Editor's Note: The following note was issued by Goldman Sachs on Feb. 15 about talks between the International Monetary Fund (IMF) mission and Ukraine's government.
The IMF mission and Ukraine’s government have not reached a staff-level agreement by the end of the mission visit, and the Fund will continue discussions with the government before deciding on the disbursement of the next SDR 1bn ($1.6bn) loan tranche from the $15.6bn Stand-By program. The government is expected to come up with additional fiscal measures to compensate for slower increases in gas tariffs for the population, and to pass the law on the pension reform in March.
The outcome of the negotiations is even less favourable than we expected, but does not suggest that a complete breakdown of the cooperation with the IMF program is likely (our baseline case for this review was that the loan
disbursement would be postponed until the authorities delivered on the structural program targets they missed, but the list of the measures necessary for the review approval would be hammered out during the mission visit). We expect that the country credit risk premium will rise further and remain elevated until the negotiations with the Fund are finalised. The developments around the pension reform and the government proposals for additional fiscal measures will be the key things to look out for in order to judge how long it is going to take to reach the agreement.
COMMENT: The IMF review mission, which was working in Kiev during February 1-15, issued a statement that it will continue talks with the authorities on the additional fiscal measures before the results are presented to the IMF Board for the review approval. The IMF agreed to a "more gradual" schedule of the increases of natural gas tariffs for the population, but required the authorities to come up with "offsetting budgetary measures" in order to keep the public deficit (including the state gas company) within the 3.5% of GDP limit specified by the program.
The Fund also expects the authorities to push the pension reform through parliament in March, and continue with the public sector administration reform. From the statement it is unclear whether the government managed to persuade the IMF to make the pension reform more gradual, too (reports in the local press suggested that the government wanted to drop or postpone the increase in the retirement age, focusing more on increasing the minimum length of employment). Given that the pension reform is one of the cornerstones for achieving long-term fiscal sustainability, we think that
it’s unlikely that the Fund can significantly relax its stance.
The head of the IMF mission Thanos Arvanitis also said that the economy was doing better than initially expected, with 2010 GDP growth above 4% on the back of stronger exports, and recovery in private consumption and investment. The monetary policy was judged as adequate, as 2010 inflation fell to 8.2%yoy. Mr Arvanitis said that the discussions focused on developing the foreign exchange market and strengthening the financial sector, but did not comment on progress with the recapitalisation of banks bailed-out during the crisis. Overall, he said that the economic program
was generally on course, and the sides agreed on most of the strategic issues for 2011, but called for the authorities to keep up the pace of reforms and efforts improve the legal framework and "still challenging" business environment.
In the near term, the delay in reaching an agreement on the second review is likely to put further pressure on the country risk premium, following the 30bp widening of the 5y sovereign CDS spreads last week on the news that the negotiations were not as smooth as some of the market participants seemed to assume. The government still needs the Fund’s backing in order to successfully tap markets for funding, so we expect that the authorities will eventually comply with the IMF requirements. The ability of the government to settle on the required offsetting budgetary
measures, and the discussions around the pension reform (the parliamentary hearings are scheduled for tomorrow) will determine how long the country risk premium will remain elevated and will be the key developments to
watch.
