February 9, 2018

As Kyiv skirts reforms, public faces higher borrowing costs

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KYIV – Ukraine must service more than $21 billion of debt over the next two years as it struggles to further unlock a $17.5 billion economic recovery lending program with the International Monetary Fund that has been hampered by compliancy issues.

Kyiv has eschewed the principal demand of Western backers and lenders to create an anti-graft corruption court, among other requirements, in order to access cheaper credit. Meanwhile, Ukraine has the distinction of being the slowest performing economy in Europe in 2017.

The country’s nominal gross domestic product (GDP) reached $110 billion, climbing only 2 percent, in what economists and business associations attribute to official reluctance to strengthen the judiciary and instill the rule of law that would enable secure investments.

An end-of-year survey by the local chapter of the American Chamber of Commerce (ACCU) of 184 respondents found that the “most corrupt state institutions are the courts,” according to 71 percent of those polled.

“Corruption remains a problem for the business community in Ukraine,” said Andy Hunder, ACCU president, commenting on the survey’s findings. “Eighty-nine percent of respondents believe that combating corruption is a priority for improving Ukraine’s business climate… the creation of [an] anti-corruption court remains a priority for 2018, with the business community’s expectations of eliminating corruption seen as a key to economic growth and foreign direct investment attraction.”

Foreign direct investment, a chief multiplier effect for any economy that creates jobs and improves industry, was about 2 percent of GDP last year, according to the Finance Ministry.

Kyiv derailed off the IMF’s lending program in the first quarter of 2017, mainly because of stalled reforms. It had achieved macroeconomic stability in the last four months of 2016, which saw the economy grow by nearly 5 percent over the same period year-on-year.

Therefore, “the trajectory of reform policy in 2018 is yet unclear,” the German Advisory Group Ukraine wrote in its January newsletter. “The leverage of the IMF and international donors has significantly weakened after the country’s successful macroeconomic stabilization… Ukrainian politicians are already preparing themselves for the [presidential and parliamentary] election campaign in 2019; this considerably reduces the will for further reforms.”

Among other lending-disbursement requirements, Kyiv was supposed to raise consumer natural gas prices to keep them at cost-recovery level, jumpstart privatization of state assets and make the newly revamped pension system more “sustainable,” according to past IMF statements.

Cumulatively, Ukraine has received only $8.7 billion of IMF money since April 2014, and the last disbursement for $1 billion came in April of last year, four months behind schedule. No additional tranches have followed.

In lieu of reform, Ukraine’s leadership has opted to tap foreign and domestic bond markets to keep the country afloat, with borrowing costs far higher than the approximate 3 percent interest rate that the IMF charges, according to Kyiv-based Investment Capital Ukraine (ICU).

For example, in September Ukraine raised $3 billion in a Eurobond placement with a 7.4 coupon rate. Kyiv has also borrowed heavily on the domestic bond market. As early as February 6 of this year, the Ministry of Finance sold 5.2 billion hrv worth of bonds with maturities of up to one year, according to an ICU note to investors.

Externally, Ukraine must pay back over $3.4 billion of expiring debt this year and an additional $4.5 billion the following year, according to the ICU’s calculations. Domestically, Ukraine must repay the equivalent of $7.1 billion in debt this year.

As of February 1, the central bank has about $18.4 billion in foreign currency reserves, or the equivalent of 3.6 months of imports. In its macroeconomic outlook for 2018-2019, Kyiv-based Dragon Capital investment bank said it expects foreign currency reserves to grow to $21 billion this year.

President Petro Poroshenko has signaled he will push through a bill this year to form an anti-corruption court. However, his version of the bill, which failed to get on the Parliament’s agenda on February 6, does not comply with IMF demands.

“Ahead are months of responsible decisions. What I would ask national deputies to do immediately is, in strict accordance with all regulatory procedures, to start the consideration of a bill on the Anti-Corruption Court, which I submitted,” Mr. Poroshenko wrote on his Facebook page.

He also called on lawmakers to rescind a controversial clause in existing anti-graft legislation that requires executive-level representatives of non-profit organizations to file yearly asset declarations.

The Venice Commission, an advisory body on constitutional issues to the Council of Europe, has said Mr. Poroshenko’s bill – one of four drafted – won’t meet its stated goal of combating graft.

In particular, the most controversial section of the president’s bill concerns the powers that a public council of international experts will have when selecting judges during a competitive process, Verkhovna Rada Chair Andriy Parubiy said during a political talk show on the ICTV channel on February 5.

“Probably the most important discussion will concern the competence of the public council of international experts,” Mr. Parubiy said. “International partners recommend that the public council of international experts be able to assess a certain candidate at the time of consideration and that the High Qualification Commission of Judges consider only those candidates who passed the preliminary discussion of the public council, and, accordingly, submit them for final approval.”

Another inconsistency that should be rectified is to ensure that the anti-graft court will be in the same jurisdiction as the National Anti-Corruption Bureau and the Specialized Anti-Corruption Prosecutor’s Office, both of which were formed after the 2014 Euro-Maidan Revolution.

Verkhovna Rada Vice-Chair Iryna Gerashchenko, in an interview she gave to Holos Ukrainy on February 6, said the bill should pass this year and start operating in 2019.

“I have no doubt that all deputies realize the responsibility for voting on this draft bill and that it will be adopted,” she said. “The president submitted his version [of the bill], and it can be worked on in the second [of two] readings to include corrections.”

At a baseline level, Ukraine’s economy will grow 3 to 3.5 percent this year, predicted Goesta Ljungman, the IMF’s resident representative in Ukraine.

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