IMF: Ukraine’s “tough programme”; Egypt next?

20 June 2014

The era of IMF-led structural reform is not over, despite Fund rhetoric on reducing inequality, country ownership and consideration of the most vulnerable (see Observer Spring 2014). The IMF’s claimed new approach to conditionality still results in a familiar austerity-focussed framework for reform attached to emergency lending (see At Issue Summer 2014). Additionally, the timing of lending decisions appears to be driven by the political preferences of major shareholders.

In early May, the IMF announced that it had agreed to provide an $18 billion standby arrangement to Ukraine, supplying $3.2 billion immediately, of which over one third is intended to pay outstanding bills to Russian gas exporter, Gazprom. Since the political instability, triggered by the overthrow of the previous president in February, the IMF had already committed in March to provide at least $14 billion, subject to commitments from other lenders, including EU members and the US (see Observer Spring 2014).

The loan to Ukraine represents 800 per cent of Ukraine’s IMF quota, placing this programme under the Fund’s exceptional access rules triggered for loans over 200 per cent of quota or 600 per cent over three years. To qualify for exceptional access, a country must normally meet four criteria. It must be experiencing exceptional balance of payments pressure, there must be a high probability that the country’s public debt is sustainable in the medium term, the country must have good prospects of regaining access to private capital markets; and its policy program must have a reasonably strong prospect of success.

Ukraine has been “stuck for many years in the transition from planned to market economy, getting the worst of both systems”Olexi Pasyuk, CEE Bankwatch

An editorial from news agency Bloomberg in late March warned of problems stemming from the IMF attempting “an economic solution to a geopolitical problem”, stating “shock therapy isn’t an option”. The editorial reflects Ukraine’s troubled history with the Fund. This is the third loan agreement since 2008, the previous two having been suspended over the country’s unwillingness to implement reforms to the IMF’s satisfaction. Now there appears to be little option for the country’s interim administration, which began implementing reforms before the loan announcement, including a 56 per cent hike in energy prices in March.

Under the agreement, it must reverse VAT reductions (back up to 20 per cent) and VAT exemptions to the agricultural sector, while providing for refunds to some businesses. The Ukrainian currency was floated, leading to an immediate depreciation in its value, increasing inflation and putting more pressure on households’ cost of living, exacerbated by the removal of key subsidies.

Inappropriate reforms?

There is widespread consensus that Ukraine’s economy is in need of significant and painful reform. Olexi Pasyuk, of Eastern European NGO network CEE Bankwatch said that Ukraine has been “stuck for many years in the transition from planned to market economy, getting the worst of both systems”. Pasyuk noted that “it is important to mitigate negative impacts of price increases on the poorest, as is stressed in the memorandum [of understanding between IMF and Ukraine]”, but that “this is going to be a challenge”. The IMF’s approach to ensure that the most vulnerable are protected will rely on an existing household assistance scheme, plus a new programme, which has not yet been designed, intended to give financial transfers to those excluded by the existing scheme.

Other areas of reform include privatisation of up to 30 per cent of Ukraine’s coal mines, while subsidies are cut. These form part of a slew of prior actions and structural benchmarks written into the programme. These laws include the VAT changes which the cabinet had indicated in early March would be retained until 2016. They also include stress and diagnostic tests of all major Ukrainian banks, with the prospect of using “public funds to … [bring the banks] back into solvency”; the IMF added that the government “should be prepared to manage its financial sector shareholdings”. Other actions include a new parliamentary procurement law, plus the reversal of subsidies to energy consumption, which entail higher gas and heating tariffs for consumers, increasing by over 40 per cent in 2015 . Finally, to protect those most impacted by these changes, the IMF has required a new social assistance scheme to be enacted where the existing scheme does not cover the “vulnerable”.

Mark Weisbrot, of US-based think tank Center for Economic and Policy Research, warned that Ukrainians may be in for a “unpleasant surprise” given the IMF’s indications that Ukraine should brace itself for several years of fiscal austerity, arguing that “you can’t destroy an economy in order to save it”. Weisbrot expressed scepticism over the Fund’s forecast of a return to growth within a year. The US president Barack Obama’s nominee for new IMF executive director, Mark Sobel, told a Congressional committee in May to expect a “very tough programme”, adding “we’re going to have to be very vigilant to make sure the tough reforms that Ukraine needs … are implemented”.

Egypt: new money but an old programme?

In the wake of June’s Egyptian presidential elections, IMF managing director Christine Lagarde personally congratulated the president-elect, former general Abdel Fattah al-Sisi, and according to a Fund spokesperson “reiterated the Fund’s continued commitment to help Egypt and its people”. Discussions over a $4.8 billion loan programme have occurred repeatedly since the overthrow of former president Hosni Mubarak in 2011 (see Update 86), but were never finalised due to continued political instability and widespread popular resistance to the scale and burden of reforms (see Update 83).

As in Ukraine, Fund-recommended reforms have included reducing energy subsidies and increases to VAT. Lagarde described reforms as a “must .. no matter who will be in charge” in the wake of private meetings between Egyptian government officials and Lagarde at the IMF spring meetings in April. Egyptian newspaper Al Ahram reported in early May that VAT will be set to a flat rate of between 10 and 12 per cent, while energy subsidies will be required to be reduced to $23 billion per year, which will lead to large increases in households’ energy costs. Despite commitments to ensure cash transfer programmes protect the most vulnerable, it is as yet unclear how or when this protection will be enabled.

Reem Abdel Haliem from the NGO Egyptian Initiative for Personal Rights argued that the issue of conditionality is “more complex than it seems”, as conditionalities can “be framed to maintain the same growth model that serves the rich rather than the poor”. Haliem noted that, despite confusion surrounding the new administration’s intentions, there are fears of “unfair taxation which burdens the poor and low middle income groups”. She added that subsidy reforms have also seen “contradictory announcements” regarding the time frame for phasing-out subsidies, which will have significant impacts on the poor, while there is little information about how any cash transfer or compensatory scheme could function.