IMF improves economic forecast for Ukraine in scenario where conflict continues into 2025
MOSCOW. March 25 (Interfax) - The International Monetary Fund, following the third review of the Extended Financing Program (EFF) for Ukraine, still considers an end to the active phase of the military operation in the country in 2024 to be the baseline scenario, however the Fund improved its macroeconomic forecast slightly in its updated downside scenario that assumes the conflict will last into 2025.
"With the shock assumed to start in Q2 2024, the output contraction [in the downside scenario] reaches 4% percent in 2024 compared with baseline growth of 3-4%," Ukrainian media reported, quoting information posted on the IMF's website.
The IMF thinks a more protracted conflict would "significantly weigh on economic sentiment, the pace of migrant return, fiscal spending needs, and export capacity."
According to its estimates, inflation will also be higher in 2024 in such a negative scenario at 10% compared to 8.5% in the baseline scenario.
The IMF said in December last year, after the second review of the program, that its downside scenario for 2024 was for GDP to fall 5% with inflation of 11%.
As for 2025, the forecast for GDP growth and inflation in the downside scenario is unchanged at 0% and 8.5%, respectively, while in the baseline scenario the fund expects economic growth of 6.5% with inflation of 7%.
The updated downside scenario improves the estimate of the trade deficit for 2024 by $5.8 billion to $33.1 billion, on which case the National Bank of Ukraine's reserves will decrease to $34.4 billion, and not to $32.4 billion, as expected in December. Also, the forecast state budget deficit was increased by 1.4 percentage points to 17.6% of GDP (13.7% of GDP in the baseline), and the estimate of public debt was reduced by 5.5 pp to 105.9% of GDP (94% in the baseline).
The estimate for the increase in donor funding compared to the baseline scenario remains the same - $140.6 billion versus $121.8 billion in the baseline scenario.
"If the severity of shocks pushes the country beyond the downside scenario, additional measures may need to be undertaken, and the authorities have the commitment and capacity to implement such measures. Renewed shocks beyond the downside scenario may compel the authorities to take temporary unconventional measures," the memorandum says.
Depending on the size of the financing needs, the IMF considers that there are contingency measures that could further boost revenues (for example a solidarity tax in the form of a supplement to personal income tax, and/or an additional tax on luxury goods, or excise duties/fees) and mobilizing domestic bond financing on an even larger scale, as well as monetary financing within program parameters, may be required. "The latter could include, if necessary, administrative measures requiring banks to hold a stipulated amount in or a minimum holding period of government securities, possibly differentiating among banks based on individual liquidity conditions. Secondary purchases of government bonds by the NBU might also serve as a backstop for the primary market. Instruments such as inflation or exchange-rate linked bonds could be considered," the IMF said.
Instruments such as inflation or exchange-rate linked bonds could be considered, it said.
Moreover, while the scope for tightening the fiscal position remains constrained, ultimately spending under certain categories would be contingent on the flow of highly concessional/grant-based external financing, it said.
"Overall, wide-ranging discussions with the authorities on contingency plans during the Third Review reconfirm that the program remains robust even in the case of such a downside scenario. The authorities' policy commitments and track record, together with the renewed financing assurances from international partners and expected debt relief, give confidence that even in this updated downside scenario, the program objectives of maintaining macroeconomic and financial stability, restoring debt sustainability on a forward-looking basis, and ensuring medium-term external viability could be met," the IMF said, adding that the authorities are ready to take appropriate political measures, if necessary.
On the fiscal side, the bulk of the adjustment would come from tax measures that could be effectively and rapidly implemented to boost revenues. Some spending should be made contingent on available financing.
"Temporary pressures on the managed floating exchange rate regime under the downside scenario may require the reintroduction of some FX controls used earlier," the IMF said.
Risks to the outlook, both baseline and downside, remain exceptionally large and continue to evolve amid prevailing uncertainties, it said. Key risks ahead include those arising from major shortfalls in external financing and/or the impact of a more intense and longer conflict. Shortfalls or prolonged delays in donor financing could require the authorities to take prompt countermeasures to cope with liquidity pressures, which could weaken confidence and further dampen growth, and be potentially destabilizing if the uncertainties last too long. Shortfalls or prolonged delays in donor financing could require the authorities to take prompt countermeasures to cope with liquidity pressures, which could weaken confidence and further dampen growth, and be potentially destabilizing if the uncertainties last too long.
As the military operation continues, defense spending needs could be sizably larger.
"In case of severe downside shocks, the authorities may resort to sub-optimal measures (e.g., accumulation of budgetary arrears and social spending cuts). The negative sentiment that would likely ensue may generate social unrest," the IMF said.
The IMF said the 2025 budget would need to account for continuing risks and involve greater self-reliance to meet expenditure priorities. Although the military operation is expected to wind down at the end of 2024 in the baseline, there will likely continue to be substantial needs for defense, reconstruction, social protection, and economic development, it said. "At the same time, external budget support, while still sizable, is expected to scale down sharply. Thus, additional efforts to raise revenues will be necessary," it said.
According to the updated program, external financing amounted to $42.5 billion in 2023 and is projected at $38.1 billion this year, falling to $22.9 billion in 2025.