The deputy prime minister of Ukraine, Sergei Tigipko, explains what measures his government is taking, with the help of the International Monetary Fund, to get the country's finances back on an even keel.

Q: What will the challenges be for Ukraine's government in implementing the measures agreed with the International Monetary Fund (IMF) in July 2010 as part of the $15.15bn standby agreement?

A: It is not the IMF [measures that are the problem] but the impact of the crisis and the mistakes of the previous government that are forcing us to take unpopular measures. In 2009, the budget deficit amounted to at least 13% of gross domestic product [GDP]. The public debt of Ukraine is growing rapidly. In 2007, we had about Hrv100bn [$12.6bn] of foreign debts; two years later, at the beginning of 2010, this had increased to Hrv316bn. Our external debts amounted to 12% of GDP and then grew to 36% of GDP. This figure is critical for us. If we do not change anything we will get into the same situation as Greece, Romania and Hungary. This will mean rises in prices, currency devaluation and sharp cuts in public spending, including cutting public sector staff, salaries and pensions. To prevent this, we need to understand our main challenges.

There are two big problems: the deficit in Ukraine's pension fund and the deficit in Naftogaz [Ukraine's state-owned oil and gas company]. In 2008, the pension fund deficit amounted to Hrv17bn; this year it will be Hrv26bn. The next year, if nothing is done, we will have a deficit in the pension fund of Hrv37bn.

Thus, the main purpose of the IMF programme is in stabilising government finances. The pension reform will take place in two stages. In the first phase this year, the retirement age for women will be gradually raised; the maximum size of pensions will be limited; and the minimum pensionable length of service increased.

The second stage involves introducing a mandatory accumulative pension system with a linkage between the amount paid in pension contributions and the size of pension received. Our purpose in the medium term is to wipe out the pension fund deficit and make the system fairer. It is unacceptable that an average pensioner with 40 years of pensionable service receives a pension of €100 a month, whereas a former deputy or minister with a minimum of pensionable service gets 10 times more.

An equally difficult task is reforming monopolies. Implementation of new laws to reform the gas market and the market for public services will allow Naftogaz of Ukraine to become a profitable company again.

Q: What were the reasons for postponing the planned $2bn Eurobond in July 2010 and how did investors respond during the roadshow?

A: This was purely pragmatic and due to market conditions. There was no advantage for the government in entering the market until negotiations with the IMF were complete and while the country was still on a low credit rating. After the IMF approved the new programme, our rating improved and now the government can borrow money at lower interest rates. The specific timing of the Eurobond's issuance will depend on the needs of the state budget.

Q: What are your expectations for the 2010 budget and how much of the IMF loan will be needed to finance it?

A: No more than $2bn of the IMF loan will be used to finance the budget deficit. The remaining money will replenish the gold reserves of the National Bank of Ukraine (NBU).

One of the main goals of the IMF loan is to ensure the stability of the hryvna exchange rate so as to reduce the risks of investing in the country. The hryvna is seriously undervalued and I anticipate that in the next few years the exchange rate will be generally more stable. Indeed, we are preparing the draft budget for 2011 on the basis of an average exchange rate of 7.95 hryvna to one dollar. So now is the perfect time to invest in hryvna assets, either by way of government securities, by participating in privatisations or by setting up new production facilities in the country.

Q: The losses at Naftogaz have been one of the major burdens on the government budget. How does the government plan to return the company to a sustainable financial position and how long might this process take?

A: The company's deficit this year will be Hrv7.4bn but next year it should break even. To achieve this, the price of gas has been increased by 50%. We have abolished preferential gas prices for the sugar, chemical and metallurgical industries, and we will maintain the price of gas for industrial consumers at parity with the price of imported gas. If necessary, in the second quarter of next year, gas prices will be revised again but with subsidies for the poor.


Independence drive: the autonomy of Ukraine's national bank has been strengthened

Q: What are the key challenges to improving the business environment and increasing investment in Ukraine?

A: We have already reformed the public procurement system and adopted a law consistent with EU practice. The government is now actively engaged in regulatory reform, including simplifying the licensing system and technical requirements. There will also be simplified procedures for opening and closing a business as well as a system for electronic registration of enterprises.

The government and the parliament are now finalising the adoption of a new tax code, which dramatically simplifies tax administration. I expect the major parts of business deregulation to be adopted in September and implemented before the end of the year.

Q: The government has announced it will strengthen the independence of the NBU. What will this process involve?

A: Parliament has already amended the law on the NBU. Autonomy of the bank has been strengthened to ensure the effective discharge of monetary policy.

The main items of the law are as follows: the primary objective of the NBU is to ensure price stability and the stability of the banking system. The national bank will support the economic policy of the Cabinet of Ministers of Ukraine only if this does not impede achieving these main objectives.

Second, the independence of the NBU has been strengthened. Qualification requirements for managers of the bank and members of its governing bodies are set out as well as grounds for dismissal of senior staff.

Third, the NBU is prohibited from granting loans in national or foreign currency, either directly or indirectly, to finance the expenditures of the state budget.

Fourth, there is a new mechanism for distribution of 'profits' of the NBU. In particular, the law establishes clear rules of distribution of 'profits' between the reserves and the state budget in a 50:50 ratio.

Q: Does the government intend to recapitalise any of the 16 banks under NBU administration, especially the largest Nadra Bank. If so, how will it choose which ones to recover and which ones to liquidate?

A: We plan to complete the programme of bank recapitalisation by the end of 2010. Banks have already completed an expanded audit and submitted recapitalisation plans that must be approved by the NBU. Under these plans, private shareholders are required to complete the replenishment of capital by the end of the year. Otherwise, the banks will be intervened and recapitalised by the state. With regards to Nadra Bank, by the end of October, a complete audit of the bank, according to International Financial Reporting Standards, will be finished to assess the scale of recapitalisation. I expect that by the end of November an agreement will be reached with investors and a business plan approved for restoring the bank to profitability. By the end of 2010, Nadra Bank must be fully recapitalised, preferably with minimal participation of the state.

Regarding the three banks nationalised previously, the government is considering options of selling them after market conditions improve.

Q: As a former banker and central banker, what steps do you think are necessary to avoid a repeat of the banking crisis that hit Ukraine in late 2008 and early 2009?

A: The government and the NBU have already learned lessons from this crisis. In particular, foreign-currency loans to borrowers who have no foreign-currency income have been prohibited. This is because the main reason for the deterioration in banks' loan portfolios was the inability of borrowers to repay in foreign currency after the hryvna depreciated by 60%. The next step is to reform legislation aimed at protecting the rights of creditors so that banks can quickly sell bad loans. The government is already preparing the appropriate legislation. Adoption of these laws will enable commercial banks to reduce significantly their credit risks and enable them to resume lending.

Sergei Tigipko is deputy prime minister of Ukraine


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