Explanatory Memorandum to COM(2018)127 - Further macro-financial assistance to Ukraine - Main contents
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| dossier | COM(2018)127 - Further macro-financial assistance to Ukraine. |
|---|---|
| source | COM(2018)127  |
| date | 09-03-2018 |
1. CONTEXT OF THE PROPOSAL
·Grounds for and objectives of the proposal
The European Union (EU) has substantially strengthened its partnership with Ukraine in recent years, going beyond mere bilateral cooperation to evolve towards gradual political association and economic integration. By promoting deeper political ties, stronger economic links and the respect for common values, the EU-Ukraine Association Agreement, which was signed in 2014 and includes a Deep and Comprehensive Free Trade Area (DCFTA), is the main tool for bringing Ukraine and the EU closer together. Parts of the Association Agreement were provisionally applied from 1 November 2014, the DCFTA since 1 January 2016. The Agreement entered into force on 1 September 2017, following its ratification by Ukraine and all EU Member States and its conclusion by the Council of the EU in July 2017.
Despite the return to growth of 2016-2017 after a deep recession in 2014-2015, Ukraine’s economy remains vulnerable to external shocks. This is reflected by the country's high dependency on commodity exports, the slower-than-expected replenishment of its international reserves and its elevated external indebtedness, in particular once payment obligations on restructured Eurobonds resume in 2019. In this context, continued support from Ukraine's international partners remains essential.
In March 2015, the International Monetary Fund (IMF) approved an Extended Fund Facility programme for Ukraine of around USD 17.5 billion that is ending in March 2019. The IMF financial assistance was complemented by substantial support from the EU, its Member States, a number of bilateral partners (such as the US, Japan, Canada, Switzerland) and other international financial institutions such as the World Bank, the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB). However, as the economic recovery is still fragile and a number of vulnerabilities persist, Ukraine will face additional external financing needs in 2018 and early 2019, which the IMF estimates at USD 4.5 billion (approximately EUR 3.8 billion 1 ).
On 29 November 2017, Ukraine Finance Minister Oleksandr Danyliuk addressed an official request to European Commission Vice-President Valdis Dombrovskis for additional macro-financial assistance from the EU. This assistance would contribute to covering the country's external financing needs and support reform implementation.
In light of this request and of the economic situation in Ukraine, in particular the emergence of additional external financing needs, the European Commission is submitting to the European Parliament and the Council a proposal to provide further macro-financial assistance (MFA) to Ukraine, based on Article 212 of the TFEU, for an amount of up to EUR 1 billion to be provided in the form of medium- to long-term loans in two tranches.
The proposed new MFA operation would complement the preceding three MFA operations, totalling EUR 3.4 billion, that have been offered to Ukraine since the onset of the crisis in 2014. A total of EUR 2.8 billion was disbursed under these operations, including EUR 1.6 billion in 2014-2015 (under the so-called MFA I and II) and two tranches of EUR 600 million each in July 2015 and April 2017 (under MFA III). A third and final tranche of EUR 600 million under MFA III, subject to the implementation of 21 policy measures jointly agreed with the Ukrainian authorities, was not disbursed. Although Ukraine fulfilled a large number of policy commitments attached to this instalment, four measures, including two related to the fight against corruption, had not been implemented by the time the availability period of the assistance expired in January 2018. Under these circumstances, the Commission was not in a position to disburse the last instalment under MFA III, which was officially cancelled on 18 January 2018.
The objective of the proposed MFA is to help Ukraine cover part of its additional external financing needs in 2018-2019, reducing the economy’s short-term balance-of-payment and fiscal vulnerabilities. In addition, the EU assistance would provide incentives to step up Ukraine's reform efforts by agreeing with the Ukrainian authorities a Memorandum of Understanding setting out an appropriate package of measures supporting economic adjustment and structural reforms. The Commission would seek a broad consensus with the Ukrainian authorities, so as to ensure ownership and hence increase the likelihood of smooth implementation of the agreed conditionality. The policy conditions should address key weaknesses of the Ukrainian economy and economic governance system and be in line with the reform commitments taken by Ukraine in the context of the Association Agreement, as well as under other EU support instruments and the adjustment programmes with the IMF and the World Bank. Delivering on key anti-corruption and governance reforms will be indispensable if the MFA operation is to be successfully completed.
In light of the incomplete implementation by Ukraine of the policy programme linked to MFA III, which led to the cancellation of the final tranche by the Commission in January 2018, it is appropriate to include specific conditions for each of the two tranches of this assistance. More specifically, it is planned to reflect the measures that were not implemented under the previous programme in the following way:
·On the verification of asset declarations of public officials, the Commission would insist on the establishment of an effective verification system, including through automatic verification software with direct and automatic access to state databases and registers. In the Memorandum to be agreed with Ukraine under the proposed new MFA operation, the Commission would therefore require the aforementioned automated verification system to be in place and operating, with a significant number of declarations verified through the automated system, giving priority to high-level officials.
·On the verification of data to be provided by companies on their beneficial owners and the enforcement of companies’ reporting obligation, it has to be recognised that this is still in its infancy internationally, including in the EU. Expert exchanges between Ukraine and the EU will be organised, on a Ukrainian request, with a view to defining feasible steps for Ukraine to operationalise a verification mechanism. On this basis, the Memorandum could specify tangible benchmarks for a verification mechanism as a condition under the MFA programme.
·The wood export ban, which is not compatible with refraining from trade-restricting measures, remains in place, and a law repealing it is yet to be considered by the responsible parliamentary committee in Ukraine. The Commission will engage with the Ukrainian authorities with a view to finding a solution to this irritant through the use of dedicated trade instruments, possibly including the bilateral dispute settlement.
·As to the law establishing a central credit registry, it was adopted by the Ukrainian parliament on 6 February 2018 and entered into force on 4 March 2018. This measure can thus be assessed as implemented and does not need to be reflected in the new Memorandum.
In addition, the Memorandum for the new programme will also include other measures to be implemented by Ukraine in order to receive the first and second disbursement. These will comprise actions in the area of public finance management, which is part of all MFA-related policy programmes. More generally, the conditionality will focus on a select number of key sectors that are relevant to Ukraine's macroeconomic stabilisation.
As further elaborated in the Commission Staff Working Document accompanying this proposal and based, among others, on the assessment of the political situation made jointly by the Commission and the European External Action Service (EEAS), the Commission considers that the political and economic pre-conditions for the proposed MFA operation are satisfied.
·General context
Ukraine was affected by a particularly deep recession in 2014 and 2015, where real GDP contracted by 6.6% and 9.8% respectively. While reflecting Ukraine's long-standing macroeconomic and structural weaknesses, the economic crisis was largely driven by the confidence loss and damage to production capacity resulting from the conflict provoked by Russia's destabilising actions in the East of the country. The combination of a strong policy response and a large-scale international support package helped the economy return to growth in 2016 (2.3%). The recovery continued into 2017, when GDP growth reached an estimated 2.2%, despite the negative impact of a cargo blockage introduced in March 2017 vis-à-vis the non-government-controlled areas. The expansion of economic activity in 2017 was mainly driven by investment and household consumption, on the back of improving confidence and wage growth.
In spite of the economic crisis, Ukraine has made significant progress in the consolidation of its public finances in the past three years. The overall fiscal deficit, including the deficit of the oil and gas company Naftogaz, was reduced from 10% of GDP in 2014 to only 2.4% in 2016 (compared with the 3.7% deficit target agreed for 2016 under the IMF programme). Budget execution continued to be strong in 2017 due to robust tax collection, rising dividend payments from state-owned enterprises and some one-off factors such as the confiscation of frozen assets of former President Yanukovych (totalling 1% of GDP). As a result, the consolidated state budget deficit in 2017 amounted to approximately 1.5% of GDP. Quasi-fiscal deficits, associated with the recapitalisation of state-owned companies and banks, have been significantly reduced, notably due to the elimination of the operating deficit of Naftogaz. Such fiscal consolidation, coupled with relative exchange rate stability since 2016, has also helped reduce general government debt to an estimated 76% of GDP at the end of 2017 (down from 81% at end-2016).
The 2018 budget envisages a fiscal deficit of 2.4% of GDP (in line with the 2.5% ceiling foreseen in the IMF programme) and is based on assumptions of 3% real GDP growth and 9% consumer price inflation. The disinflation trend that prevailed from spring 2015 (60.9% in April 2015) to mid-2016 (6.9% in June 2016) has been gradually reversed. Since then, the pick-up in inflation (14.1% in January 2018) has been driven by growing production costs and consumer demand (notably resulting from wage hikes), as well as rising raw food prices (due to the frost in early 2017 which damaged crops) and fuel prices. Growing inflationary pressure has led the central bank to raise its policy interest rate by a cumulative 4.5 percentage points since October 2017 to 17% as of 2 March 2018.
With respect to the external sector, Ukraine’s current account deficit has gradually widened (3.5% of GDP in 2017) following the sharp downward adjustment induced by the economic crisis (from 9% of GDP in 2013 to 0.3% in 2015). This was mainly the result of the recovery in investment imports (in line with improving business confidence) and of robust domestic consumption. A further widening of the current account deficit was contained by the strong rebound in exports (17% year-on-year in 2017) on the back of a growing global economy and favourable terms of trade. Private, non-FDI, capital inflows have also increased, notably as a result of a USD 3 billion Eurobond placement by the government in September 2017. The support from Ukraine's multilateral and bilateral partners, coupled with current account adjustment and a gradual return of private financial flows, helped Ukraine replenish its international reserves to USD 18.6 billion at end-January 2018, despite weakness in FDI.
Despite the improvement of the economic situation since 2015, a number of vulnerabilities remain due to the country's high dependency on commodity exports, the slower-than-expected replenishment of its international reserves and its elevated external indebtedness. Additionally, the unstable domestic political environment and a continued threat of intensification of tensions in the Eastern part of the country are downside risks that could weigh on the still timid recovery.
Being a commodity exporter (agricultural products and metals account for approximately 70% of Ukraine's merchandise exports), Ukraine remains particularly vulnerable to worsening terms of trade and to the measures introduced by Russia to restrict transit from Ukraine. In fact, the global plunge of commodity prices was a key factor for the balance of payments crises which Ukraine went through in 2009 and 2014-2015.
Ukraine's high external indebtedness constitutes another source of vulnerability. Despite steep deleveraging by the corporate and banking sectors since the 2014 crisis, gross external debt amounted to USD 117.3 billion as of 1 October 2017 (111% of GDP), including USD 47.5 billion of short-term maturities (45% of GDP). While this debt relates predominantly to the private sector and does not represent as such a direct liability for the state, part of it is related to state-owned companies (sometimes guaranteed by the state) and thus amounts to a contingent liability for the authorities. The amount of direct state-owned external debt maturing in the following year has significantly declined with the crisis, as the authorities resorted to long-term lending from international financial institutions and rescheduled some USD 15 billion of bonded debt (both directly owned as well as guaranteed) with its so-called debt operation of November 2015. However, it remains relatively elevated and the repayment obligations in 2018-2019 are considerable.
Reserves remain below IMF adequacy standards, notably in a context of high external indebtedness. While Ukraine has managed to replenish its gross international reserves over the last three years, the process has been slower than initially programmed by the IMF. With USD 18.6 billion at end-January 2018, reserves remain below their pre-crisis level and the level foreseen for end-2017 at the launch of the IMF programme (USD 22.3 billion). Reserves could come under renewed pressure in 2018-2019, when the country is expected to make more than USD 12 billion of payments (interest and principal) on sovereign and quasi-sovereign external debt. This peak in debt repayments comes at the time of the presidential and parliamentary elections in 2019. In this context, the further replenishment of Ukraine’s international reserves seems necessary, and the EU’s additional MFA could usefully support this effort, both directly (through its disbursements) and indirectly (as a catalyst for private capital inflows and instilling confidence in the local currency).
In this context, continued support from the IMF and Ukraine's international partners, including the EU, remains essential. Since the onset of the crisis, the USD 17.5 billion Extended Fund Facility programme for Ukraine approved by the IMF in March 2015 has been complemented by substantial support from Ukraine's bilateral partners, including the EU. Other international financial institutions such as the World Bank, the EBRD and the EIB have also significantly scaled up their activity to support the country’s economic transition. However, as Ukraine's economy remains fragile and exposed to a number of vulnerabilities, the IMF estimates that the country will face additional external financing needs in 2018 and early 2019, amounting to USD 4.5 billion (approximately EUR 3.8 billion 2 ). The proposed MFA would cover 26.5% of the total additional financing gap. The World Bank is also preparing a new Development Policy Loan in the amount of USD 800 million as a contribution towards the financing gap. Once the potential contribution from the World Bank is taken into account, the EU MFA will finance 32% of the remaining gap of USD 3.7 billion.
·Existing provisions in the area of the proposal
–Council Decision of 12 July 2002 providing supplementary macro-financial assistance to Ukraine (2002/639/EC) 3
–Decision No 646/2010/EU of the European Parliament and of the Council of 7 July 2010 providing macro-financial assistance to Ukraine 4
–Council Decision of 14 April 2014 providing macro-financial assistance to Ukraine (2014/215/EU) 5
–Decision No (EU) 2015/601 of the European Parliament and of the Council of 15 April 2015 providing macro-financial assistance to Ukraine 6
·Consistency with the other policies and objectives of the Union
The proposed MFA is consistent with the EU’s commitment to support Ukraine’s economic and political transition. It is consistent with the principles governing the use of the instrument of MFA, including its exceptional character, political preconditions, complementarity, conditionality and financial discipline.
The proposed MFA is in line with the objectives of the European Neighbourhood Policy (ENP). It contributes to support the European Union’s objectives of economic stability and development in Ukraine and, more broadly, resilience in the Eastern European neighbourhood. By supporting the authorities’ efforts to establish a stable macroeconomic framework and implement ambitious structural reforms, the proposed operation enhances the added value of the overall EU involvement in Ukraine and improves the effectiveness of other forms of EU financial assistance to the country, including budget support operations and grants available through external financial instruments under the current multiannual financial framework for 2014-2020. The proposed MFA is also an integral part of overall international support for Ukraine and will continue to complement the assistance provided by other multilateral and bilateral donors.
Ukraine has important economic ties to the EU. On 1 September 2017, the EU-Ukraine Association Agreement came into force. The provisions concerning the Deep and Comprehensive Free Trade Area (DCFTA) had been provisionally applied since 1 January 2016, when the EU and Ukraine started to mutually open their markets for goods and services. The EU is Ukraine's first trading partner, accounting for 40.6% (in value terms) of Ukraine's total trade in 2016. Bilateral trade increased further in 2017. Ukrainian exports to the EU grew by 27.3% year-on-year, while imports from the EU rose by 22.1% (in value terms).
2. LEGAL ELEMENTS OF THE PROPOSAL
·Summary of the proposed action
The European Union shall make MFA available to Ukraine for a total amount of up to EUR 1 billion, provided in the form of medium- to long-term loans, which will contribute to cover Ukraine’s residual external financing needs in 2018-19. The assistance is planned to be disbursed in two loan instalments. Provided the policy measures attached to each tranche have been implemented in a timely manner, the first instalment is expected to be disbursed in the second half of 2018, while the second instalment could be released in the first half of 2019. The assistance will be managed by the Commission. Specific provisions on the prevention of fraud and other irregularities, consistent with the Financial Regulation, are applicable.
The Commission and the Ukrainian authorities would agree on a Memorandum of Understanding setting out the structural reform measures associated with the proposed MFA operation, including aspects of timing and sequencing. Moreover, as is normally the case with MFA, the disbursements would inter alia be conditional on satisfactory reviews under the IMF programme and the continued drawing by Ukraine on IMF funds.
·Legal basis
The legal basis for this proposal is Article 212 of the TFEU.
·Subsidiarity principle
The subsidiarity principle is respected as the objectives of restoring short-term macroeconomic stability in Ukraine cannot be sufficiently achieved by the Member States alone and can therefore be better achieved by the European Union. The main reasons are the budgetary constraints faced at the national level and the need for strong donor coordination in order to maximise the scale and effectiveness of the assistance.
·Proportionality principle
The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of short-term macroeconomic stability and does not go beyond what is necessary for that purpose.
As identified by the Commission based on the estimates of the IMF in the context of the stand-by arrangement, the amount of the assistance corresponds to around 26.5% of the estimated additional financing gap for the period 2018-2019. This significant commitment is justified by: the political importance of Ukraine for the stability in the European Neighbourhood; the political association and economic integration of the country with the EU as reflected by the Association Agreement between the two sides that entered into force on 1 September 2017; as well as the challenging situation that Ukraine continues to face, notably as a result of the conflict in the Eastern part of the country.
·Choice of instruments
Project finance or technical assistance would not be suitable to address macroeconomic objectives. The key value added of the MFA in comparison to other EU instruments would be to alleviate the external financial constraint in a swift manner and to help create a stable macroeconomic framework, including by promoting a sustainable balance of payments and budgetary situation, and an appropriate framework for structural reforms. By helping to put in place an appropriate framework for macroeconomic and structural policies, MFA can increase the effectiveness of the actions financed in Ukraine under other, more narrowly focused EU financial instruments.
3. RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS
·Consultation of interested parties
In the preparation of this proposal for MFA, the Commission services have been in regular contact with the Ukrainian authorities, in order to foster Ukraine's ownership of the programme. Besides, as MFA is provided as an integral part of the international support for the economic stabilisation of Ukraine, the Commission has also consulted with international partners of Ukraine such as the International Monetary Fund and the World Bank, which are supporting the country through sizeable financing programmes.
·Collection and use of expertise
An Operational Assessment verifying the quality and reliability of Ukraine's public financial circuits and administrative procedures was carried out by the Commission with the assistance of external experts, with the final report prepared in August 2014. A new Operational Assessment is foreseen to be conducted in the second quarter of 2018 in order to reflect recent developments.
·Impact assessment
The EU’s macro-financial assistance is an exceptional emergency instrument aimed at addressing severe balance-of-payment difficulties in third countries. Therefore, this MFA proposal is exempted from the requirement to carry out an Impact Assessment in accordance with the Commission’s Better Regulation Guidelines (SWD(2015) 111 final) as there is a political imperative to move ahead quickly in this emergency situation requiring a rapid response.
More generally, the Commission’s MFA proposals build on lessons learned from ex-post evaluations carried out on past operations in the EU’s neighbourhood. The MFA and the economic adjustment and reform programme attached to it will help alleviate Ukraine’s short-term financing needs while supporting policy measures aimed at strengthening the country's fiscal and external positions in the medium term and at laying the ground for sustainable growth.
4. BUDGETARY IMPLICATION
The planned assistance would be provided in the form of loans and should be financed through borrowing operations that the Commission will conduct on behalf of the EU. The budgetary costs of the assistance will correspond to the provisioning, at a rate of 9%, of the amounts disbursed into the guarantee fund for external lending of the EU, from budget line 01 03 06 (“Provisioning of the Guarantee Fund”). Assuming that the first loan disbursements will be made in 2018 for a total amount of EUR 500 million and the second loan disbursement in 2019 for the amount of EUR 500 million, and according to the rules governing the guarantee fund mechanism, the provisioning will take place in the budgets for 2020 (EUR 45 million) and 2021 (EUR 45 million).
Based on current projections on the utilisation of the budget line 01 03 06, the Commission assesses that the budgetary impact of the proposed MFA operation for Ukraine can be accommodated.
5. OPTIONAL ELEMENTS
·Review/revision/sunset clause
The proposal includes a sunset clause. The proposed MFA would be made available for two and a half years, starting from the first day after the entry into force of the Memorandum of Understanding.