Since the start of Russia’s full-scale invasion, Ukraine’s remarkable resilience has prompted many countries to provide it with substantial military, financial, and humanitarian aid. But the war has still had a tremendous impact on Ukraine’s economy. In 2022, real GDP dropped by 29.1 percent, while inflation reached 26.6 percent year-on-year in December, largely due to rising food prices. Meanwhile, the country has relied on taxes and domestic borrowing to finance a surge in defense and security spending.
Despite these challenges, the government has remained intact and successfully negotiated multiple rounds of external support. By late April 2023, Ukraine had received $47.4 billion in budgetary support, not including military assistance and humanitarian aid, since the start of the full-scale invasion in February 2022. Donors have gone to unprecedented lengths to provide Ukraine with the funds it needs to pay on time and in full its key liabilities, including wages, social benefits, and pensions. The United States provided Ukraine with grants, while the EU included substantial assistance to Ukraine in its budget for 2023.
Even traditionally cautious international financial institutions, notably the International Monetary Fund (IMF), revised their rules to support Ukraine. Ukraine’s new IMF program, approved at the end of March 2023, is a significant step toward predictable and sustainable multiyear financing. It includes rigorous reform requirements aimed at ensuring Ukraine’s macroeconomic stability. The IMF’s willingness to adapt in support of Ukraine could also benefit countries that find themselves facing similar external shocks in the future.
Moreover, the new program represents a healthy departure from the requirements of past IMF programs. For example, the IMF is not currently demanding that Ukraine raise energy tariffs, despite requiring it to do so in previous programs. The IMF is also attuned to the country’s rising poverty rates and the fragility of its social safety net during wartime, and the changes the fund is proposing to the country’s social welfare system will allow it to better protect vulnerable households.
But key uncertainties remain, most importantly the war’s trajectory and the future of U.S. and EU financial support. The new IMF program aims to serve as a framework for attracting additional external financial support, including private sector investment. Ambitious as the IMF-mandated structural reform agenda might be, Kyiv and its partners will have to explore other policy tools, such as war insurance, to attract private investment in what will be a massive reconstruction effort.
How Wartime Ukraine Won the IMF’s Trust
Until recently, IMF regulations dictated that it could not lend to countries at war. Regular IMF programs rely on a debt sustainability assessment, which was not feasible for Ukraine in 2022 due to the lack of a medium-term economic forecast. Despite this limitation, the IMF recognized that Ukraine was in need of support and used alternative instruments to provide emergency assistance. In March 2022, the IMF provided Ukraine with $1.4 billion under the Rapid Financing Instrument (RFI); it followed up in October with an additional $1.3 billion under the RFI’s new food shock window, designed to alleviate the global food insecurity crisis sparked by Russia’s blockade of Ukrainian ports. However, these loans only slightly exceeded the $2.4 billion Ukraine paid back to the IMF in 2022.
Meanwhile, the IMF launched the Program Monitoring with Board Involvement (PMB) in September 2022, designed to assess and monitor the policies of countries seeking an IMF program. In December, the IMF executive board approved a four-month PMB for Ukraine: in essence, a preparatory period for Ukraine to show it was ready for a full IMF program. The PMB itself did not involve any financial disbursements. Still, it included the typical features of an IMF program—namely, structural benchmarks—that were aimed at shoring up Ukraine’s economic stability and catalyzing donor financing.
Ukraine fulfilled all five benchmarks laid out by the PMB. Those conditionalities included the appointment of a new supervisory board for state-owned oil and gas company Naftogaz, as well as measures related to public-sector arrears, taxation, and banking-sector stability. The IMF also stipulated a condition related to the social safety net, an unusual focus for the fund that reflected an understanding of Ukraine’s dramatic wartime social challenges.
The IMF Finally Comes to Ukraine’s Rescue
Ukraine’s success with the PMB opened a path for the IMF to provide it with a full program. To do so, the fund made significant changes in its policy in March 2023. New regulations allow for financing to countries under “exceptionally high uncertainty involving exogenous shocks that are beyond the control of country authorities and the reach of their economic policies, and which generate larger than usual tail risks.” Crucially, this new policy does not apply only to Ukraine. It will enable future lending to other countries in similar conditions, as Ukrainian civil society groups proposed last fall. Ukraine will serve as a pilot for the program. If Ukraine’s program succeeds, other countries with sound macroeconomic policies that face external shocks will be able to benefit from IMF lending in the future.
As a result of these policy changes, at the end of March, the IMF Executive Board approved a new four-year program for Ukraine under the Extended Fund Facility (EFF). The program is valued at $15.6 billion and, according to the IMF, is part of a $115 billion total support package for Ukraine. The program is based on a macroeconomic forecast with a baseline scenario of continued high uncertainty in Ukraine’s economy; the IMF forecasted real GDP change ranging from -3 percent to +1 percent in 2023. The IMF also outlined a negative scenario involving a longer period of war and greater destruction, which would make it harder for the Ukrainian government to finance its liabilities.
The IMF estimated the total support package’s value at $115 billion based on Ukraine’s financial needs for the next four years. This broader package includes debt relief and restructuring estimated at $15.3 billion for the program’s duration.
It is evident that donors would rather help Ukraine stay afloat than force it to make payments to private bondholders. The Group of Creditors of Ukraine, which includes all of the G7 countries except Italy, agreed to extend a moratorium on Kyiv’s official debt repayments until 2027. More challenging for the Ukrainian government will be negotiations on debt restructuring with Eurobond holders, which must take place before the end of August when the previously agreed standstill on interest and repayment expires.
At the same time, the IMF has not proposed suspending or canceling Ukraine’s payments to the fund for earlier programs during the course of the new one. As a result, Ukraine in the next four years will end up repaying the IMF almost as much as it receives from the fund. Also, the interest on IMF loans—estimated to exceed 6 percent—is quite expensive compared to Ukraine’s other sources of financing. It receives grants from the United States and zero-interest loans from the EU, and it will pay only 1.5 percent on its loan from Canada. Moreover, Ukraine will have to start repayments on the new IMF program starting in 2027, while other concessional lending has a much longer repayment horizon.
It is essential to note that the IMF’s role here is not to act as an international lender of last resort but rather to help Ukraine stick to sustainable macroeconomic policies and catalyze funds from other donors. In particular, other donors rely on the IMF’s assessment of Ukraine’s economic situation and implementation of reforms to make their own decisions about providing financial support.
The IMF program provides clarity on donor financing to Ukraine for the first year of the program, when the estimated financial gap will be $37.9 billion. Of this amount, Ukraine is expected to receive concessional loans from the EU worth $14.5 billion, grants from the United States worth $7.4 billion, financing from the IMF worth $5.6 billion (of which $2.7 billion was disbursed in early April), and various forms of assistance from Japan worth $5.5 billion. The remaining funds will come from other partners. These figures do not include financing Ukraine already received in the first quarter of 2023, including a $1.8 billion loan from Canada, $4.9 billion in concessional loans from the EU, and $3.5 billion in grants from the United States.
The IMF program outlines the financing Ukraine is expected to need over the next three years, with the bulk expected to come from official donors excluding the IMF between 2024 and 2026. Surprisingly, the program envisions zero financing from official donors in 2027. Of greatest concern is the absence of guaranteed financing for Ukraine in the EU and U.S. budgets after 2024. The EU will need to take the lead in establishing a special financing instrument to support Ukraine in 2024 and beyond, both to help the country keep going as well as to finance its postwar economic recovery. For the latter, it might accelerate the deployment of its Rebuild Ukraine instrument announced last year.
If external financial support dries up after 2024, the sustainability of Ukraine’s economic recovery efforts will be in doubt. In that scenario, the Ukrainian government might again turn to the National Bank of Ukraine to finance the budget deficit, in essence by printing money. That, in turn, could trigger higher inflation and currency devaluation.
Ukraine’s Near-Term Homework
As with typical IMF programs, Ukraine will have to fulfill its obligations in a timely manner for financing to continue. The program outlines a total of eleven reviews to ensure compliance. It is designed as a two-stage program. The first stage, covering the first year of the program, is aimed at anchoring Ukraine’s macroeconomic stability. The focus will be on controlling the fiscal situation, as well as maintaining price and exchange rate stability. The second stage aims for ambitious structural reforms to ensure medium-term economic growth, support postwar reconstruction, and facilitate Ukraine’s EU accession. The IMF has defined nineteen structural benchmarks Ukraine will have to meet in the first stage, and additional benchmarks will be determined thereafter.
In the first year, the government will need to present the IMF with a credible multiyear budget plan and a debt management strategy, both of which will be built on an official medium-term economic forecast. These strategic public finance documents will create a solid basis for future structural reforms. One of the most hotly debated issues will likely be the National Revenue Strategy for 2024–2030, which will encompass a variety of policy and administrative measures including tax reform for postwar reconstruction and private investment. The IMF will insist that revenue anchors be defined so that Ukraine’s fiscal position will not worsen after any tax policy changes. Starting in July 2023, the IMF expects that the government will restore prewar tax inspections and other measures to make the revenue generation system more effective.
The program also focuses on public investment management, and IMF has asked Ukraine to review current procedures and develop of roadmap for reform. The goal is to ensure a competitive base and transparent criteria for project selection and financing. Moreover, the IMF wants the Ministry of Finance’s role in public investment management to be strengthened. Currently, the Ministry of Infrastructure has the lead on developing policies for recovery and implementing reconstruction projects. Transparency can be ensured through Ukraine’s Digital Restoration Ecosystem for Accountable Management (DREAM), which will contain information on all projects from the proposal stage to completion. DREAM was developed by a coalition of civil society organizations, in cooperation with the Ministry of Infrastructure, and will be a platform to ensure transparency for all recovery and reconstruction projects.
Another set of structural benchmarks focuses on monetary and banking sector policy. The IMF will require the National Bank of Ukraine to approve a strategy to move to a more flexible exchange rate, ease FX controls, transition to inflation targeting, and strengthen bank governance and supervision. Moreover, the IMF wants a bank rehabilitation program developed in cooperation with Ukraine’s Deposit Guarantee Fund.
There are four additional measures related to governance and anti-corruption policies, signaling the IMF’s continued focus on strengthening the rule of law. Surprisingly, despite the IMF’s prewar focus on reforming Ukraine’s energy sector, it outlined only one benchmark related to energy policy: the transfer of the gas transit operator’s shares to the Ministry of Energy and the adoption of a new corporate statute. At the same time, in contrast to many previous IMF programs, this one does not require Ukraine to increase energy tariffs on the population. Indeed, Ukrainian authorities have repeatedly stressed that energy tariffs cannot be increased while the full-scale war continues and poverty surges. (The World Bank estimates that poverty levels in Ukraine increased from 5.5 percent in 2021 to 24.1 percent in 2022.)
An Ambitious but Uncertain Medium-Term Perspective
The IMF forecasts that Ukraine’s economy will return to sustained GDP growth over the duration of the program, with annual growth projected to be 3.2 percent in 2024, 6.5 percent in 2025, and 5 percent 2026. But it is essential to bear in mind that the $115 billion overall support package does not account for the totality of Ukraine’s needs for full-scale reconstruction but rather only those related to emergency recovery and reconstruction. Indeed, the World Bank estimated in February 2023 that Ukraine will need $411 billion for full reconstruction and recovery. Therefore, if additional financing materializes during reconstruction, Ukraine’s economic growth is likely to be higher than forecasted.
Meanwhile, Ukraine is expected to increase public capital outlays to about 5 percent of GDP after 2027, a historically high level of public investment but still rather low considering the country’s needs. Private capital, both domestic and foreign direct investment, is therefore critical. But private foreign investors will come to Ukraine only if war insurance is available. Currently, the funds available for such insurance under the Multilateral Investment Guarantee Agency are not sufficient. The European Commission should consider establishing a new facility to insure the activities of EU companies working in Ukraine. If proper war insurance is in place and Ukraine enacts the ambitious structural reform program envisioned in the IMF program, foreign private investors might be persuaded to become involved in Ukraine’s reconstruction.
Overall, it is crucial for Ukraine to demonstrate its commitment to the agreed reforms and to make progress in meeting all of the structural benchmarks in a timely manner. Failure to do so may jeopardize the flow of funding from both the IMF and associated donors, which would create significant risks for the Ukraine’s economic stability—and for its future.