Ukraine faces an economic crisis as well as a political one. Its economy is a mess and it will take a lot of money and time to put it on a sustainable growth path. It may not have enough of either. Caught in the middle is the IMF.
The Ukrainian economy was facing a crisis well before the collapse of the Yanukovich regime. Per capita GDP has been in decline since 2004 and the economy is expected to contract by 5 -10% this year. The budget deficit has been growing, the current account deficit is over 8% of GDP and external debt over 80% of GDP.
With the political crisis has come capital flight. Ukraine's foreign reserves are nearly depleted, along with the country's capacity to meet debt repayments and purchase critical imports, such as energy.
Where will the money come from? All eyes are on the IMF. Ukraine's finance minister said he hoped the IMF would work on a loan program of $15 billion, in line with the IMF's last loan to Ukraine in 2010, which was frozen a year later because Ukraine did not implement the reforms that formed part of agreement.
But even if Ukraine received another $15 billion loan from the IMF, it would be spread over a number of years and subject to Ukraine passing tough economic reforms. And Ukraine has said it needs at least $35 billion in assistance over the next two years. The US has proposed a loan guarantee of $1 billion. The EU has also referred to an aid package of over $1 billion now, and up to $15 billion over the next six years. So even if this assistance is delivered, Ukraine still faces a large financing gap, meaning the pressure may be on the IMF for an even larger loan.
Will a new IMF program be more successful than previous failed attempts?
Views are mixed. Some feel that given the political situation, the pressure from the US and Europe will be for a program of 'light' reforms. The Brazilian Director at the IMF has warned that the IMF will suffer a loss of credibility if, under pressure from the US and the EU, the IMF bends its rules to support Ukraine.
An alternative view is that the Fund may seek an excessively austere reform package, focusing on reducing Ukraine's huge energy subsidies, public transfer payments and wages. The concern is that this will lead to public upheaval prior to the forthcoming general election. As Mitchell Orenstein has warned, the IMF may lose Ukraine.
Another view is that there is no point bailing out Ukraine until its core problem is addressed, and that is pervasive corruption, much of it linked to the natural gas trade with Russia. Transparency International called Ukraine the most corrupt country in Europe. A perverse aspect of a rescue package is that a large part of the money may go to repaying some of Ukraine's debts to Russia. The Russian gas monopolist, Gazprom, has demanded Ukraine pay $2 billion in debts or it will cut off gas supplies to Ukraine.
The IMF will have to walk a tightrope with a new loan arrangement for Ukraine.
Adding to the mix is the Obama Administration's opportunistic decision to link IMF governance reforms to the legislation going to Congress on the Ukraine aid package. The IMF reforms were agreed by the G20 in 2010. They increase IMF quotas along with the quota share of emerging markets. Their implementation has been held up because of the failure of the US Congress to ratify the reforms.
The Administration's argument is that the reforms will increase the IMF's capacity to assist Ukraine, along with increasing Ukraine's access to IMF resources, given that its quota will rise. However, Republican Speaker John Boehner has said 'The IMF money has nothing to do with Ukraine'.
Both the Administration and Boehner have a point. The increase in the IMF's quota will not increase its overall resources. As part of the arrangement, the increase in the IMF's quotas (equivalent to shares) will be matched by a reduction in loans that countries have made to the Fund. And while Ukraine's quota will increase, IMF Loans can be many times larger than a country's quota.
But the Administration is right in emphasising that the IMF governance reforms are important in ensuring that the IMF can continue to fulfil its role in assisting countries facing financial difficulties, such as Ukraine. As the Brazilian IMF Director stated, IMF resources not only come from the US and Europe, but also from emerging markets. He warned, 'It is not advisable to treat this matter as a function only of opinions expressed by Americans and the Europeans'.
The bottom line is that if the US wants the IMF to continue to assist countries in difficulties, it is going to have to let emerging markets have a bigger say in the organisation. For now, the US aid package and the IMF reforms are in limbo. Not a good look for the US or the IMF.
Photo by Flickr user IMF.