One of the biggest challenges for our central bank was the nationalization of PrivatBank. Was it effective?

—  Unfortunately, PrivatBank had posed a risk to the whole banking system in Ukraine: it became effectively insolvent, while being the largest commercial bank in Ukraine. It was critical to ensure that bank’s operations continue without interruption, and  it was successfully achieved.

The question of the resolving some of the legacy problems is in the hands of the government. These tend to be complex economic and legal issues, but they should be sorted out over time.