Rebuilding Ukraine’s Economy:
The IMF’s Strategic Role And Insights
Natan Epstein, Deputy Division Chief and Deputy Mission Chief for Ukraine at the International Monetary Fund offers his perspective on how global investors are thinking about their support and loans, and what Ukraine can do to build lasting growth and stability.
This episode was recorded on September 5th, 2023. Some details may have changed since the time of this conversation.
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MOVA: The Business Language for the New Ukraine is a new podcast series hosted by Andrew Wilson, CIPE’s executive director. The series is a part of CIPE’s Democracy that Delivers podcast.
Transcripts are available in English below.
Andrew Wilson:
Ukraine is fighting a war of survival against a powerful enemy. As the war rages on, it’s clear the country will need more financial support in its fight for freedom. In this tough environment, how are investors looking at the many challenges facing Ukraine?
Natan Epstein:
The program is anchored in two phases. So, in the first phase, which is currently while the war is ongoing, the program is designed to maintain stability. In the second phase of the program — this is once active combat has abated — the focus of the program will shift to more ambitious structural reforms that are aimed at supporting both reconstruction and long-term growth.
Andrew Wilson:
More on how the IMF and others are reviewing and setting priorities for financial assistance just ahead.
I’m Andrew Wilson, executive director of the Center for International Private Enterprise. Welcome to MOVA, the Business Language for a New Ukraine, a podcast from where we’ll take a deep look at what’s happening on the ground in Ukraine and what’s being done to enhance the business outlook for the future. Our guest today is Natan Epstein, Deputy Mission Chief for Ukraine at the International Monetary Fund. He’s co-led the successful negotiations and a four-year IMF lending program with Ukraine and he’s here to tell us about the role of the IMF in the financial review and assistance effort for Ukraine, as well as how the IMF approaches considerations for rebuilding in a war-torn economy. Welcome Natan.
Natan Epstein:
Thank you, Andrew. Pleasure to be here.
Andrew Wilson:
Natan, despite the devastation of war, Ukraine’s economy has shown impressive resilience. What economic strengths has Ukraine relied on up to this time?
Natan Epstein:
Well Andrew, thank you again. Look, I agree that the Ukraine economy has been remarkably resilient, but before I discuss the economic strengths that have contributed to this resilience, I think it is important to illustrate the degree to which Ukraine has been devastated by the war. For instance, about a quarter of the population of Ukraine were either forced to migrate out of the country or internally displaced. The economy contracted by close to one-third last year, and a large portion of the country’s capital stock has been completely destroyed. These are devastating statistics. Now, despite these challenges, Ukraine has shown, as you say, remarkable resilience. The economy is now recovering — actually, it is gradually expanding — and there continues to be a well-functioning government that is delivering services to households and businesses across the country. I would attribute this resilience to three main economic strengths. First, Ukrainian policy makers have responded rapidly — indeed we believe skillfully — to the economic shocks associated with the war.
At the outset of the war, they took emergency measures to preserve economic and financial stability. These included hiking interest rates and fixing the exchange rate against the US dollar. They also introduced capital controls to preserve foreign exchange liquidity to help facilitate important priority imports. In addition, the National Bank of Ukraine, or the NBU, and commercial banks quickly implemented business continuity plans. The largest banks migrated the IT systems to the cloud, which helped the payment system function normally. The digitalization of the banking system, which started even before the war, has been a particular source of pride for the Ukrainians and a source of economic strength.
A second key strength is the financial support that Ukraine has been receiving from the international community, primarily from the European Union, the United States, G7 countries and international financial institutions, such as the IMF. In particular, earlier this year, the IMF helped mobilize $115 billion in budget support from international donors under a four-year IMF-supported program with Ukraine. This support has allowed the government of Ukraine to continue to deliver vital services to its people and to rebuild the economy, including repairing critical infrastructure which has been repeatedly targeted.
The third economic strength that we see is a fortitude of the Ukrainian people. It is their determination to not let the war bring them down, and this has helped the economy adapt to the realities of the war. Despite daily attacks, people are going to work, they’re out shopping, they’re going to restaurants, banks are fully operating, and companies and households are paying their taxes. Importantly, rapid technological advancements have made access to social, administrative, and financial services easier than even before the war. Most businesses have resumed operations thanks in part to the restoration of power, water, and heat following sustained attacks on infrastructure. So, this is what we see as the primary economic strengths that have contributed to this remarkable resilience.
Andrew Wilson:
The story of governance indeed is really an amazing story. As I was just saying, watching how the reform process has moved along after, being a Ukraine observer myself for many years, it was always a stalled process, always a political process that found reasons not to happen and it really is an amazing story now to see this unity and skill within the Ukrainian government that I think has been — my own personal opinion — has been lying dormant for a while now be activated and to work so effectively, quickly, and it gives one heart I think for the future of reform and recovery, especially when hostilities resolve themselves, at whatever point that will be.
As for the IMF — you have so much experience in these areas — what’s the top priorities that you’ve identified in working in Ukraine for stabilizing and strengthening the economy during the war period? It’s always a very tricky balance. Production isn’t always predictable. The requirements of the government to pay soldiers and other civil servants puts a tax burden on the local companies. We’ve heard that from people we’ve talked with. What do you see as these top priorities as far as stabilization and strengthening go?
Natan Epstein:
Okay, so first I think the point to highlight is that Ukraine is facing what we refer to as exceptionally high uncertainty because of the war. And in our economic support program with Ukraine, we have adopted in this regard a two phase approach to address these policy priorities. Broadly speaking, the first phase of the program coincided with a period in which the war is still ongoing and the second phase kicks in when the war starts to wind down. So let me focus here on the priorities that are under the first phase. So, while the war is ongoing, the primary goal is to support Ukraine in sustaining macroeconomic stability. That’s the key priority and the key goal. If we get into some specifics, let me start with the role of fiscal policy. Given large financing needs, fiscal policy must balance providing adequate resources for priority spending. So, military obviously, social spending, social protection, and while maintaining a strong tax base to enable the government to pay for this large expenditure.
So, a key priority in this domain for the government, if it is going to maintain a sustainable fiscal position, is to mobilize tax revenue. And this is a key priority under the program. This includes minimizing tax exemptions and avoiding any legislation that might erode the tax base. Ukraine also needs to restore the sustainability of its large public debt. Maintaining debt sustainability and predictability during the wartime will be essential for achieving sustainable public finances in the post-war period. Another top priority that we consider is to ensure price stability. Inflation rose to an annual rate of close to 26% in 2022. This is very high, and it was mostly because of supply bottlenecks associated with the war. Now since then, thanks in part to the National Bank or Ukraine (NBU), tight monetary policy and to some resolution in supply bottlenecks, inflation has fallen to around 11%.
Now this is still above the inflation goal of around 5% annually, but it is moving in the right direction, and it is helping the NBU begin loosening its monetary policy through early cuts in interest rates. In addition to fiscal and price stability, I’d also like to highlight a key priority, which is to ensure long-term financial stability. So far, the authorities have done an excellent job in maintaining financial stability. This was largely helped by the emergency measures introduced under martial law and building on important reforms they have undertaken prior to the war to clean up the banking system. Most banks today are profitable, notwithstanding that lending activity has been low, due to high credit risk, and looking ahead policies will need to preserve financial stability and plan for the post-war recovery, including by strengthening banking supervision.
One final priority, and it’s bringing me to your earlier point about the need for governance reform, is indeed the urgent need to advance both governance and anti-corruption reforms. Ukraine has a history of endemic corruption and a combination of very large fiscal financing needs and limited resources calls for an even stronger focus on transparent and efficient governance and the expectations of continuous anti-corruption reform efforts. In fact, the government began anti-corruption reform efforts before the war, and to their credit, they have continued to make progress even during the war. They understand that these reforms are critical to building public trust and the confidence of the international community. Governance reform will also be important to attract for investment for the post-war recovery and to enable Ukraine’s aspiration to ultimately join the European Union, which as you know is an important goal for them.
Andrew Wilson:
The IMF has a lot of experience working in war-torn areas both during conflict periods and the post-war recovery period. How does that approach your considerations when you’re looking at a situation like Ukraine? Do you do things a little differently at the IMF when you’re dealing with a war economy?
Natan Epstein:
So, this is a very important question. Rebuilding an economy that is battered by the war, and strengthening institutions through structural reforms will be crucial for Ukraine, especially in the post-war period. Robust growth in the post-war period, which will be helped by sizable reconstruction of the economy, will be also complimented by a comprehensive reform agenda which will be needed to swiftly regain the living standards of the population which have been devastated by the war. And, as I said, to help pave the way for EU accession, which is an important goal for them. Now in this context of the war and in our engagement with the country, rebuilding human capital will be crucial. The workforce of Ukraine has been severely affected by dislocation, military deployment, and loss of life. And in this context we are coordinating closely with international partners to scale up both training and technical assistance to address emerging capacity gaps, especially in the public sector.
Strengthening institutions will be critical to attracting unprecedented levels of investment, especially from foreign private investors. Investors want to be confident that there is a level playing field in Ukraine and strong institutions and governance are principal ingredients for building this confidence. Robust institutions are also essential to retaining the confidence of foreign governments providing financial support to Ukraine. Importantly, post-war reconstruction should meet the highest standards of transparency and accountability and this will help promote private and public trust and donor confidence in the reconstruction phase. So again, this engagement in a country that is battered by war is not a usual practice for the IMF and it’s important for us to sort of balance both the reform priorities with a consideration of the challenges that it takes to implement reforms during the war.
Andrew Wilson:
When we’ve looked at agenda setting, there’s a lot of science into it, but there’s also art involved in the idea of setting a reform agenda. And I think often in economies such as Ukraine, which have a history of transition behind them, sometimes a difficult transition, it’s often balancing really what is achievable with what is aspirational and understanding what the priorities of the government are, but also its actual ability to implement the commitments that it makes. And on the other side, it’s the ability of the private sector to actually live up to the expectations and the assumptions that are being made about its role. And at CIPE we focus a lot on improving the ability of the private sector, both to participate in these dialogues and these assessments to make sure that those making decisions have good information on which to base their assumptions, but also a better understanding of what the priorities of the private sector are and what is realistic on their behalf.
I think sometimes people look at the IMF process and don’t have a real appreciation for how it goes about making its reviews and determining its financial assistance. Sometimes it seems, I think for especially those in countries receiving IMF support, a bit of a black box. Can you shine a little light into this space for us and help us understand how this review and financial assistance priorities are determined and how do you reach a consensus on the design of a program and the objectives that you may identify that underline the basis of the program?
Natan Epstein:
Okay, so let me first start with what I’ve hinted earlier that the IMF does not normally lend to a country in a full-fledged war setting. The international community has seen this as an important priority for us to engage. And indeed, since the start of the war, the IMF has dispersed $6.3 billion. This funding comprised of $2.7 billion under two emergency facilities that were approved last year, and $3.6 billion under the new $15.6 billion financial arrangement that we approved in March of this year. Now this $15.6 billion IMF program is part of the $115 billion financial package that I mentioned earlier which was mobilized by international donors. Now with donor assurances of resources at this scale the Ukraine authorities can be confident that they can continue to run core functions while preserving macroeconomic stability. Importantly, the four-year program that was put in place is designed to work in a downside scenario in case the war intensifies or for that matter is longer lasting.
Now as with any IMF lending arrangement, we conduct frequent reviews mostly on a quarterly basis to help us assess the progress that the Ukrainian authorities are making on those reforms that they committed to under the program. But in view of the war, as I mentioned, when we design program conditionality, we have to balance the need for policy reform measures with the challenges of implementing these reforms during wartime. So, this is a balancing act and indeed we are as we speak, we are in between the first and the second review of the program and we continue to calibrate these reform measures as the war environment evolves and as the economic developments progress forward. As I indicated earlier, the program is anchored in two phases. So, in the first phase, which is currently while the war is ongoing, the program is designed to maintain stability.
In the second phase of the program, this is once active combat has abated. The focus of the program will shift to more ambitious structural forms that are aimed at supporting both reconstruction and long-term growth. More specifically, fiscal policies would focus on critical structural reforms to anchor medium-term revenue, which as I mentioned is a top priority through the implementation of a national revenue strategy. And this will go alongside the need to strengthen public financial management to support post-war reconstruction. Ukraine is also expected to revert to its pre-war policy frameworks; principally the central bank, the NBU, plans to gradually introduce flexibility in the exchange rate, which has been fixed since the onset of the war and eventually returned to its inflation targeting framework. Finally, structural reforms would aim to boost productivity and competitiveness and strengthen institutions. So, all these reforms being stipulated as part of the program are carefully designed, reviewed, and assessed as we move forward with the implementation of this IMF-supported program.
Andrew Wilson:
We talk a little bit, or touch a little bit, on the economic drivers of a recovery once the conflict has ended or even frankly during the conflict. We’ve spoken a lot on this broadcast with the agricultural sector, with the small business sector. There’s also the question, I think of the role that major investment, large scale industry, might play despite the fact that a lot of that is currently in areas of conflict or has been damaged severely. But we also see the opportunities ahead such as EU accession and other factors at play. What do you see as the main drivers of any economic recovery in the post-war growth of Ukraine?
Natan Epstein:
So, as I highlighted earlier, the economy has so far proved very resilient and firms and households continuously adapt to the war. As I mentioned, most businesses have resumed operations, thanks in part to the rapid restoration of power which followed these repeated attacks on the energy infrastructure, but also more recently on the grain infrastructure, which as you mentioned, agriculture is a key sector for the economy and it’s important that the country can revive its agricultural production and exports. This year we are already seeing a recovery taking shape. The economy has expanded during the first half of this year, and we expect it to generate growth of 1 to 3 percent this year. Now as far as the way we look at the drivers for growth, let me sort of split them between the near term and the medium term or the post-war environment. So, in the near term we do see sustained economic recovery both this year as well as into 2024.
It’s a gradual recovery that is going to be largely driven by a rebound in private consumption, investment and government spending. The recovery is also being supported by a stabilizing labor market, which has seen lower net migrant outflows in recent months. This is an important piece of this puzzle of how to generate growth in this kind of war-torn economy. That said, economic outlook is subject to exceptionally high uncertainty and risks to the recovery are exceedingly large. For example, the recent decision by Russia to quit the Black Sea Grain initiative illustrates the presence of large risks with Ukrainian economic recovery. In addition, the security situation could worsen or the war could extend for longer than currently expected. Shortfalls or delays in external financing could widen the financing gaps that I’ve highlighted earlier. And if reform implementation slips or even reverses, it could lead to a worsening of fiscal and external positions and weaken confidence, especially among private investors as noted.
So, all these could dampen near-term economic recovery prospects and one must be cognizant of these large risks. Now over the medium term, or as we like to put it as in the post-war period, we do see growth underpinned by reconstruction as the main driver of growth, as well as the recovery in private demand. For example, consumption recovering quickly as migrants begin to return to the country. And of course, structure reforms undertaken by Ukraine to prepare them for the potential EU accession. Indeed, structural reforms related to upgrading the regulatory framework and the strengthening of rule of law and boosting trade and competitiveness would help support long-term growth in Ukraine. Finally, in assessing the prospects for robust post-war growth, it’s important to know that we look at the experience of other post-war cases to draw lessons and implications and, on balance, we assume modest gains to growth from reconstruction and EU accession, at least in the early post-war period. And this is primarily because of absorption capacity constraints and the expectation of a fairly lengthy EU accession period, again based on prior experiences and other cases.
Andrew Wilson:
That’s very interesting and I think the issues that you outlined, especially in terms of the short term barriers that are in place largely reflect what we’ve heard from our friends and partners in Ukraine’s private sector, labor market, affordable credit infrastructure, just the basics of trying to get a business put together or keep a business operating are really the key things that they’re facing. We get a sense from them that they’ve sort of normalized working in the war economy to the extent that they can in terms of unpredictability and other issues. They can be flexible, they can respond, but if we can’t address those major constraints that they’re identifying, I think that’s the key for success there.
And I think I would offer our insights in terms of post-war recovery and making sure that when we see a program of reconstruction and redevelopment that the small-and-medium enterprise sector, which can put boots on the ground in terms of construction and other things, has an ability to access those programs and understand how to get contracting opportunities and other things so that the growth that we do see has got a very healthy basis to it and a widespread basis.
And we’re hoping that the lessons that you’ve learned at the IMF and from other places are taken on board as the government of Ukraine considers its own strategy in that regard. As we close out, I just want to get back to the question that you alluded to earlier about anti-corruption. We saw some actions by the government of Ukraine both against major business figures, but also figures within the government that are very publicly facing anti-corruption efforts. And we know that it’s the priority of the Zelenskyy government to address this. And because its own credibility, I think with the international donor community is at stake if it doesn’t. Can you expand just a little bit more on what the IMF’s vision for the development of effective anti-corruption institutions looks like and what other potential policy reforms you might be discussing but may not be finalized but are on the agenda for the IMF moving forward?
Natan Epstein:
Okay, so as I mentioned before, and as you yourself noted, this is a top priority under the IMF program, advancing crucial governance and anti-corruption reforms. If we step back since the Maidan revolution back in 2014, the country has worked very hard to develop the institutional infrastructure that is necessary to effectively combat corruption. The culture of increased transparency and accountability helps ensure the country’s resources are effectively channeled and focused on the war effort and we give them credit for that. But further progress on anti-corruption reforms will be needed even more so in the post-war reconstruction and especially as Ukraine is considering joining the European Union. So the predicate, the back loop here is such that the government is very aware and keen in promoting these reforms going forward. Now under our program, under the IMF program, we have identified several priority areas for bolstering anti-corruption institutions and governance reform.
Over the near term, priorities are to restore asset declaration obligations of public officials, aligning the anti-money laundering framework with international standards, and importantly strengthening the institutional autonomy and capacities of the Specialized Anti-Corruption Prosecutor’s Office known as SAPO to prosecute corruption crimes. We do think that implementing these types of measures, there’s a number of legislations that need to go through the Rada, will help them move forward on this front. Now these efforts will indeed help mitigate corruption risks while the war’s ongoing, and promote both private and public trust and the donor confidence in the period after the war ends. And the agenda and scope for improvement in this period is very large and we recognize, again, the efforts underway to combat high-level corruption. Suffice to say that there is indeed recognition that measures to combat corruption is an important priority for this government.
When it comes to governance, let me just maybe highlight that the authorities have also been committed to further strengthen the governance of state-owned enterprises. They take a large share of economic activity and this includes strengthening the accountability and broadening the powers of supervisory boards of state-owned enterprises so they can operate without political interference. So this is also an important priority when it comes to governance. I think in summary, I would say that strengthening the rule of law, promoting independent anti-corruption institutions, and ensuring a level playing field for all types of businesses will be critical to both attract investment for reconstruction as well as encourage migrants to return back to Ukraine to help rebuild a war-torn country. So there is a lot here to obviously hope for, and this is obviously a challenging area for the government, but the sign that they’re making is that they’re serious about it and they’re taking an important step to move forward on this front.
Andrew Wilson:
You mentioned one thing that I think goes underappreciated by many people when we discuss anti-corruption efforts and that really is the role of boards of directors and state-owned enterprises and building that capacity for independent directors. It’s something we’ve been focusing on in Ukraine for quite a while. And the big challenge here of course is also building up the body of experienced and qualified independent directors for these firms, and a place where I think additional effort needs to be made to ensure that once that opportunity is in place, that the qualified people are there to govern these institutions on behalf of the taxpayer in those countries. What we’ve heard from you today, Natan, is that even though the IMF isn’t used to or usually works in war-torn economies and this type of environments, I think it itself is showing a great degree of imagination and resilience in how it’s approaching this situation.
And I think our listeners might go away from our discussion today with a better understanding of the role of the IMF, not just as a financer, but also an influencer of reform agendas. And that expertise that you bring to this situation is critical, a very critical element in the continued recovery of the country. And I was heartened to hear from you that many of the priorities and barriers that you are seeing from where you sit are very close to the barriers and priorities that we hear from the local private sector when they’re discussing their priorities. And again, with the anti-corruption work, what we hear from our partners in civil society in Ukraine.
So, I think the good news coming out of this is that we do have, I think, a broad consensus on the way forward for the reform package. And I think we have the influence and the other sort of externalities that can exist to help drive that process in Ukraine. So, it sounds to me like many of us have perhaps learned the lessons of other places, and that might make us in a better position to ensure that Ukraine’s transformation stays on the rails. So, I just wanted to offer our thanks to you Natan. It’s been a very illuminating discussion, and we wish you all the best moving forward.
Natan Epstein:
Thank you, Andy. I enjoyed this conversation and all the best. Thank you again.
Andrew Wilson:
And thank you for listening to this episode of MOVA. For more information on the Center for International Private Enterprise site and our work, please visit our website at www.CIPE.org. If you found value in this episode, please show your support by liking and subscribing to MOVA. Sharing this podcast with others helps expand the conversation. Bye-bye.
Published Date: September 22, 2023