Proposal for a Council Decision providing macro- financial assistance to Ukraine
Date: 1994-11-04
Institutions: European Commission
Subjects: Community loan, EU aid, European Commission, International Monetary Fund, USSR, economic development

COMMISSION  OF  THE  EUROPEAN  COMVIUNITIES 

C0M(94) 487 final 
Brussels, 04.11.1994 

9 4 / 0 2 56 

(CNS) 

Proposal 

for a Council Decision 

providing macro-financial  assistance 

to Ukraine 

(presented by the Commission) 

J, 

EXPLANATORY MEMORANDUM 

Ukraine's request for Community  macro-financial  support 

In June  1994,  the Corfu  European  Council  invited  the  Council  to  continue  its  work  on 
the  formulation  of  an  overall  policy  towards  Ukraine,  drawing  on  the  full  range  of 
Community  instruments  to  support,  inter  alia,  the  achievement  of  market  oriented 
economic  reforms  and  the  acceptance  by  Ukraine  of  internationally  accepted  nuclear 
safety standards. The European Council also underlined the Union's readiness to  support, 
in the context of a G-7  initiative, a nuclear safety plan for Ukraine with ECU 400  million 
in EURATOM  loans  and  ECU  100  million  grant  over  three  years  under  TACIS.  This 
approach was confirmed  at the G-7 Naples Summit in July. 

In  early  October,  the  General  Affairs  Council  agreed  on  a  strategy  paper  for  Ukraine 
stressing  again  the  need  for  the  Union,  together  with  other  donors,  to  encourage  the 
Ukrainian authorities to  design and implement  a comprehensive  stabilization and  reform 
programme  in agreement  with  the  IMF  and to  pursue with the  EU/G-7  action plan  for 
the closure of Chernobyl. 

On  14  October  1994,  Mr  Kuchma,  the  new  President  of  Ukraine,  addressed  to  the 
Commission  a  request  for  urgent  Community  macro-financial  assistance.  This  request 
was  made  in the  context  of  a  comprehensive  reform  and  macro-economic  stabilization 
and  reform  programme  on  which  the  Ukrainian  authorities  have  reached  an 
understanding with the International Monetary Fund. This programme is to be supported 
by  the  Systemic  Transformation  Facility  (STF)  already  in  1994  and  by  a  stand-by 
arrangement in  1995, yet to be negotiated.  Balance of payments  support  and adjustment 
lending  is  also  expected  from  the  World  Bank  aimed  at financing critical  imports  and 
supporting  a  new  strategy 
in  the  energy  sector  However,  despite  substantial 
contributions  from  the  international  financial  institutions  and  rescheduling  of  existing 
arrears towards  Russia  and Turkmenistan,  substantial  residual financing gaps  remain to 
be filled by official  support to ensure the viability of the IMF programme. 

On  10  October,  the  ECOFIN  Council,  recognizing  the  political  importance  of  timely 
support  to  Ukraine's  emerging  reform  effort  has  indicated  that  it  would  contemplate 
conditional macro-financial  assistance to Ukraine from the Community. 

During  a  donors  pledging  session  held  on  18  October  by the  IMF  and  World  Bank  in 
Washington, the Commission announced its intention to make a proposal  for  Community 
macro-financial  assistance  to  Ukraine.  During  this  session,  Russia  and  Turkmenistan 
confirmed  their  support  in the form  of  rescheduling  of arrears  (some  US$  350  million  in 
1994). The United  States  committed  US$  70 to US$  100 million  of balance  of  payments 
assistance  (most  in  the  form  of  grants)  and  indicated  its  intention  to  provide  further 
financing  to help cover the  1995  financing  gap. The US  contribution  is expected  to  reach 
roughly  a  fifth  of  the  resources  needed  to  cover  Ukraine's  residual  external  financing 
needs during the  15-month period  to be covered  by the combined  STF/SBA  programme. 
Canada  also  gave  strong  assurances  and  Japan  made  clear  its  support  to  the  Ukrainian 
reform  efforts  but could not at this stage commit any specific  amounts. 

On the basis of the financing assurances given at the donors' meeting and on account of 
the steps undertaken by the Ukrainian  authorities  at the outset  of the programme,  the 
IMF Executive Board was able to approve the first tranche of the STF (US$ 365 mio) on 
26  October.  Subject  to  further  progress  with  economic  stabilisation  and  reform,  it  is 
expected that disbursements of the second tranche of the STF of an equal amount will be 
made in 1995, together with disbursements under a stand-by arrangement currently under 
negotiation. 

The Ukraine's economic programme 

Already  difficult  at  the time of  independence,  Ukraine's  macro-economic  situation  has 
steadily worsened  during the period  1990-93 owing mainly to the continued  absence of 
sufficient  political  support for  any  strategy to  deal with the disintegration  of  economic 
structures and links with the former  Soviet Union. Real GDP fell by roughly 35%, hyper 
inflationary  conditions  were  predominant  until  the  end  of  1993  and  severe  balance  of 
payments  problems  continued,  in  large  part  because  prices  of  energy  imported  from 
Russia and Turkmenistan have been moving towards world levels. Over the period as a 
whole,  general  lack  of  confidence  in  the  domestic  currency  led  to  a  growing 
demonetization of the economy and the implementation  of incoherent foreign  exchange 
policies and regulations. 

Following the election of Mr Kuchma as Ukraine's new President, the Government  and 
the  National  Bank  of  Ukraine  have  reached  an  understanding  with  the  IMF  on  a 
comprehensive macro-economic stabilization and policy-reform programme. 

In  accordance  with  this  programme,  a  number  of  measures  have  already  been 
implemented. In the area of economic liberalization, the authorities have reduced the role 
of  government  in  the  setting  of  prices.  In  particular,  subsidies  on  coal  and  electricity 
prices to industrial uses were cut. The authorities are committed to fully pass the implied 
increase in the cost of imported energy to industrial and agricultural users. In addition, a 
number  of  export  controls  were  abolished.  Finally,  the  interbank  auction  market  for 
foreign  exchange  was  reopened  and  the  government's  official  exchange  rate  for  the 
surrender of foreign exchange rate was abolished. 

Regarding  stabilization,  the  Government  and  the  Central  Bank  are  committed  to 
conducting the monetary and fiscal policies necessary to bring about a tasting decline in 
inflation,  which exceeded  10.000% in the course of  1993 and remains high even after  a 
substantial decline in the first half of 1994. The programme also foresees a curtailment of 
budgetary  expenditures  in  particular  for  coal  subsidies  and  support  to  the  agricultural 
sector. A revised budget for  1994 has been presented to Parliament in this context.  For 
1995, the Government plans to reduce the budget deficit relative to GDP by at least one 
half 

With regard to structural reform, the Government has already approved an action plan to 
remove  the  legal  obstacles  to  the  ability  of  enterprises  and  individuals  to  own  and 
transfer land. It is also committed to speed up privatization, to strengthen the governance 
of enterprises  remaining under  state  ownership  and to  tackle the problem  of  monopoly 
abuse.  In  addition,  the  authorities  pledge  to  begin  addressing  the  problem  of  non-
performing  loans  of  commercial  banks  and  to  strengthen  banking  supervision  and 
regulation in 1995. 

The reform and stabilization efforts in Ukraine should be enhanced further  in the context 
of the IMF stand-by arrangement for 1995. 

External outlook and financing needs 

With the move of energy  prices towards world  market  levels starting in  1992, Ukraine 
suffered  severe  terms  of  trade  shocks  both  in  1992  and  1993.  Given  the  heavy 
dependence of its production  on energy, Ukraine was forced  to  reduce  import  volumes 
both  for  energy  and  other  goods,  adding  further  to  the  economic  decline.  The  current 
account  deficit  widened  somewhat  to  US$  1 bn  in  1993. Given  the  continued  capital 
outflow, this was made possible by debt conversion agreements mainly with Russia. 

In  1994, the current  account  balance has deteriorated  further  to  an estimated  deficit  of 
US$  1.8  bn,  with the  accumulation  of  external  arrears  providing  the financing for  the 
balance of payments in the first three quarters. For the fourth  quarter  of  1994, the IMF 
expects a residual financing gap of US$ 600, after  contributions of the IMF (first tranche 
of  the  STF  in  the  order  of  US$ 365  mio)  are  taken  into  account.  After  taking  into 
account  the  rescheduling  of  arrears  (some  US$  350  mio)  committed  by  Russia  and 
Turkmenistan, the remaining gap is reduced to US$ 255 mio. 

Unless this gap can be closed,  Ukraine's  ability to  secure stable energy  supplies and  to 
meet its external financial commitments would be put into question. Hence, the  success 
of  the  whole  stabilization  and  reform  programme  to  which  the  Government  and  the 
Central Bank are committed  could be undermined before its expected positive effects  on 
the  balance  of  payments  (revival  of  exports,  reversal  of  short-term  capital  flows  and 
pick-up in foreign direct investment) could be realized. 

For  1995, the IMF expects that  in the context  of the envisaged  stand-by  arrangement, 
backing  strengthened  stabilization  and  reform  efforts,  the  residual financing gap  (after 
IMF and World Bank contributions are taken into account) will amount to  US$ 3.5 bn. 
Allowing for the expected rescheduling of arrears by Russia and Turkmenistan and for a 
build-up in reserves, the final residual needs for  1995 are estimated  in the order of US$ 
1.5 bn. 

Main features of the loan 

The Commission  is proposing that  the Community would  make available to  Ukraine  a 
balance of payments loan of ECU 85 million with a maximum duration often years. 

The assistance would be granted on the basis of the adoption of the STF arrangement. It 
would  complement  the  resources  made  available  by  the  International  Financial 
Institutions and would be subject to the following conditions: 

-  the régularisation of Ukraine's external financial relations with the Community; 

-  strong  commitments  by the  Ukrainian  authorities  to  implement  the  EU/G-7  plan  for 

the closure of Chernobyl; 

-  assurances that a stand-by arrangement between Ukraine and the IMF is within reach; 

-  satisfactory  burdensharing among the major donors (especially US and Japan). 

The  assistance  would  be  released  in  a  single  tranche  after  verification  of  the 
conditionally attached to it. The proposed duration of the loan (ten years) is consistent 
with the medium-term balance of payments outlook for Ukraine, which is expected  to 
face substantial financing needs for the years to come. 

As in the case of similar operations in favour of third countries, the Community would 
provide the funds through market borrowing with a guarantee by the general budget. 
Ukraine would subsequently borrow from the Community. The borrowing and lending 
operations  will  be  perfectly  matched  and  without  any  commercial  risk  for  the 
Community. 

In accordance  with  the  Guarantee  Fund  mechanism,  the  budgetary  implications  of  a 
decision to make available assistance of up to ECU 85 million to Ukraine would imply an 
ECU 12 million provisioning of the Fund. 

On the basis of a proper assessment of the residual financing needs of Ukraine for  1995 
and subject to further pledges from the other major donor countries,  the Commission 
may consider proposing supplementary macro-financial assistance for this country. 

5 

Proposal for a 

COUNCIL DECISION 

providing macro-financial assistance 

for Ukraine 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  establishing  the  European  Community,  and  in  particular 
Article 235 thereof, 

Having  regard  to  the  proposal  of  the  Commission1  submitted  after  consulting  the 
Monetary Committee, 

Having regard to the opinion of the European Parliament2, 

Whereas  Ukraine  is  undertaking  fundamental  political  and  economic  reforms  and  is 
making substantial efforts to implement a market economy model; 

Whereas Ukraine and the European Union have signed on a Partnership and Cooperation 
Agreement which will help the development of a full co-operation relationship; 

Whereas  Ukraine  has  agreed  with  the  International  Monetary  Fund  (IMF)  on  a 
comprehensive  set  of  stabilization  and  policy  reform  measures  to  be  supported  by  a 
purchase  under  the  IMF's  "systemic  transformation  facility";  whereas  this  facility  was 
approved  by the  IMF  Board  on  26  October  1994  and  whereas  further  discussions  are 
under  way  between  the  Ukrainian  authorities  and  the  IMF  on  a  macro-economic 
adjustment  and reform programme to be supported by a "stand-by arrangement"; 

Whereas  the  authorities  of  Ukraine  have  requested  financial  assistance  from  the 
international financial institutions,  the  Community  and  other  bilateral  donors; whereas, 
over  and  above  the  estimated financing which  could  be  provided  by  the  IMF  and  the 
World Bank, important residual financing gaps remain to be covered in the remainder of 
1994 and  1995 in order to  strengthen Ukraine's reserve position and  support  the policy 
objectives attached to the government's reform  effort; 

Whereas  the  Ukrainian  authorities  have  committed  :  to  pursue  promptly  with  the 
implementation  of the action  plan for  nuclear  safety  supported  by the European  Union 
and  the  G-7;  to  reach  rapidly  an  understanding  with  the  IMF  on  the  "stand-by 
arrangement"; and to fully  and timely service their external financial obligations towards 
the Community; 

Whereas a  Community  long-term loan to  Ukraine is  an appropriate  measure  to  help 
easing the countries' external financial constraints,  supporting the balance of payments 
and strengthening the reserve position; 

Whereas the Community loan should be managed by the Commission; 

» 

Whereas the Treaty does not provide, for the adoption of this Decision,  powers other 
than those of Article 235, 

HAS DECIDED AS FOLLOWS : 

Article 1 

1.  The  Community  shall  make  available  to  Ukraine  a  long-term  loan  facility  of  a 
maximum amount of ECU 85 million in principal with a maximum maturity of ten 
years,  with  a  view  to  ensuring  a  sustainable  balance-of-payments  situation  and 
strengthening the country's reserve position. 

2.  To this end, the Commission is empowered to borrow, on behalf of the European 
Community, the necessary resources that will be placed at the disposal of Ukraine in 
the form of a loan. 

3.  This  loan  will  be  managed  by  the  Commission  in  close  consultation  with  the 
Monetary  Committee  and  in  a  manner  consistent  with  any  agreement  reached 
between the IMF and Ukraine. 

Article 2 

1.  The Commission is empowered to  negotiate with the Ukrainian authorities,  after 
consultation  with  the  Monetary  Committee,  the  economic  policy  conditions 
attached  to  the  loan.  These  conditions  shall  be  consistent  with  the  agreements 
referred to in Article 1(3). 

2.  The Commission shall verify at regular intervals, in collaboration witb the Monetary 
Committee and in close  co-ordination  with the IMF, that the  economic  policy  in 
Ukraine is in accordance with the objectives of this loan and that its conditions are 
being fulfilled. 

* 

\ 

' 

• 

Articled 

1.  The loan shall be made available to Ukraine m a single tranche to be  released as 

soon as possible, subject to the provisions of Article 2. 

2.  The funds shall be paid to the National Bank of Ukraine. 

Article 4 

1.  The borrowing and lending operations referred  to in Article  1 shall be carried  out 
using  the  same  value  date  and  must  not  involve  the  Community  in  the 
transformation  of maturities, in any exchange or interest rate risk, or  in any  other 
commercial risk. 

2.  The Commission shall take the necessary steps, if Ukraine so wishes, to ensure that 
an early repayment  clause is included  in the loan terms  and  conditions and that  it 
may be exercised. 

3.  At the request of Ukraine, and where circumstances permit  an improvement  in the 
interest  rate  on  the  loans,  the  Commission  may  refinance  all  or  part  of  its  initial 
borrowings  or  restructure  the  corresponding financial conditions.  Refinancing  or 
restructuring  operations  shall be carried  out  in accordance with  the conditions  set 
out in paragraph  1  and shall not have the effect of extending the average maturity of 
the  borrowing  concerned  or  increasing  the  amount,  expressed  at  the  current 
exchange rate, of capital outstanding at the date of the refinancing or restructuring. 

4.  All  related  costs  incurred  by  the  Community  in  concluding  and  carrying  out  the 

operation under this Decision shall be borne by Ukraine. 

5.  The Monetary Committee shall be kept informed  of developments in the operations 

referred  to in paragraphs 2 and 3 at least once a year. 

Article 5 

At least once a year the Commission shall address to the European Parliament and  to 
the Council  a  report,  which will include  an evaluation,  on the  implementation  of this 
Decision. 

Done at 

, 

For the Council 

The President 

1.  Budget line concerned 

FINANCIAL RECORD 

Article  (...)guarantee  for  the  Community  loan  facility  to  Ukraine  (to  be  created 
through an amending and/or a supplementary budget). 

2.  Referencesflegal base) 

Article 235 of the Treaty 

3.  Classification of the Expenditure 

Obligatory 

4.  Description and Justification for the action 

a)  Description of the action 

The budget  entry  reflects  the  commitment  of the budget  guarantee  associated 
with the Community loan to  Ukraine designed to ensure a sustainable balance-
of-payments position and strengthening international reserves of this country. 

b)  Justification for the action 

The viabiUty  of  Ukraine's  external  accounts  heavily  depends  on  external financial 
assistance from official  sources. 

5.  Nature of the expenditure and method of calculation 

a> Nature of the expenditure 

Guarantee for the Community loan to Ukraine. 

b) Method of calculation 

A token  entry is proposed  given that the amount and timing of any call  on this 
budget line cannot be calculated  in advance and because it is expected  that  this 
budget guarantee will not be called. 

6.  Effect  of the action on intervention credits 

Only in the case of an effective call on the guarantee. 

7.  Financing of intervention expenditure 

-  Endowment  of  the  line  by  transfer,  by  reutilization  of  reimbursed  amounts 
(Article  27(3)  of  the  Financial  Regulation  of  1977),  or  by  amending  and/or 
supplementary Budget. 

-  In order to fulfil  its obligations, the Commission can provisionally ensure the debt 
service  with  funds  from  its  treasury.  In  that  case,  Article  12  of  the  Council 
Regulation (EEC, EURATOM) no. 1552/89 of 29.5.1989 will apply. 

a 

ANNEX 

BUDGETARY RESOURCES NECESSARY FOR THE PROVISIONING OF THE 
GUARANTEE FUND IN 1994 AND NOTIONAL MARGIN UNDER THE 
RESERVE FOR GUARANTEES 
(IN ECU MILLION) 

Operations 

Basis of the 
Calculation 

Provisioning of 
The Fund (U 

Reserve 
Margin 

Project related assistance 

EEB/CEEC 
EEB/MED 
EEB/PVDLA 
EURATOM 

Macro-financial  assistance 

Moldova 
Bulgaria 
Romania 
Algeria 
Slovakia 
Ukraine 

765 
100(3) 
500(4) 
150 

45 
40(5) 
125 
200(6) 
130(6) 
86(6) 

107 
14 
70 
21 

6 
6 
18 
28 
18 
12 

318(2) 

211 
197 
127 
106 

100 
94 
76 
48 
30 
18 

( 1 )  According to the provisioning rules agreed in the Council's common position of 13 

September  1993 

(2)  Reserve amount in 1994 under the financial perspective 
(3) 

Including amounts of estimated disbursements in 1993 and operations for Cyprus 
and Malta 
Including amounts of estimated disbursements in 1993 

(4) 
(5)  Commission proposal to increase the amount of assistance (ECU  110 million) 

decided in 1992 
(6)  Commission proposal 

y/C? 

wt 

Catalogue number : CB-CO-94-516-EN-C 

ISBN 92-77-81912-X 

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