BES reform, tariffs, and benefits review: What Ukraine needs to do to get IMF money
Almost all of Ukraine’s revenues are spent on defense. At the same time, other expenditure items are covered by assistance from international partners, including the IMF. However, a number of requirements must be met to receive it.
On March 31, 2023, the International Monetary Fund approved a four-year Extended Fund Facility (EFF) program for Ukraine.
It provides access to $15.6 billion in IMF loans. The program is part of a total package of support for Ukraine by international partners worth $122 billion under the baseline scenario.
In 2023, Ukraine received three tranches from the IMF totaling $4.5 billion. This year, there are to be four tranches totaling $5.4 billion. According to Roksolana Pidlasa, Chair of the Parliamentary Committee on Budget, Ukraine has fulfilled all the conditions for receiving the tranches provided for in the program.
"Cooperation with the IMF is now one of the most successful for all the years of independence. We have gone through three program reviews, meaning that we have fulfilled all the conditions we undertook in each review. Now there is trust and understanding between the Government of Ukraine and the International Monetary Fund that we will continue to implement reforms and remain in the IMF program. And they will continue to allocate funds," she explains.
The third revision of the EFF program was approved on March 21 this year, and on March 26 Ukraine received a tranche of $880 million.
These funds, according to Prime Minister Denys Shmyhal, will be used to cover priority budget expenditures and maintain macro-financial stability.
According to Pidlasa, this primarily means social payments, public sector salaries, compensation to Ukrainians for destroyed or damaged housing, etc. The IMF has no special requirements as to where these funds should be allocated, as long as they are not used for war.
Although defense spending is a top priority for Ukraine today, international partners' money is not used to finance the army - such conditions for aid were stipulated from the very beginning.
Ukraine maintains its defense sector on its own. UAH 1.69 trillion is allocated for this purpose, which is almost all of the revenues budgeted for 2024 - UAH 1.76 trillion.
In general, the EFF envisages two scenarios for the development of events related to the war:
- basic - the hot phase of hostilities should end in the first half of 2024;
- negative - it will happen in 2025.
Thus, according to IMF estimates, Ukraine will need between $114.4 billion and $139.6 billion in external financing in 2023-2027. The final amount will depend on the scenario.
However, this does not mean that the money will be given for free - the Ukrainian government must implement reforms. The IMF leadership calls this reform plan "ambitious."
The next review of the current program for Ukraine is scheduled for the second half of June - early July.
BusinessCensor analyzed what Ukraine needs to do in 2024 to continue receiving money from the IMF.
Available loans 5-7-9
The government's 5-7-9 affordable loan program is gradually becoming too large. While in 2020, 5% of all new business loans were issued through the program, in 2023 this figure exceeded 25%. That is, every fourth loan is subsidized by the state, which is too expensive for the latter.
In the first quarter of 2024, 5.8 thousand entrepreneurs received loans totaling UAH 22.8 billion under the program. 20% of these loans went to businesses operating in the high military risk zone.
The issue of the 5-7-9 affordable loan program was made one of the structural benchmarks back in July 2023, when the memorandum of financial and economic policy within the EFF was updated.
Ukraine had until the end of March this year to submit a concept paper on the 5-7-9 program with proposals to reorient to small and medium-sized enterprises by gradually excluding large companies from the program.
According to People's Deputy Yaroslav Zhelezniak, First Deputy Chairman of the Committee on Finance, Taxation and Customs Policy, the changes to the 5-7-9 program are ready. Financial state support for business will now be focused only on micro, small and medium-sized enterprises.
The government took steps to this end in late December 2023 by adopting a resolution.
"Supervision of the 5-7-9 subsidized lending program needs to be strengthened to improve its targeting given limited budgetary resources and limit risks to the financial sector," the IMF said.
Rebooting the BES
Another structural benchmark concerns the reboot of the Bureau of Economic Security (BES). The relevant law should be adopted by the end of June this year.
The new legislation should resolve the issue of replacing the BES management and detectives through transparent competitions. This will give a chance to turn the Bureau into an effective body that will prevent economic crimes and schemes that cause losses to the budget.
Since October last year, the Verkhovna Rada has been considering draft law 10088-1. It is recommended for adoption in the first reading by the relevant committee.
At the same time, in late December, the government prepared its draft law. Subject matter experts, as well as the Speaker of the Verkhovna Rada, criticized it for not meeting the standards agreed with partners. Representatives of the G7 countries also criticized it. Although the President's Office insisted on this option.
The head of the Verkhovna Rada Committee on Finance, Taxation, and Customs Policy, Danylo Hetmantsev, had previously predicted that the parliament would return to considering the draft law to reboot the Bureau of Economic Security by the end of March. However, this did not happen.
According to him, the biggest controversy was caused by the issue of shortening the timeframe for the certification of BES employees. At the same time, discussions were also held over the procedure for electing the chairman of the commission - for example, whether one candidate would be proposed for approval by the government or three. Another controversial point is whether the "internationals" in the commission should have a decisive vote.
Zhelezniak calls the issue of the BES reboot the most problematic. "But there are no options here – it is in all international programs," the People's Deputy emphasizes.
In other words, the BES will be rebooted in the near future anyway. There is no room for delay because the current benchmarks are essentially overdue loose ends of 2023. It is unlikely that the international community will like it if we start delaying the reform again.
The Bureau of Economic Security is one of the key areas that the International Monetary Fund insists on. They are convinced that the effective work of this body will reduce corruption risks. And the fight against corruption in Ukraine is one of the top priorities of international support.
Optimization and efficiency of the HACC
It was expected that by the end of March Ukraine would adopt a law to rationalize the consideration of cases by the High Anti-Corruption Court by a single judge or a panel of judges. This, according to the IMF, "will increase the efficiency and effectiveness of the consideration of numerous and complex corruption cases."
In October 2023, the relevant draft law 10178 was registered in the Parliament. The document provides for the exclusion from the Criminal Procedure Code of special provisions on mandatory criminal proceedings for crimes within the jurisdiction of the High Anti-Corruption Court in the first instance by a three-judge panel.
No progress has been made so far. The card of the draft law on the Verkhovna Rada's website states that the document is provided for review.
In addition, Ukraine has committed to ensure an open and competitive competition for 24 vacancies in the HACC and to appoint new judges by the end of July 2024. To participate in the competition, 238 candidates applied to the High Anti-Corruption Court. The application period ended on March 30.
"This gives us a good start for holding a high-level competition, which will allow us to select professional and independent candidates for the High Anti-Corruption Court," comments Oleh Koliush, HQCJ member and head of the working group on organizing and conducting the competition for vacant positions of HACC judges.
The final appointments are to be completed by the end of July 2024.
NABU audit
Ukraine should conduct an external audit of the NABU with the participation of independent experts and publish a report with the results of the audit. This will be the first independent audit in the history of the institution.
"This process has already begun. The Cabinet of Ministers has sent the relevant letters to nominate candidates for this commission to review the Bureau's activities. We are ready to fully facilitate this process and we are ready to demonstrate its results as transparently as possible," NABU Director Semen Kryvonos said in late February.
IMF experts note that "an external audit of NABU will provide an impartial and formal assessment of NABU's performance since its establishment in 2015 and may identify areas for improvement and help strengthen accountability."
The deadline for the audit is by the end of September 2024.
New court to replace Kyiv District Administrative Court (KDAC)
By the end of July this year, people's deputies are to adopt a law establishing a new court that will hear administrative cases against central government agencies (e.g., the NBU, NABU, NAPC) by judges who have been duly vetted for professional competence and integrity. This court will replace the scandalous KDAC, which the Verkhovna Rada liquidated in December 2022.
The High Qualification Commission of Judges (HQCJ) and the High Council of Justice (HCJ) will be responsible for recruiting honest, fair judges. The latter, by the way, gained observer status in the European Network of Councils of Justice last year.
The IMF is convinced that the creation of a new administrative court will help strengthen the independence of the judiciary and predictability of dispute resolution for business.
Revision of tax benefits
The government will analyze the effectiveness of existing tax privileges. Based on the results, some of the benefits may be canceled to increase state budget revenues. This issue must be resolved by the end of July 2024.
Hetmantsev already announced the process in early March.
"It is important for us to understand how effective and fair the remaining benefits are today, what is the overall economic effect, or whether they do not, but only create holes in the budget. And then, together with our partners, we will be able to decide what should be kept and what actually harms the economy," he explained.
At the same time, the People's Deputy acknowledged that the abolition of tax privileges would not dramatically affect budget revenues. Moreover, most of the benefits and preferences introduced after the start of the full-scale invasion have already been canceled.
The State Tax Service keeps track of tax privileges in special reference. The latest one contains 133 items.
Audit of the financial condition of DHC
Ukraine's district heating companies (DHCs) are in a financial crisis, and it is deepening.
The reason is that after the outbreak of a full-scale war, the parliament passed a law prohibiting tariff increases during martial law and for six months after it ended.
The difference in tariffs in 2022-2023 was not covered by the budget, although the law provided for such compensation. Heat supply companies cannot solve technical and organizational problems: restore equipment damaged by shelling, repair outdated networks, replace worn-out equipment, influence personnel policies, etc. As a result, there is a risk that companies may stop supplying heat to consumers during the heating season.
That is why Ukraine should conduct an external audit of the financial condition of the DHCs by the end of June to separate debts accumulated before and after the start of a full-scale war. This will help plan the needs for repairing heating systems for the 2024-2025 heating season.
Read also: Early end of the heating season will save up to 500 million cubic meters of gas
Improve the management of state-owned enterprises
By the end of August 2024, Ukraine should develop a state ownership policy, dividend policy, and privatization strategy.
Currently, there is virtually no ownership policy, which prevents state-owned enterprises from operating efficiently. The share of dividends to be transferred to the budget is determined annually based on budget needs, not on the need for state-owned enterprises to operate efficiently.
In total, there are 3116 state-owned enterprises in Ukraine, of which 1736 (56%) are not operating. The state does not know anything about the activities of 526 enterprises (17%) because they do not report on their work.
Only 475 enterprises bring money to the budget. Over the past five years, the number of state-owned enterprises that do not work has increased dramatically.
Rehabilitation of the banking system
This benchmark stipulates that all banks with majority state ownership will remain under the management of the Ministry of Finance, while any nationalized non-systemic banks will be transferred to the DGF (Deposit Guarantee Fund) for rehabilitation.
In addition, the updated memorandum with the IMF states that two state-owned banks, namely Ukrgasbank and the recently nationalized Sens Bank (formerly Alfa-Bank), are being prepared for sale. An internationally recognized financial advisor is to be appointed by the end of May to propose a comprehensive action plan for the sale of the financial institutions.
In preparation for the privatization of state-owned banks, the Ministry of Finance, in consultation with the NBU and international financial organizations, is reviewing and updating the draft law on the privatization of state-owned banks of 2012. The updated draft law was to be submitted to the Parliament by the end of March 2024.
According to the National Bank, there are currently 62 banks operating in Ukraine. The 5 state-owned banks account for 63% of the total profit of all banks: PrivatBank, Ukreximbank, Oschadbank, Sens Bank, and Ukrgasbank.
Restore medium-term budget planning
Medium-term budgeting in Ukraine is measured in one year. The budget declaration for three years was adopted only once - in 2021. This practice was not returned due to the war.
However, the Ministry of Finance is now calling the restoration of medium-term budget planning the main task for 2024.
"Among the main achievements, I would like to note the progress in the development of a new modern IT system for planning and monitoring the implementation of the state budget. We are currently testing the developed modules and hope to be able to use the system in practice during the preparation of the Budget Declaration for 2025-2027 and the draft state budget for 2025," said First Deputy Minister of Finance Denys Uliutin.
In addition, the Cabinet of Ministers approved a draft law aimed, among other things, at restoring medium-term planning of community budgets.
This benchmark is scheduled to be implemented by the end of October.
Why cooperation with the IMF is important
Each positive revision of the Extended Fund Facility program is an important signal to Ukraine's official partners, namely foreign governments and international financial organizations that provide us with external financing.
According to the Ministry of Finance, Ukraine's need for external financing to cover the state budget deficit in 2024 is estimated at about $37.3 billion.
Cooperation with the IMF is evidence that Ukraine is fulfilling its commitments, maintaining macrofinancial stability and implementing structural reforms even in times of war.
In addition, the IMF's loan resources are among the cheapest compared to the terms of other lenders. Interest on IMF loans ranges from 2-3%.
Thus, a positive review of the Extended Fund Facility program is not only a recognition of the country's achievements but also a strategic signal that indicates a willingness to implement the necessary structural changes that will determine Ukraine's future and its further cooperation with international partners. We cannot do without international partners, neither now nor during the post-war reconstruction of the country. And the EFF program is aimed at rebuilding.
