IMF's macro forecast of Ukraine: Hostilities will subside, and along with them, external financial aid will decrease. Where to find the funds for the country's recovery?

The International Monetary Fund has released a report on the results of the first review of Ukraine's Extended Fund Facility (EFF) programme, worth $15.6 billion. The document bears the technical title "IMF Country Report No. 23/248". Essentially, it is an updated Memorandum between Ukraine and the IMF, which includes some changes in Ukraine's commitments to the fund, as well as a macro forecast for the Ukrainian economy.

The IMF mission began its work on the first review of the Extended Fund Facility programme on May 23. The Ministry of Finance reported that representatives from the Ministry of Finance, Ministry of Justice, National Bank, and other relevant authorities and institutions responsible for economic, energy, and anti-corruption issues participated on behalf of Ukraine in this process.

On June 19, one month later, Prime Minister Denys Shmygal announced during a government meeting that Ukraine had taken on a series of new commitments as a result of the review.

"During today's Cabinet of Ministers meeting, we are making a crucial decision for the macro-financial stability of the country. We approve the updated Letter of Intent and Memorandum with the IMF regarding economic and financial policies. These documents contain Ukraine's commitments that we are already implementing and will continue to implement in the future. This includes improvements in the business climate, strengthening the rule of law, and the fight against corruption," said Shmygal.

He also added that Ukraine is soon expected to receive the second tranche of funding from the IMF. The size of this tranche amounted to $890 million, and the funds arrived in the state budget at the beginning of July. In total, the IMF has allocated $3.6 billion to our country under the EFF programme since the beginning of 2023.

Mind looked into what has changed in the agreements between Ukraine and the IMF.

What does the updated macro forecast from the IMF represent? The memorandum's text traditionally includes a detailed assessment of the state of the Ukrainian economy and a macroeconomic forecast up to 2033.

In general, the current IMF expectations do not significantly differ from what the fund predicted for Ukraine in March. The GDP forecast for 2023 remains in the range from minus 3% to plus 1%, as before. Economic recovery will only begin in 2024-2025. The estimate for the real GDP in 2023 has been improved by over 7% to 6500 billion hryvnias.

The IMF has significantly improved its inflation expectations, reducing them from 20% to 15.5% by the end of 2023. Those figures are in line with the National Bank's estimates.

Forecasts for tax revenues have remained mostly unchanged. For the year 2023, the state budget is expected to receive slightly less than 2.2 trillion hryvnias through taxes. The major contributors to this amount will be personal income tax (655 billion hryvnias), value-added tax (617 billion hryvnias), excise taxes (173 billion hryvnias), and the unified social contribution (507 billion hryvnias), which, although not technically a tax, is included in the overall tax base.

The IMF also predicts a revival of international trade. The estimation for commodity exports in 2023 has improved by 7% compared to March, and imports are expected to rise by almost 9%. However, the balance of trade in goods will still be deeply negative, exceeding $27 billion.

Ukraine's key macroeconomic indicators for 2023

Indicators	March version of the memorandum with the IMF	July version of the memorandum with the IMF
Real GDP	from -3% to +1%	from -3% to +1%
Nominal GDP	6050 billion UAH	6500 billion UAH
State budget deficit (including grants)	-20.4% of GDP	-19.1% of GDP
External financing	19.8% of GDP	17.1% of GDP
Tax revenues to the state budget	UAH 2190 billion	UAH 2198 billion
Exports	$33 billion	$35.3 billion
Imports	$57.5 billion	$62.5 billion
NBU foreign gold and exchange reserves (end of 2023)	$29.6 billion	$30.5 billion
Inflation (end of 2023)	20%	15,5%
Direct investments (net)	-$400 million	-$600 million

Source: IMF data

How does the fund assess the stability of the Ukrainian economy? Commenting on its assessments and forecasts, the IMF has put forward the following points:

• despite some improvements in certain indicators, the Ukrainian economy (particularly the manufacturing sector) is still under significant pressure due to war risks;
• overall, the economy has proven to be more resilient than expected, primarily due to the recovery of internal business activity and consumption;
• the baseline scenario still foresees the winding down of hostilities by mid-2024. The term "wind down" indicates a reduction in the intensity of conflicts, not a complete cessation of the war;
• there is a possibility of a repeat of attacks on Ukraine's energy infrastructure in the autumn and winter of 2023. However, this time the country is better prepared for such challenges, so there won't be significant disruptions in energy supply;
• the “grain corridor” remains open, ensuring stable agricultural exports;
• the financial system, on the whole, is stable and liquid, with deposits in banks continuing to grow, but lending remains stagnant (effectively functioning only through the 5-7-9 programme);
• the negative scenario, as before, is not ruled out. It involves escalation and prolongation of the active phase of hostilities until 2025. In such a case, the GDP may contract by 7% in 2023, inflation rates may accelerate to 22%, the state debt volume could exceed 105% of GDP, and the budget deficit may rise up to 32%.

What will happen with public finances in 2024? According to the IMF, security and defence will remain the most significant items in government spending. At the same time, there will be some reorientation of budgetary resources towards social needs and the recovery and resolution of the consequences of military actions.

The state budget will still depend on external financing, which will reach 14.5% of GDP. However, the volume of internal borrowing (through military bonds) will be five times smaller, amounting to 3.3% of GDP.

In connection with this, the IMF recommends improving coordination between the Ministry of Finance and the NBU to more effectively determine financing needs, manage the overall government debt, and minimise the risks of currency emission.

Although the IMF does not rule out the possibility of monetary financing of the budget, such a step can only be taken by the National Bank and the Ministry of Finance in extreme situations. For example, in case of a lack of external assistance or in acute need of funds that cannot be covered by existing resources.

How does Ukraine complete its “homework” from the IMF? The text of the memorandum contains a table with 23 structural benchmarks. These are a set of agreed-upon legislative changes and strategic tasks that Ukraine must adopt/implement during 2023-2024.

With some delay, the Verkhovna Rada approved Bill 8401 (another structural benchmark), which provides for the cancellation of the 2% preferential tax rate for the unified tax, restoration of tax audits, and the return of penalty sanctions for taxpayers.

Additionally, the National Bank recently presented a strategy for easing currency restrictions and transitioning to a floating exchange rate. This was also one of the structural benchmarks, but the IMF has not yet marked it as completed. This might be due to the fact that the memorandum text was prepared before the NBU presented its strategy.

Among the structural benchmarks that Ukraine is obligated to fulfil in the second half of the year are as follows:

• transfer shares of the Gas Transmission System Operator to the Ministry of Energy (the corresponding bill has been adopted in the first reading);
• reinstate mandatory asset declaration for public servants and officials and simplify the declaration process;
• provide a forecast of state budget revenues and expenditures for 2025-2026, including sources of financing its deficit, as part of the budget declaration for 2024;
• update and publish the Medium-Term Public Debt Management Strategy;
• strengthen banking supervision, conducting audits for both banks and non-bank financial institutions;
• adopt the National Revenue Strategy (no later than December 2023);
• approve legislative changes aimed at ensuring the institutional independence of the Specialised Anti-Corruption Prosecutor's Office.

What other obligations did Ukraine take on with the IMF? As mentioned above, following the review of the EFF programme, new structural benchmarks have been added. There are four in total:

• amendments to the Budget Code: This needs to be done as part of the preparation for the budget in 2024, for medium-term budget planning, and to develop a public debt management strategy (deadline – the end of September 2023);
• developing proposals for mitigating fiscal risks related to the 5-7-9 lending programme. In the event of mass non-repayment of loans, the burden of “bad” debts will fall on the state budget (deadline – the end of September 2023);
• preparation of an action plan. This will be overseen by the Ministry of Finance, State Tax Service, and State Customs Service. The plan will contain the necessary reforms for implementing the National Revenue Strategy (deadline – the end of October 2023);
• corporate governance reform in the Operator of GTS (Gas Transmission System Operator) that involves the formation of a supervisory board (deadline – the end of October 2023).

What does all this mean for Ukraine and its economy? The IMF explicitly states that one of the most crucial conditions for sustainable post-war growth in Ukraine must be a comprehensive reform programme, which includes strengthening the rule of law, establishing independent and robust anti-corruption institutions, and creating equal opportunities for businesses. All these measures will be crucial for attracting long-term investments in the country's reconstruction (besides continuous donor support) to improve the living standards of citizens and ensure Ukraine's successful accession to the EU.

So, clearly, there will be a strengthening of tax policies and a search for additional sources to replenish the state budget. For example, the IMF has once again hinted that the simplified tax system is a “harmful” phenomenon that allows people to evade paying taxes. Therefore, it cannot be ruled out that sooner or later, lawmakers will discuss dismantling or significantly reducing the simplified taxation system.

Furthermore, the Ministry of Finance and the National Bank of Ukraine will have to address the issue of the state debt seriously, considering how to reduce it in the future and how to deal with those creditors who are not providing funding for free (which amounts to about half of them).

So, the IMF's forecasts bring some relief and hope for growth in 2024. However, this growth will be challenging, and reliance should primarily be on the country's own efforts. As time goes on, external support will likely diminish. It's evident.