The International Monetary Fund approved a $17.5 billion loan program for Ukraine, including an immediate $5 billion disbursement, to help the former Soviet republic stave off default amid a conflict with pro-Russia rebels.
The IMF’s executive board, which represents the 188 member nations, gave the go-ahead for the four-year program, Managing Director Christine Lagarde said in a statement on Wednesday. The aid is part of what the Washington-based lender and Ukraine’s government hope will be a $40 billion package, including contributions from the U.S. and European Union and a prospective $15 billion in savings to be negotiated with Ukraine’s bondholders.
The financing offers a lifeline to an economy that the government expects to shrink as much as 11.9 percent this year, as the conflict in the eastern part of the country hobbles its industrial capacity. The program, which replaces a two-year loan from last April, also marks a deepening of the IMF’s involvement in the worst standoff in Europe since the end of the Cold War.
The revamped IMF plan “will provide more funding, more time, more flexibility, and better financing terms for Ukraine,” Lagarde said in a statement. “The program is ambitious and involves risks, notably those stemming from the conflict in the east of the country.”
About $2.7 billion of the initial $5 billion payment will be allocated to budget support, the IMF said in a separate statement on Wednesday. Further disbursements will be based on standard quarterly reviews and performance measures, the fund said.
Lagarde told reporters in Berlin today that Ukraine could receive as much as $10 billion in the first year of the program if it satisfies the IMF that the country is making progress on reforms.
The approval opens the way for $7.5 billion more in international loans, Ukraine Finance Minister Natalie Jaresko said Wednesday in Kiev. It also allows Ukraine to begin negotiations with holders of its sovereign bonds, a move that Jaresko has said could save the country $15 billion. She said she will hold a videoconference with investors on Friday.
The IMF said it expects Ukraine’s real gross domestic product to shrink about 5.5 percent this year, before growing 2 percent next year. Inflation will spike due to the appreciation of the hryvnia and energy tariff increases, before subsiding to 27 percent by the end of 2015, according to the IMF.
Government debt will rise to 94 percent of GDP this year, before falling to 71 percent of output by 2020, following a debt restructuring on sovereign bonds, according to the fund.
Ukraine has agreed to measures including maintaining exchange-rate flexibility, a monetary policy aimed at restoring price stability, overhauling the country’s energy sector and cracking down on corruption, the IMF said.
Ukraine’s bonds have recovered recently on optimism that investors won’t be subject to writedowns. The country’s $2.6 billion of 9.25 percent 2017 notes gained 0.6 cent to 47.29 cents on the dollar at 6:56 p.m. in Kiev.
The nation may avoid writedowns on the principal and instead reach a “straightforward extension of maturities,” Paul Rawkins, a senior director at Fitch Ratings, said in an interview this week.
A truce negotiated in Minsk, Belarus, last month by leaders of Russia, Ukraine, Germany and France is gradually taking hold after 11 months of fighting that has killed at least 6,000 people, according to the United Nations.
The U.S. said Wednesday that Russian-armed separatists have recently violated the cease-fire. Russia has denied U.S. and EU accusations that it’s sending troops and weapons into eastern Ukraine to help the rebellion.
Ukraine’s international reserves have slid by almost two-thirds to $5.62 billion as its central bank fights to end a rout in the nation’s currency, the hryvnia.
Lagarde announced initial details of the program Feb. 12, saying the financial assistance would help Ukraine stabilize its economy and restore growth. She said Wednesday that the new arrangement “will support immediate economic stabilization in Ukraine and a set of deep and wide-ranging policy reforms aimed at restoring robust growth over the medium term and improving living standards for the Ukrainian people.”
The new IMF program replaces last year’s package that was valued at $17 billion at the time. The government had drawn about 27 percent of the available aid from the program.
Approval by Ukraine’s parliament of IMF-recommended policy changes including austerity measures and increased household energy prices have contributed to a 55 percent rally in the the hryvnia since Feb. 26. The currency is still down 27 percent this year.
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“Everyone is wondering about what is happening next, and what people are really looking out for is the details on Ukraine’s debt restructuring,” William Jackson, a London-based economist at Capital Economics, said by phone. “Unless we see a peaceful and lasting resolution of the conflict, not on paper, but in reality, it will be really hard to reduce capital flight and improve the economic situation.”
Earlier Wednesday in Washington, the U.S. imposed sanctions on officials close to former Ukrainian President Viktor Yanukovych, as well as several separatists. The penalties, which follow similar actions by the European Union and Canada on Feb. 16, come after a truce last month and a lull in fighting between pro-Russian separatists and Ukrainian government troops.
Uncertainty over the security situation continues to present risks to Ukraine’s economy, Ramin Toloui, the U.S. Treasury Department’s assistant secretary for international finance, told the Senate Foreign Relations Committee on Tuesday.
“This year’s intensification of the conflict has imposed severe damage on an already-fragile economy,” Toloui said at a hearing in Washington. “Currency depreciation and deposit flight have put a strain on the banking sector, and significant structural damage has occurred within Ukraine’s economy.”