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Ukraine won a reprieve from its economic and financial crisis on March 11, when the executive board of the International Monetary Fund (IMF) approved a $17.5 billion economic and financial support program, invoking the Fund's policy of providing exceptional (abnormally large) access to IMF financial resources in extreme circumstances. The IMF program is the keystone of a $40 billion package that includes other multilateral lending institutions (the World Bank and the European Bank for Reconstruction and Development), bilateral assistance from the United States, the European Union, and other sources, and a debt operation that is expected to yield $15 billion in financial relief.
Although the package lifted the immediate specter of financial collapse, its requirement that Ukraine negotiate a market-friendly (voluntary) debt reduction operation of the expected size by mid-June is unlikely to be met. More important, the Ukraine case will demonstrate that the IMF's policy on exceptional access is unrealistically rigid.
Background
In 2002, after much discussion, the IMF executive board adopted four criteria that a member should meet before it could obtain "exceptional access" to the IMF's financial resources beyond the normal standard of 200 percent of a country's quota for borrowing from the Fund in any one year and 600 percent over three years. The criteria, modified in 2009, are:
- The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current account or the capital account resulting in a need for Fund financing that cannot be met within the normal limits.
- A rigorous and systemic analysis indicates that there is a high probability that the member's public debt is sustainable in the medium term.
- The member has prospects of gaining or regaining access to private capital markets within the timeframe when Fund resources are outstanding.
- The policy program provides a reasonably strong prospect of success, including not only the member's adjustment plans but also its institutional and political capacity to deliver on that adjustment.
The presumption of this policy was that if a country cannot satisfy the second criterion, it would have to seek a restructuring of its debt prior to the approval of its program or as part of that program. The Ukraine program is the first since 2002 in which this presumption has been incorporated into an IMF program involving exceptional access.
The Ukrainian Debt Operation
The IMF staff judged that for Ukraine to resolve its balance of payments problem and achieve "debt sustainability with a high probability," its program should include "private sector involvement through a debt operation." The aims of the debt operation are to "(i) generate $15 billion in public sector financing during the program period [2015–19]; (ii) bring the public and publicly guaranteed debt/GDP ratio from a projected 80 percent of GDP to under 71 percent of GDP by 2020; and (iii) keep the budget's gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019-2025" (IMF 2015, 66).
These three laudable objectives will be very difficult to achieve. The associated reduction in the net present value of Ukraine's public and publicly guaranteed debt at the end of 2014, estimated at $70.8 billion, could be achieved via many different combinations of principal reduction, interest rate reduction, and reprofiling of when obligations are due.1 The holders of Ukrainian debt range from domestic banks to foreign investment funds and $3 billion in eurobonds held by the Russian sovereign wealth fund that come due at the end of 2015. Russian authorities argue that the eurobonds are official debt, which means that their terms would have to be renegotiated in the Paris Club of official creditors. Russia is a member of the Paris Club but could decline to participate in a rescheduling. If Ukraine were in debt arrears to Russia, Russia could seek to block further IMF disbursements to Ukraine.
If the mid-June target is not met, a substantial part of the benefits of the private sector involvement in the debt operation will be lost for 2015. The gross external financial requirements of the program are that $5.2 billion of the $15 billion in "exceptional financing" (code for the debt operation) be achieved in 2015 (IMF 2015, 51). As June 15 approaches without a deal, Ukraine will have to scale back its goals for the debt operation or abandon the voluntary, market-friendly approach and suspend payments on some or all of its debts. The latter option, which is most likely in my view, would shift the incentives for consummating the debt operation in Ukraine's favor but with a substantial delay, at the potential cost of considerable financial market disruption, and will require the IMF to continue its lending to Ukraine while it has arrears to private, possibly official, creditors. Under either option, significant uncertainty about the Ukrainian program will persist, and the IMF will have to rethink its approach to sovereign debt and its policy on exceptional access.
My next posting will consider the implications of the Ukrainian case for IMF policy on exceptional access to its financial support.
References
IMF (International Monetary Fund). 2015. Ukraine: Staff Report on Request for Extended Arrangement under the Extended Fund Facility. IMF Country Report 15/19 (March). Washington: International Monetary Fund.
Note
1. The net present value of a country's debt is that discounted stream of expected payments of interest on and principal of that debt. Calculations may differ based on the interest rate used to discount those payments. Reprofiling involves postponing the payment of some or all of a country's near-term obligations to later dates while the debt continues to be serviced on the same financial terms. Depending on the precise payments' schedule and interest rate, the loss in net present value (NPV) of the creditors' claims might be small, and presumably smaller than with a full debt restructuring, but not necessarily.
