The announcement of a staff-level agreement for a Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) supports Ukraine's credit profile, Fitch Ratings says. It increases the likelihood of the sovereign gaining access to external financing. It may also spur structural reforms that reduce imbalances and address Ukraine's twin deficits.
However, there are significant risks to implementing the programme in light of the continuing geopolitical risk in the region and the possibility of a further escalation of the crisis, and the domestic political and economic situation following the fall of Viktor Yanukovych's government and the the incorporation of Crimea into the Russian Federation. Failure to take unpopular measures has seen previous IMF agreements suspended, and structural reform will be a long-term process.
The scale of the challenges facing Ukraine is reflected in Fitch's 'CCC' foreign-currency sovereign rating, which denotes substantial credit risk.
The IMF said on Thursday, March 27, that the two-year SBA will be worth USD14bn-18bn, depending on other bilateral and multilateral support. Ultimately the programme will unlock USD27bn of support from the broader international community over the next two years, the IMF said. Consideration by the Executive Board is expected in April, and if approved, the first disbursements could happen as early as next month.
Ukraine faces heavy external funding needs this year, and IMF disbursements on this timescale would reduce the risk that sizeable repayments due in May and June put further pressure on reserves (which stabilised in the second half of February but remain low), especially if it prompted other lenders to accelerate their programmes (the EU has said it would provide EUR1.6bn of emergency aid if an IMF deal were agreed, for example), Fitch believes.
The Ukrainian authorities will have to adopt a comprehensive package of prior actions before this happens. These include expenditure-led fiscal adjustment (albeit "at a pace commensurate with the speed of economic recovery and protecting the vulnerable," according to the IMF) that will reduce the fiscal deficit to around 2.5% of GDP by 2016, and moving retail gas and heating tariffs to full cost recovery.
The current Ukrainian coalition government had said it would accept any IMF conditions, such was the importance of the deal in filling the fiscal gap. Dates have already been set for initial gas price increases, and the Ukrainian parliament (where the coalition has a 50-seat majority) approved amendments to the 2014 Budget broadly consistent with the IMF's requirements on Thursday.
But political and execution risk remain high. Preparations for May's presidential elections may be a distraction, and the proximity of elections creates policy uncertainty given the fragmented nature of the anti-Yanukovych grouping of opposition parties from which the leading candidates will be drawn (although it is also likely that they will be broadly favourable to cooperation with the IMF).
The long-delayed fiscal and external adjustment now being demanded also poses a challenge. It remains to be seen what popular reaction will be to gas price hikes. Introducing these in the summer will delay their impact, but failure to implement them has been a key reason for previous suspensions.
Meanwhile, Ukraine faces major economic and financial difficulties resulting from the crisis. Already, the loss of Crimean territory and economic disruption will result in a significant slowdown (the revised 2014 budget is based on a 3% contraction of GDP this year). Russia remains in a position to exert significant economic pressure. And the previous high rollover rates on private external debt cannot be taken for granted