Proposal for a COUNCIL DECISION providing further macro-financial assistance to Ukraine
Date: 1995-05-16
Institutions: European Commission
Subjects: Community loan, International Monetary Fund, Ukraine, cooperation agreement (EU), decommissioning of power stations, economic reform

COMMISSION  OF THE EUROPEAN  COMMUNITIES 

Brussels,  16.05.1995 
COM(95)  195  final 

95/0118(CNS) 

Proposal  for  a 

COUNCIL  DECISION 

providing further  macro-financial  assistance 
to Ukraine 

(presented  by the  Commission) 

EXPLANATORY  MEMORANDUM 

ECONOMIC  SITUATION  AND  PROGRESS  WITH  STABILIZATION  AND  REFORM 
In  October  1994,  Ukraine  embarked  on  a  radical  and  comprehensive  programme  of 
economic stabilization  and market  reforms. The Ukrainian  reform  efforts  were  supported 
by  an  IMF  arrangement  under  the  Systemic  Transformation  Facility  (STF)  approved  in 
October  1994 and  by  a rehabilitation  loan from  the  World  Bank  approved  in  December 
1994.  In  addition,  the  programme  was  backed  by  commitments  from  bilateral  donors, 
including  EU  macro-financial  assistance  of  up  to  ECU  85  million. 
Ukraine's  economic  conditions  remain  difficult.  Following  a  38% decline  of  real  GDP 
in the  period  1990-93,  output  is  estimated  to  have  contracted  by  another  23% in  1994. 
The  impact  of the  output  collapse  of the  official  economy  was  only  partly  offset  by  the 
rapid  growth  in  the  informal  sector.  But  at  the  beginning  of  1995,  economic  activity 
seems to  have  stabilized.  In the  first  quarter  of  1995, industrial  production  increased  by 
0.5%)  compared  to  the  previous  quarter.  Inflation  has  come  down  in  1994  from  record 
levels  observed  in  1993, but  is  still  high.  In  March  1995, consumer  prices  rose  11.4%. 
Ukraine's  balance of payments  situation  remains  fragile  since the economy  continues  to 
depend  heavily  on oil and  gas imports from  Russia and Turkmenistan  whose prices  have 
been  moving  towards  world  levels.  In  the  first  two  months  of  1995, Ukraine  continued 
to  accumulate  external  payment  arrears. 
In the context of the  STF programme, Ukraine made substantial  progress with  economic 
stabilization;  all  quantitative  financial  targets  under  the  STF  were  observed,  each  by  a 
significant  margin.  A  major  tightening  of  the  budget  was  implemented  bringing  the 
deficit  in  1994  down  to  8.6%  of  GDP  and  limiting  monetary  financing  of  the 
government  in the fourth  quarter to 5% of GDP. The bulk of fiscal adjustment  was made 
on the expenditure  side, with sharp reductions  in subsidies to coal mines, agriculture  and 
communal  services.  Monetary  conditions  were  also  tightened.  In  late  October, 
commercial  credit  to  the  non-government  sector  was  frozen  for  the  remainder  of  1994 
and  the  central  bank's  refinance  rate  was  increased.  The  Ukrainian  authorities  also 
reopened  the  interbank  currency  exchange,  unified  the  official  exchange  rate  with  the 
rate  prevailing  in the  currency  exchange  and  established  convertibility  for  most  current 
account  transactions.  There  was  also considerable  progress  with  structural  reform,  even 
though  several  actions  subject  to  structural  benchmarks  under  the  STF  were  postponed. 
Under  the  programme,  the  authorities  advanced  considerably  towards  full  price 
liberalization,  including  with  the  revoking  of  controls  on  profit  margins.  Administered 
prices  set  by  the  State  were  raised  for  rents, utility  charges, bread  and  energy  products. 
The  Government  also  took  a  number  of  steps  toward  reducing  the  role  of  the 
Government  including the formulation  of the mass privatization programme for  1995 and 
the  preparation  of  the  elimination  of  the  old  system  of  state  orders  starting  from  1 
January  1995. To  shelter vulnerable groups from  the impact of the adjustment  measures, 
minimum  pensions  and  social  benefits  were  raised. 

T HE  GOVERNMENT'S  STABILIZATION  AND  REFORM  PROGRAMME  FOR  1995 
The Ukrainian  authorities are fully  committed  to continue  and enhance their  reform  and 
stabilization  efforts.  On  7  April  1995,  the  IMF  Board  approved  a  12-month  Stand-by 
arrangement  (SBA)  and  the  second  tranche  of  the  STF  in  support  of  Ukraine's  macro-
economic  programme  for  1995.  This  programme  has  three  main  objectives:  reducing 
inflation  through  tight  financial  policies,  liberalizing  the  export  potential  by  removing 
administrative  obstacles  and  stimulating  economic  recovery  with  structural  reforms. 
With  respect  to  stabilization,  the  Government  aims  at bringing  monthly  inflation  down 

Ai 

to  1% in  December  1995.  One  important  element  in this  strategy  is the  sharp  reduction 
of  the  State  budget  deficit  to  3.3%  of  GDP.  The  corresponding  budget  proposal 
approved  by the  Parliament  on  6 April  1995 also contained  a number  of revenue  raising 
measures to compensate  for reduced  budget revenues resulting  from  recently adopted  tax 
reforms.  On the expenditure side, except  for social expenses and subsidies to households, 
all other  budgetary  expenditures  will  be reduced  by over  10% of GDP compared  to  their 
1994  level.  The  National  Bank  of  Ukraine  has  adopted  a  monetary  programme  that  is 
consistent  with  this budget  and  with the  objective  of lower  inflation.  It includes  keeping 
the rate of increase  of broad  money  substantially  below the projected  rate of increase  of 
nominal  GDP  and  severely  constraining  net  real  credit  to  the non-government  sector  in 
the  first  half  of  1995. 
The  Government  also  intends  to  complete  the  far-reaching  reform  of  the  trade  system 
initiated  in  the  second  half  of  1994.  It  has  already  decided  to  abolish  all  remaining 
quotas  and  licenses  other  than  on  grain  and  goods  subject  to  voluntary  export  restraint 
(VER)  under  international  agreements.  It  also  intends  to  abolish  quotas  on  ferrous  and 
non-ferrous  metals  and  on  grain  by  mid-1995.  In  addition,  the  authorities  are  now 
considering  to  reduce  or  even  abolish  the  50% foreign  currency  surrender  requirements 
for  export  receipts. 
The  Ukrainian  Government  has  in  parallel  undertaken  to  deepen  structural  reform.  It 
envisages  to  largely  complete  price  deregulation  this  year  by  removing  the  existing 
restrictions  on  price  increases  by  artificial  monopolies.  Prices  of  goods  and  services 
provided  by  natural  monopolies  will  be  further  adjusted  ensuring  a  gradual  decline  in 
subsidies.  A  major  privatization  effort  is planned  for  1995, aiming  at the  completion  of 
the  privatization  of  8,000  medium  and  large  enterprises  by  year-end  through  vouchers, 
as  well  as  of  90%  of  small-scale  enterprises.  Foreigners  will  be  allowed  to  participate 
in  cash  privatization.  The  authorities  also  intend  to  improve  enterprise  governance. 
Bankruptcy  procedures  are  expected  to  be  simplified  and  land  reform  will  be  further 
pursued. 

PREVIOUS  MACRO-FINANCIAL  ASSISTANCE  TO  UKRAINE 
On  22  December  1994,  the  Council  (Decision  94/940/EC)  decided  to  provide  macro-
financial  assistance  in the  form  of  a long-term  loan  of up to  ECU  85  million  to  support 
Ukraine's  adjustment  and  reform  process. 
This  loan  facility  was  made  conditional  upon  agreement  between  IMF  and  Ukraine  on 
a  Stand-by  arrangement  and  the  rapid  implementation  of  the  EU/G-7  Nuclear  Safety 
Action  Plan.  In  addition,  it  was  understood  that  the  mobilization  of  macro-financial 
assistance  for  Ukraine  would  require  that  the  country  fully  and  timely  services  its 
financial  obligations  towards  the  Community. 
Now that the Stand-by  arrangement  has been approved  and substantial  progress has been 
achieved  towards  the  closure  of the  Chernobyl  power  plant,  the  Commission  intends  to 
proceed  rapidly  with  the  implementation, of  the  ECU  85  million  loan  facility. 

FINANCING  NEEDS  FOR  1995 
Following  the  severe terms  of trade  shocks  Ukraine  experienced  both  in  1992 and  1993 
and  given  the  heavy  dependence  of  its  production  on  energy,  the  country's  external 
situation  remains  very  constrained.  Ukraine  faces  a  high  starting-level  current  account 
deficit  and  a  rising  debt  burden.  At  the  same  time,  the  country  requires  an  increase  in 
non-energy  imports  that  had  been  previously  reduced  if  restructuring  is to  proceed. 
The  IMF  estimates  that  in  the  context  of  Ukraine's  macro-economic  programme 
supported  by  the  SBA,  and  assuming  a  stabilization  of  the  current  account  deficit  at 

some US$  1.5  bn and an increase  in international  reserves of US$ 800 mio,  Ukraine's 
external  residual  financing  needs over  and  above  IMF and  WB contributions  for  1995 
are in the order of US$ 3.4 bn. After  taking into account the rescheduling of Ukraine's 
arrears, mainly  by Russia, this gap is reduced  to about  US$ 900 mio. 
Unless this remaining  gap can be closed,  Ukraine's  ability to  secure  stable energy and 
other import 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, including the revival  of exports, 
the  reversal  of  short-term  capital  flows  and  the  pick  up  in  foreign  direct  investment, 
could be  realized. 

PROPOSED  FURTHER  MACRO-FINANCIAL ASSISTANCE AND MAIN FEATURES OF THE LOAN 
The  Commission  is proposing that the Community  would make available to Ukraine a 
balance  of payments  loan of up to ECU  220 million  with  a maximum  duration  of ten 
years. The proposed duration of the loan 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. 
The  assistance  would  be  granted  in  the  context  of  the  present  SBA  and  would 
complement  resources  made  available  by  the  International  Financial  Institutions  and 
bilateral  donors. 
The assistance  would  be released  in two tranches  subject  to a satisfactory  track  record 
of Ukraine's macro-economic programme agreed with the IMF and progress with respect 
to  structural  reforms  (including  observance  of  a  number  of  performance  criteria).  Its 
effective  implementation would take place on the understanding that Ukraine will service 
fully  and  timely  its  financial  obligations  towards  the  Community  and  will  pursue 
according  to  schedule  with the closure  of Chernobyl. 
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  would  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 220 million to Ukraine would imply 
an ECU  33 million provisioning  of the Fund. 

Proposal for a 

COUNCIL DECISION 

providing further 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  the  authorities  of  Ukraine  have  requested  financial  assistance  from  the 
International  Financial  Institutions,  the Community  and other  bilateral  donors; 
Whereas Ukraine has agreed with the International Monetary Fund (IMF) on a "stand-by 
arrangement"  and  a  second  purchase  under  the  "systemic  transformation  facility" 
supporting Ukraine's comprehensive stabilization and reform programme; whereas these 
facilities  amounting to approximately US$  1.9 billion were approved by the IMF Board 
on  7  April  1995; whereas  policy  based  loans  to  Ukraine  of  approximately  US$  600 
million  are also  expected  from  the  World  Bank  in  1995; 
Whereas, over and  above the estimated  financing  which  could  be provided  by the IMF 
and the World Bank, a residual financing  gap of US$ 3.4 billion remains to be covered 
in  1995  in  order  to  support  the policy  objectives  attached  to the  government's  reform 
effort;  whereas after  rescheduling of Ukrainian debts towards Russia and Turkmenistan, 
this  gap  is  reduced  to  US$  900  million;  whereas  substantial  contributions  are  also 
expected  from  the United  States and Japan; 
Whereas by  Decision  94/940/EC3, the  Council  approved  macro-financial  assistance  for 
Ukraine of up to ECU 85 million; whereas, however, further  official  support is required 
in order to support the balance of payments, consolidate the reserve position and comfort 
the  necessary  structural  adjustment  of that  country; 
Whereas  the  Ukrainian  authorities  are  committed  to  pursue  promptly  with  the 
implementation  of the plan for the closure of the Chernobyl nuclear power plant by the 
year 2000, in accordance  with the modalities  supported by the Group of Seven and the 
European  Union; 
Whereas an additional Community long-term loan to Ukraine is an appropriate measure 
to help easing the country's  external  financial  constraints; 
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, 

OJN°  L366, 31.12.94,  p. 32 

HAS DECIDED AS FOLLOWS : 

Article 1 
1.  The  Community  shall  make  available  to  Ukraine  a  long-term  loan  facility  of  a 
maximum principal  amount of ECU 220 million with a maximum maturity  of ten 
years,  with  a  view  to  ensuring  a  sustainable  balance-of-payments  situation, 
strengthening  the country's reserve position and comforting  the implementation of 
the necessary  structural  reforms. 

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  agree  with  the  Ukrainian  authorities,  after 
consulting 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 with 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. 

Article 3 

1.  The loan shall be made available to Ukraine in two instalments. The first instalment 
shall not be released before one quarter after the release of the ECU 85 million loan 
approved by Council Decision 94/940/EC, subject to the provisions of Article 2 and 
to progress in Ukraine's application of the "stand-by arrangement" agreed  with the 
IMF. 

2.  Subject to the provisions of Article 2, the second instalment shall be released on the 
basis of a satisfactory  continuation of the "stand-by arrangement" and not before one 
quarter  after  the release  of the first instalment. 

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

2.  Referencesdegal  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's  borrowing  and  corresponding  lending  operations  to 
Ukraine. 
Justification for  the  action 
The  viability  of  Ukraine's  external  accounts  heavily  depends  on  external 
financial  assistance  from  official  sources. 

b) 

5.  Nature of the expenditure  and method  of  calculation 

a)  Nature of the  expenditure 

Potential activation of budget guarantee for the Community borrowing aimed 
to fund  the  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 

-  Recourse  to  the  Guarantee  Fund  established  by  Council  Regulation  (EC, 

EURATOM)  n° 2728 of 31 October  1994. 

-  In  case  the  Guarantee  Fund  did  not  contain  sufficient  resources,  additional 
payments  would  be  called  up  from  the  budget  by  transfer,  by  reutilisation  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. 

ANNEX 
BUDGETARY  RESOURCES  NECESSARY  FOR  THE  PROVISIONING  OF  THE 
GUARANTEE  FUND IN  1995 AND MARGIN  UNDER  THE  RESERVE  FOR 
GUARANTEES 
(IN ECU  MILLION) 

Operations 

Basis of the 
Calculation 

Provisioning of 
the Fund(l) 

Reserve 
Margin 

* 

Project  related assistance 
EIB/CEEC 
EIB/MED 
EIB/PVDLA 
EIB/SOUTH AFR. 
EURATOM 

1121 

52.5 

139 
125(3) 
50 

157 

7.3 
19.5 
18.7 
7 

323 (2) 

166 
158.7 
139.2 
120.5 
113.5 

Macro-financial  assistance 
Bulgaria 
Belarus 
Ukraine-II 

40(4) 
75 (5) 
220(3} 

6 
11.25 
33 

107.5 
96.2 
63,2 

(1)  According to the provisioning rules provided in the Council regulation (EC, EURATOM) n° 
2728/94 of 31 October  1994. After a first drawing of the Guarantee Fund, and in compliance 
with Article 5 of the Regulation, the rate of provisioning for new operations is being increased 
from  14 % to 15% in 1995. For 1995, all EIB and EURATOM operations approved  in 1993 
and  1994 have been provisioned with a 14% rate. New macro-financial assistance operations 
have been provisioned with a 15% rate, 

(2)  Reserve amount in  1995 under the financial perspective. 
(3)  Commission proposal. 
(4)  Commission proposal (COM(94)l 18 of 21.11.1994,94/0103(CNS)) to increase the maximum 
amount of the existing loan facility to Bulgaria from  ECU 110 million to ECU 150 million. 

(5)  Council decision of  10 April 1995. 

I 

ISSN 0254-1475 

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