Explanatory Memorandum to COM(2022)450 - Exceptional macro-financial assistance to Ukraine - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2022)450 - Exceptional macro-financial assistance to Ukraine. |
|---|---|
| source | COM(2022)450  |
| date | 01-07-2022 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
The EU’s support to Ukraine in the current extraordinary situation is embbeded in a strong long-term relationship. Ukraine has been developing a strong partnership with the European Union since 2014, going beyond bilateral cooperation to evolve towards gradual political association and economic integration. The EU-Ukraine Association Agreement, which entered into force on 1 September 2017 and includes a Deep and Comprehensive Free Trade Area, has been the main tool for bringing Ukraine and the EU closer together. 1 In addition to promoting deeper political ties, stronger economic links and the respect for common values, the Agreement has provided a solid framework for pursuing an ambitious reform agenda, focused on the fight against corruption, an independent judicial system, the rule of law, and a better business climate. The EU has shown continuous support for Ukraine’s important structural reforms that are crucial for attracting investments, boosting productivity and lifting the standards of living in the medium and longer term. Following the country’s application for Union membership, the European Council recognised the European perspective of Ukraine and granted candidate country status, thus cooperation with Ukraine is set to deepen further as the country moves forward in its European path.
The long-term economic development and the reform orientation of Ukraine have been facing a tremendous challenge since Russia invaded the country on 24 February 2022 in an unprecedented act of unjustified and unprovoked aggression. In addition to the immense human suffering, the on-going war in Ukraine has caused already tremendous damage to the physical infrastructure (roads, bridges, factories, etc.) and to the residential and communal buildings (housing units, schools, hospitals, etc.). The fighting has also caused a massive human exodus, with more than 6 million internally displaced persons and more than 7 million refugees.
In addition to inflicting tremendous damage to the economy, Russia’s war of agression against Ukraine has caused the sovereign to lose access to the international capital markets. The resulting underlying balance-of-payments funding gap is estimated by the authorities and the IMF to reach around USD 39 billion for the whole of 2022. In the IMF’s own assessment, Ukraine could finance, through a safe draw-down on its official international reserves that would not threaten its macro-financial stability, USD 9 billion of this gap. 2 Bilateral and multilateral commitments of financial support pledged to Ukraine in the context of the G7 Finance Ministers and Central Bank Governors meeting on 18 to 20 May have reached almost USD 20 billion. Germany provided a grant for direct budgetary support of EUR 1 billion. Further commitments by EU member states include EUR 200 million by Italy and EUR 190 million by France. In order to make a contribution toward financing the remaining estimated funding gap of Ukraine for the whole of 2022 of about USD 10 billion, the Commission intends to present a proposal for an exceptional MFA operation of up to EUR 9 billion to Ukraine.
In order to address the immediate and most urgent funding needs of Ukraine, as a first step, the Commission is submitting to the European Parliament and the Council this proposal for a decision to provide additional MFA of up to EUR 1 billion to Ukraine, in the form of a highly consessional long-term loan. As a second step, the Commission intends to present as soon as possible the remainder of this highly exceptional package, given its nature and size. It responds therefore to the European Council’s call from 23-24 June for a swift proposal. Together with the emergency MFA of EUR 1.2 billion disbursed earlier this year, 3 the total macro-financial support from the EU to Ukraine since the start of the war would reach EUR 2.2 billion and could reach up to EUR 10 billion once the whole exceptional MFA to Ukraine becomes operational. 4 This financial assistance comes in addition to many other types of support, notably humanitarian, development and defence assistance, the suspension of all import duties on Ukrainian exports for one year or other solidarity initiatives, e.g. to address transport bottlenecks so that exports, in particular of grains, could be ensured.
This additional MFA, of up to EUR 1 billion, is seen as the first part and the Commission intends to come forward with a proposal for the second part of the exceptional MFA as soon as feasible. This first part of the exceptional MFA aims to provide swift financial support in a situation of acute funding needs and to ensure the continued functioning of the most critical functions of the Ukrainian state. It will have an availability period of one year and will be disbursed as a single instalment, which may be split into one or more tranches. A Memorandum of Understanding (henceforth “MoU”), to be agreed with the Ukrainian authorities, will condition the release of the instalment and the assistance. This MoU will include enhanced transparency and reporting on the use of funds and will define the setting-up of reporting requirements to which this MFA will be linked. The policy actions to improve the country’s resilience and stability, in the area of governance and rule of law, and in the energy sector from the EUR 1.2 billion emergency MFA, disbursed in March and May 2022, that have not been completed due to reasons of force majeure, could then also be considered. The implementation of this MFA, as the first part of the announced exceptional MFA in the ‘Ukraine relief and reconstruction’ communication, is expected to go hand-in-hand with humanitarian aid and support financed by the Neighbourhood, Development and International Cooperation Instrument - Global Europe (NDICI-GE). 5 Moreover, it is part of the extraordinary international effort by bilateral donors and international financial institutions to support Ukraine at this critical juncture.
The proposed instalment of EUR 1 billion will be supported by provisions available from the EU budget for the External Action Guarantee established under the NDICI-GE. These provisions equip the EU with resources to repay investors in bonds that have been used to finance the MFA loans in the event that a beneficiary country fails to honour its repayment commitments to the EU. The current MFF foresees a general MFA programme of approximately EUR 11 billion in loans, overall, which are provisioned at the rate of 9%. On this basis, EUR 1 billion in provisions have been earmarked in the financial programming provisions for MFA loans to third countries under the current MFF. The provisioning should be financed within the limits set in Article 31(5), second subparagraph of Regulation (EU) 2021/947. This provisioning will provide the budgetary means which will underpin the proposed loan to Ukraine.
However, taking into account the recent dramatic and unforeseeable developments in Ukraine, the provisioning rate of 9% generally applied to countries addressing a balance-of-payment crisis is not adequate in the present instance. This proposal envisages a coverage rate of 70% through paid-in provisions under the Union budget. This exceptionally high rate of provisioning is deemed sufficient to contain the risk implied by this additional MFA to Ukraine, in line with the principles of sound financial management. Application of this 70% provisioning rate to the foreseen loan programme of up to EUR 1 billion in the form of a loan implies that an amount of EUR 700 million, already available under this MFF for macro-financial assistance to third countries, will be used as a cushion against potential losses on this new loan. That provisioning rate would apply instead of the general rule set out in Article 31(5), third subparagraph of Regulation (EU) 2021/947.
Recognising the extremely challenging situation Ukraine is facing, to limit the impact on fiscal sustainability from this loan, it is also proposed that the EU budget exceptionally assumes the interest rate costs arising from the proposed macro-financial assistance of up to EUR 1 billion, in the form of a loan. This way, the EU will provide additional financial relief to Ukraine, which contributes to improving its public debt sustainability. The Commission will arrange a loan with a long maturity in order to provide as long a period as possible for Ukraine to return to growth, reconstruct its economy in line with its European aspirations and maximise the chances of full repayment.
Upon adoption of this proposal, and completion of all related formalities (signature of the Memorandum of Understanding, entry into force of the Loan Agreement), the Commission will arrange this loan as a matter of urgency, reflecting the needs of Ukraine. The Commission will take forward the preparations for the organisation of the remaining package of the exceptional MFA loans as expeditiously as possible.
• General context
The economic situation of Ukraine has deteriorated dramatically following Russia’s war of aggression. Ukraine’s GDP is unofficially estimated to have decreased by 35-40% in March-April year-on-year. Inflation increased to 18.0% year-on-year in May. The National Bank of Ukraine (NBU) suspended the inflation-targeting framework for the duration of the conflict and kept its main refinancing rate at 10% until 3 June, when it raised it to 25% to discourage the demand for foreign exchange that started to build up in the second part of May. It also promised to acquire government war bonds in case of insufficient private demand and actually purchased the equivalent of around USD 4.1 billion of these bonds. Part of the subsequent monetary budget financing was, however, absorbed by NBU FX sale interventions, which account for an aggregate decline of the official international reserves by around USD 4 billion between late January and end-May to USD 25.1 billion.
Russia’s war of aggression triggered sizable funding needs for the Ukrainian budget that reflect into a substantial external funding gap. On the one hand, the war resulted in a significant contraction of public revenues, even though some of it is policy-driven as a relief measure for SMEs (VAT moratoria, exemption from customs duties). On the other hand, expenditure increased substantially to cover Ukraine’s exceptional military and humanitarian needs, including social support to the internally displaced persons and a higher wage defence bill. The resulting overall balance-of-payments funding gap is estimated by the authorities and the IMF to reach around USD 39 billion for the whole of 2022. In IMF’s assessment, Ukraine could finance, through a safe draw-down on its official international reserves that would not threaten its macro-financial stability, USD 9 billion of this gap. 6 Bilateral and multilateral commitments of financial support to Ukraine pledged in the context of the G7 Finance Minister and Central Bank Governors meeting on 18 to 20 May have reached almost USD 20 billion. Germany provided a grant for direct budgetary support of EUR 1 billion. Further commitments by EU member states include EUR 200 million by Italy and EUR 190 million by France. In order to make a sizable contribution toward financing the remaining estimated funding gap of Ukraine for the whole of 2022 of about USD 10 billion, the Commission intends, in particular as called upon by the European Council of 23 and 24 June, to provide exceptional MFA of up to EUR 9 billion to Ukraine, in the form of highly concessional long-term loans. In order to address the immediate and most urgent funding needs of Ukraine, the current proposal for additional MFA of up to EUR 1 billion in the form of a loan is the first part. The Commission intends to come forward shortly with an appropriate proposal concerning the rest of the exceptional MFA to Ukraine. It aims at contributing to financing the most urgent and immediate funding needs of Ukraine, while taking into account the current availabilities under the Union’s budget. The sizable contributions by international donors to the financing of the overall balance-of-payments funding gap of Ukraine could limit the adverse inflationary and overall destabilizing impact that would ensure if it were financed in full through money printing by the NBU.
• Consistency with existing policy provisions in the policy area
This proposal for macro-financial assistance to Ukraine follows the Decision (EU) 2022/313 on providing macro-financial assistance to Ukraine in the amount of EUR 1.2 billion in loans, which was fully disbursed in two tranches in March and May 2022. This additional MFA as a first stage of the implementation of the planned exceptional MFA, reinforces actions by the Union for direct humanitarian, development and defence support, as well as Union’s initatives to coordinate multilateral actions, such as the “Stand-up for Ukraine”.
• Consistency with other Union policies
The provision of further support to Ukraine in the form of a highly concessional long term loan, at this juncture, can assist the Ukrainian authorities in overcoming significant funding challenges arising from the conduct and impact of the Russian war of aggression. Moreover, by supporting the authorities’ efforts to maintain a stable macro-financial environment, the proposed MFA 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 2021-2027. The proposed MFA is part of the EU’s relief and reconstruction initiative for Ukraine and is an integral part of the overall international support for Ukraine. 7
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Legal basis
Article 212 TFEU constitutes an appropriate legal basis in respect of financial assistance to third countries.
The unprovoked and unjustified military aggression by Russia requires granting of additional financial assistance to Ukraine. To reinforce the budgetary sustainability of these measures, it is also necessary to increase the coverage rate of the additional MFA loan to 70% through paid-in provisions under the Union budget.
• Subsidiarity (for non-exclusive competence)
The subsidiarity principle is respected as the objectives of restoring macro-financial stability in the short-term in Ukraine cannot be sufficiently achieved by the Member States alone and can 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, whilst limiting the burden on the administrative capacity of Ukrainian authorities, which is very stretched in the current circumstances.
• Proportionality
The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of maintaining macro-financial stability in the short-term and does not go beyond what is necessary for that purpose.
As identified by the Commission based on the estimates by the authorities and confirmed by the IMF 8 , together with the forthcoming remainder of the planned exceptional MFA, the amount of the proposed MFA of up to EUR 1 billion corresponds to close to half of the estimated residual funding gap for 2022. This proportion is consistent with standard practices on burden-sharing for MFA operations (for a country with an Association Agreement, the upper limit would be 60% according to the ECOFIN Council conclusions of 8 October 2002), taking into account the assistance pledged to Ukraine by other bilateral and multilateral donors.
• Choice of the instrument
Project finance or technical assistance would be neither suitable nor sufficient to address the broader macro-financial objectives of this MFA, nor the proposal of the overall planned exceptional MFA. The key value added of the MFA in comparison to other EU instruments is to alleviate the external financial constraints swiftly and to help ensure a continued stable macro-financial framework, including by promoting a sustained and sustainable balance of payments and budgetary situation, within an appropriate framework for reporting requirements. By helping to ensure an appropriate overall policy framework, MFA can increase the effectiveness of the actions financed in Ukraine under other, more narrowly-focused EU financial instruments. By setting up the operation in a highly concessional manner, with longer maturities and a subsidy to cover interest costs, the impact on the country’s debt sustainability is lessened. Swiftly providing the much needed and very sizeable amount of financial support through the MFA’s highly concessional set-up for loans therefore appears warranted, notably in view of limits the international community, including the EU, faces to provide substantial grant financing.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Ex-post evaluations/fitness checks of existing legislation
Past ex-post evaluations of previous MFA operations to Ukraine have shown that in general they were highly relevant in terms of its objectives, financial envelope and policy objectives.
They proved crucial to support Ukraine in addressing its balance-of-payment problems and implementing key structural reforms to stabilise the economy and enhance the sustainability of its external position. They allowed for fiscal savings and financial benefits, and acted as catalyst for additional financial support and investor confidence. The MFA conditionality package was fully aligned with the related IMF programme and created a politically reinforcing effect that contributed to the mobilisation of Ukrainian authorities around essential reforms, especially in areas not covered by other international donor programmes.
• Stakeholder consultations
This exceptional MFA is provided as an integral part of the international support to Ukraine. In the preparation of this proposal, the Commission services have consulted with the IMF, the World Bank and other bilateral and multilateral donors, with significant macro-financial expertise, including as regards the Ukrainian economy. The Commission has also been in regular contact with the Ukrainian authorities.
• Collection and use of expertise
Commission services have based this proposal on a careful analysis, conducted in cooperation with the IMF and the competent international institutions, of the financial needs and broader macro-financial situation of Ukraine.
Commission services have also engaged in discussions with their counterparts in the risk departments of international financial institutions having extensive exposures in Ukraine. The purpose of these discussions has been to understand how those institutions will provision for and manage their exposures to Ukraine. These discussions have revealed the extent to which the institutional approach of each institution depends on how its balance-sheet is exposed to the impact of losses on the Ukrainian exposures. Some institutions benefit from full or partial counter-guarantees against their exposure or benefit from other forms of safeguard (reserves held by Ukraine at the IMF). The situation of the EU, which has financed macro-financial assistance loans through back-to-back lending, means that it is in the unique situation of having to ensure a steady and predictable stream of payments to its bond-investors according to a fixed and regular schedule in the event of missed payment flows from the loan beneficiaries. In order to be able to provide this additional MFA swiftly, as a first step in the organisation of the full exceptional MFA package and on a secure budgetary footing, the Union needs to apply a provisioning rate of 70% to this additional exposure to Ukraine.
In line with the requirements of the Financial Regulation, the Commission services will carry out during the implementation of the assistance an Operational Assessment (OA) of the financial and administrative circuits of Ukraine in order to ascertain that the procedures in place for the management of programme assistance, including MFA, provide adequate guarantees, also taking account the exceptional circumstances of the war. This will allow to update previous assessment, which concluded that the financial circuits and procedures in Ukraine are found to be based and work on sound principles and are therefore deemed appropriate for the purposes of Macro-Financial Assistance.
• Impact assessment
The Union’s macro-financial assistance is an exceptional emergency instrument aimed at addressing severe balance-of-payment difficulties in third countries. Given the specific context and urgency, 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 a 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. This MFA will help alleviate the short-term funding needs of Ukraine in the current extraordinary circumstances. The reporting requirements to be agreed in the MoU aim to ensure the efficiency, transparency, and accountability of the support. This additional MFA, and the subsequent part of the exceptional MFA, should build upon the achievements of the six MFA programmes since 2015, including the latest COVID-19 and the early 2022 emergency MFA assistance.
The proposal was not supported by an Impact Assessment. The application of a 70% provisioning rate follows a thorough financial risk assessment of outstanding liabilities.
• Regulatory fitness and simplification
The proposal is not linked to regulatory fitness and simplification.
• Fundamental rights
Countries that are covered by the European Neighbourhood Policy (ENP) are eligible for MFA. A pre-condition for granting MFA is that the eligible country respects effective democratic mechanisms, including a multi-party parliamentary system and the rule of law, and guarantees respect for human rights.
The renewed reform-commitment and strong political will by the Ukrainian authorities, in particular as evidenced by the successful completion of the structural policy conditionality attached to the emergency COVID-19 MFA programme to Ukraine, in key areas including the judiciary, good governance, the rule of law and the fight against corruption, is a clear positive sign. Similarly, the efforts deployed to underpin their application for an EU membership, notably through providing elaborated answer to two very comprehensive and detailed questionnaires, send a clear sign of the authorities’ willingness to follow, and deliver upon, the European aspirations of Ukraine. Since the Russian aggresion, the Ukrainian authorities have shown an impressive degree of resilience and have remained committed to pursue these reforms in a transparent manner and in line with EU standards. To that end, the political pre-condition for an MFA operation is considered to be satisfied at present.
4. BUDGETARY IMPLICATIONS
The funds for this up to EUR 1 billion additional MFA to Ukraine will be borrowed in the capital markets and on-lent to Ukraine. The elevated provisioning at a rate of 70%, that is needed to reflect the higher risks associated with this loan shall be applied, which deviates from Article 31(5), third subparagraph of Regulation (EU) 2021/947. The relevant provisions will be earmarked under the Neighbourhood, Development and International Cooperation Instrument (NDICI-Global Europe), for a total amount of EUR 700 million (budget line 14 02 01 70 “NDICI – Provisioning of the Common Provisioning Fund”).
In line with the principles of sound financial management, the budgetary protection through the increased provisioning rate of 70% is necessary to reflect the more acute risks of losses on this loan compared to traditional MFA assistance to countries addressing a balance-of-payment crisis and that typically comes on top of a disbursing IMF programme. This level of provisioning provides a high level of confidence that any amounts owed to investors that buy the bonds, used to finance the new loan, will be repaid in full and on time. The increased provisioning rate will be an appropriate response to the accounting losses on any unpaid loans that are to be recognised by the EU budget. In the event of non-payment by a beneficiary, the Union accounts must recognise a loss for the full amount of the loan in accordance with the international financial standards applicable to the Union budget accounts (IPSAS). Given the increased provisioning rate for the macro-financial assistance, it is appropriate to cover the financial liability from the macro-financial assistance under this Decision separately from other financial liabilities under the External Action Guarantee. In particular, it is appropriate to use the provisioning set aside in the Common Provisioning Fund in respect of this macro-financial assistance solely for financial liabilities under this Decision, instead of applying the general rule set out in Article 31(6) of the Regulation (EU) 2021/947 and not to apply the effective provisioning rate, instead of applying the general rule set out in Article 213 of the Financial Regulation. In addition, an interest rate subsidy should be exceptionally provided as described below, to be borne by the envelope referred to in the first indent of point (a) of Article 6 i of Regulation (EU) 2021/947 during the period of the MFF 2021-27. The administrative costs related to the borrowing and lending would be waived and thus not recovered from Ukraine. They will be borne under the respective administrative budget lines.
5. OTHER ELEMENTS
• Implementation plans and monitoring, evaluation and reporting arrangements
As a first stage of the implementation of the full exceptional MFA to Ukraine, the European Union shall make this additional MFA under this Decision available to Ukraine for a total amount of up to EUR 1 billion, in the form of a long-term loan. This assistance, which is planned to be disbursed as a single instalment, which may be split into one or more tranches, will contribute to covering the residual external funding gap of Ukraine in 2022. The release of the single instalment would occur swiftly after the approval of this proposal and the entry into force of the corresponding MoU that will indicate the setting-up of reporting requirements.
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 will work closely with the international financial institutions and the national authorities to monitor relevant developments and the application of the requirements and conditions as agreed in the MoU.
• Explanatory documents (for directives)
• Detailed explanation of the specific provisions of the proposal
The decision lays down the rules for the macro-financial assistance.
Article 1 presents the main features of this macro-financial assistance.
Article 2 provides for compliance with the political preconditions necessary for the disbursement of the macro-financial assistance.
Article 3 provides for clearly defined reporting and monitoring requirements that shall be set out in a Memorandum of Understanding.
Article 4 provides for the conditions necessary for the disbursement of this macro-financial assistance.
Article 5 presents the rules for the borrowing and lending operations.
Article 6 requires an operational assessment by the European Commission, during the implementation of the MFA.
Article 7 provides for specific rules on the provisioning to be held in the Common Provisioning Fund.
Article 8 stipulates that a Committee shall assist the Commission, in accordance with Comitology procedures.
Article 9 presents the reporting obligations of the Commission before the European Parliament and the Council, during the implementation of this macro-financial assistance to Ukraine.
Article 10 clarifies the terms of the entry into force of this macro-financial assistance.