The International Monetary Fund (IMF), following the third revision of Ukraine’s EFF Extended Fund Facility program, still considers the baseline scenario as the end of active hostilities in 2024, however, in the updated negative scenario, where the assumption of a more intense war that will last into 2025 remains, the Fund has slightly improved the macro outlook.
“Assuming that the shock starts in the second quarter of 2024, the contraction of the economy reaches 4% in 2024, compared to growth of 3-4% in the baseline scenario. A longer and more intense war is expected to have a significant impact on economic sentiment, the rate of return of migrants, fiscal spending needs, and export capacity,” the IMF said in a submission published on its website.
According to its estimates, inflation in 2024 in such a negative scenario will also be higher – 10% compared to 8.5% in the baseline scenario.
At the same time, last December, after the second revision of the program, the IMF in the negative scenario for 2024 expected a decline in GDP by 5% with inflation of 11%.
As for 2025, the forecast of GDP growth and inflation in the negative scenario was kept at the same level – 0% and 8.5%, respectively, while in the baseline scenario the Fund expects economic growth of 6.5% with inflation of 7%.
In addition, the updated negative scenario significantly improved the estimate of the trade deficit for this year – by $5.8 bln to $33.1 bln ($28.7 bln in the base case), respectively, the NBU reserves will be reduced to $34.4 bln ($42.1 bln in the base case), not $32.4 bln, as expected in December.
In addition, the forecast of the state budget deficit has been raised by 1.4 percentage points (p.p.) to 17.6% of GDP (13.7% of GDP in the base case), while the estimate of the state debt has been reduced by 5.5 p.p.. – to 105.9% of GDP (94% of GDP in the base case).
“Given the reserve holdings, some intervention is expected to prevent excessive exchange rate volatility and inflation carryover. Unlike in the baseline scenario, in the downside scenario, inflation will take longer to return to the target level,” the materials said.
According to them, the estimate of the increase in donor funding compared to the baseline scenario was left unchanged at $140.6 billion versus $121.8 billion in the baseline scenario.
“If the severity of shocks takes the country beyond the downside scenario, additional measures may be required, and the authorities have the commitment and capacity to implement them. Repeated shocks beyond the downside scenario could force the authorities to take temporary unconventional measures,” the Fund also pointed out.
Depending on the size of the financing need, according to IMF experts, extraordinary measures that could further raise revenues (e.g. a solidarity tax as a complement to the personal income tax, and/or an additional tax on luxury goods, or excise taxes/levies) and mobilization of domestic bond financing on an even larger scale, as well as monetary financing within program parameters, may be needed. “The latter could include, if necessary, administrative measures requiring banks to hold government securities at a set amount or with a minimum holding period, possibly differentiating banks according to individual liquidity conditions. Secondary purchases of government bonds by the NBU could also support the primary market,” the Fund explained.
Instruments such as inflation- or exchange rate-linked bonds could also be considered, he said.
In addition, says MF, while the scope for fiscal tightening is limited, it will have to be considered as well, as ultimately spending in some categories depends on the inflow of external financing.
“Overall, the extensive discussions with the authorities on contingency plans during the Third Review reaffirm that the program remains credible even in the event of such a negative scenario. The authorities’ political commitment and track record, as well as renewed financial guarantees from international partners and expected debt relief, give confidence that even in this updated deterioration scenario, the program’s objectives of maintaining macroeconomic and financial stability and restoring debt sustainability in the future will be achieved,” the Fund concluded, noting that the authorities are prepared to take appropriate policy measures if necessary.
It is specified that in the fiscal sphere, the bulk of the adjustment will be done through fiscal measures that can be effectively and quickly implemented to increase revenues, while some expenditures should be made contingent on available financing.
“Temporary pressure on the managed floating exchange rate regime under the negative scenario may require the reintroduction of some of the exchange controls used earlier during the war,” the IMF also noted.
The materials note that the risks to both forecasts – both basic and negative – remain extremely significant and continue to develop against the background of prevailing uncertainty. Among the main risks, the Fund categorized the risks associated with a serious shortfall in external financing and/or the impact of a more intense and prolonged war. It is explained that shortages or prolonged delays in donor funding could require the authorities to take swift countermeasures to overcome liquidity pressures, which could weaken confidence and further dampen growth, and be potentially destabilizing if uncertainty lasts too long.
Whereas, as the war continues, defense spending needs could increase significantly due to mobilization and increased intensity of hostilities, which could negatively affect confidence and lead to financing gaps.
“In the event of serious negative shocks, the authorities may resort to suboptimal measures (e.g., accumulation of budgetary arrears and cuts in social spending). The negative sentiment that may arise from this could lead to social unrest,” indicated another IMF risk.
It is emphasized that the 2025 budget will need to take into account continued risks and allow for greater Ukrainian autonomy to meet priority expenditures. “While the baseline scenario expects the war to end by the end of 2024, significant needs for defense, reconstruction, social protection, and economic development are likely to remain. At the same time, external budgetary support, while still substantial, is expected to decline sharply. Thus, additional efforts to increase revenues will be required,” the Fund noted.
According to the updated program, while in 2023 external financing amounted to $42.5 billion, and this year it is projected at $38.1 billion, next year it is expected to drop to $22.9 billion.
Earlier, the Experts Club think tank released a video on how countries’ GDPs have been changing in recent years, more video analysis is available here –
