COMMISSION STAFF WORKING DOCUMENT Ex-ante evaluation statement on EU macro-financial assistance to Ukraine Accompanying the document Proposal for a Decision of the Council providing macro-financial assistance to Ukraine
Date: 2014-03-19
Institutions: European Commission
Subjects: EU aid, Ukraine, economic stabilisation, financial aid, macroeconomics, political reform













EUR-Lex - 52014SC0112 - EN











|



52014SC0112

COMMISSION STAFF WORKING DOCUMENT Ex-ante evaluation statement on EU macro-financial assistance to Ukraine Accompanying the document Proposal for a Decision of the Council providing macro-financial assistance to Ukraine /* SWD/2014/0112 final */









1............ Problem analysis and needs assessment 3
1.1......... Introduction. 3
1.2......... Ukraine's
macroeconomic situation. 4
1.3......... Structural
reform challenges. 7
1.4......... International
support to Ukraine. 8
1.5......... Ukraine's
external financing needs. 10
2............ Objectives
and related indicators of the macro-financial assistance. 10
2.1......... Objectives. 10
2.2......... Conditionality. 11
2.3......... Indicators. 11
2.4......... Delivery
mechanisms. 11
2.5......... Risk
assessment 12
3............ Added
value of EU involvement 14
4............ Planning
of future monitoring and evaluation. 14
4.1......... Monitoring. 14
4.2......... Evaluation. 15
5............ Achieving
cost-effectiveness. 15

1.                      
Problem analysis and needs assessment
1.1.                
Introduction

The Ukrainian economy has been in recession since
the second half of 2012, with only one quarter of positive growth in the end of
2013, which was quickly reversed in the first two months of 2014 as a result of
the deterioration of the political and security situation.
The Ukrainian government lost access to international
financial markets during 2013 as confidence dropped in view of the widening
fiscal and current account and in the absence of much needed reforms, including
as regards utility tariffs, adjustments of the exchange rate of the hryvnia
(UAH) and business climate. The unwillingness of the authorities to commit to
reforms also prevented them from concluding a financing agreement with the IMF.

Ukraine's government
bond rating was initially downgraded by Moody's from B3 to Caa1 in September
2013 and by S&P and Fitch in November from B to B-. Since then, S&P
further downgraded Ukraine to CCC+ on 28 January 2014 and to CCC on 21
February, Moody's to Caa2 on 31 January and Fitch to CCC on 7 February,
entering into a default risk category. Ukraine now has three C-level ratings,
which is the first such occurrence in Ukraine's rating history. As a result of
large debt repayments in the fourth quarter of 2013 and beginning of 2014 and
of the central bank's interventions to defend the currency peg against the dollar,
reserves have dropped dramatically to USD 15.5 billion at the end of February,
leaving Ukraine with a very weak and rapidly worsening balance-of-payments
situation. The current political crisis has very damaging effects on Ukraine's already precarious economic and financial stability. The
de facto interruption of Russia's assistance under its USD 15 billion package
agreed last December, and the announced end to the reduced gas prices granted
by Gazprom from April 2014 onwards, will deteriorate the situation even
further. Under these circumstances Ukraine faces a serious risk of default in
the near future.
At the same time, during the month of February and
following mass protests on-going since end-November, the government resigned in
February. A new government was approved by the Verkhovna Rada on 27 February
and there was a reversal to the 2004 Constitution. Despite these changes, Ukraine has not been able to return to political stability since the sovereignty and territorial
integrity of Ukraine has recently been violated by the Russian Federation.
The new government immediately invited the IMF to
come for a fact finding mission and discussions on a comprehensive reform
programme going forward. The new government has publicly committed itself to
begin implementing significant and comprehensive reforms before the 25 May
presidential elections. Although the political process at the moment is
volatile, so far it shows clear signs of a commitment to economic reforms.  
Against this background, the Ukrainian authorities
are seeking financial assistance from the multilateral and bilateral creditors
and donors to support a reform programme, currently under preparation, that
would reduce economic vulnerabilities, boost international reserves and foster
economic growth. The IMF sent a staff mission to Ukraine in the beginning of
March and is expected to play the key role in the preparation of this programme
and mobilisation of international financial assistance to Ukraine. In the next weeks, the IMF and the Ukrainian authorities are expected to come to an
agreement on an economic programme that will be supported by a financing
arrangement.
It is expected that the external financing needs of Ukraine will exceed the funding likely to be provided by the IMF. In this context, the
European Commission announced on 5 March 2014 a package of financial support to
  Ukraine, that was welcomed by the EU Heads of State or Government the day
after. One of the elements of the package is a new Macro-Financial Assistance
(MFA) programme in the amount of up to EUR 1 billion. 
The European Commission submits to the Council a
proposal to grant MFA to Ukraine amounting to a maximum of EUR 1 billion. The
assistance would take the form of medium-term loans, with no grant component
being envisaged given that Ukraine does not meet the eligibility criteria for
the use of grants in MFA operations. 
The
proposed EU MFA is intended to help Ukraine cover part of its urgent  external
financing needs in the context of the stabilisation and reform programme
currently under preparation, reducing in this way the economy’s short-term
balance of payments and fiscal vulnerabilities. The proposed assistance would
support the urgent fiscal consolidation and external stabilisation and
encourage the implementation by the authorities of structural reforms aimed at
improving the overall macroeconomic management, strenghtening economic
governance and transparency and improving conditions for sutainable growth. 
The
proposed MFA is in line with the aims of the Eastern Partnership and the
orientations of the new European Neighbourhood Policy (ENP). It would signal to
the other countries in the region that the EU is ready to support countries
embarking on political reforms, in moments of economic difficulties. 

1.2.                
Ukraine's macroeconomic
situation

After
5 quarters of consecutive decline, real GDP grew by 3.3% y/y in 4Q2013,
leading to flat growth for the year 2013. The poor performance of the economy
was due to a combination of a bad harvest, decline in steel exports and delayed
domestic reforms. According to the IMF, it is believed that growth negative in
January and February. Due to the volatile situation forecasts for 2014 range
from -5% to +3% depending on assumptions. Macroeconomic adjustments, including
fiscal consolidation and exchange rate flexibility, will have contractionary
effects, but on the other hand, the foreseen IMF arrangement would increase
confidence that could lead to FDI inflows quite quickly. Still, Russia's policy towards Ukraine signifies a substantial downside risk to growth.   
Inflation
has been very low in the last few years, reaching 0.3% at end-2013; however
inflationary pressure has increased in 2014. CPI was 0.5% in January and 1.2%
in February and the National Bank of Ukraine (NBU) expects it could reach 10%
or more by end-2014, as a result of the depreciation of the hryvnia (UAH) and
the expected increase in energy tariffs for households.
The
fiscal deficit, including Naftogaz operational deficit, was estimated at
6.5%-7.5% of GDP in 2013, largely as a result of continued energy subsidies,
which amount to 7% of GDP, but also as a result of the economic slowdown.
Capital expenditure was cut by 40% in 2013, while VAT revenues dropped by 7%.
The 2014 budget was passed by the Rada in early January, but was based on
unrealistic assumptions of growth and inflation and is currently being revised
by the Ministry of Finance in close cooperation with the IMF. Revenues in
January-February 2014 amounted to 82% of what was planned in the budget,
suggesting that expenses need to be cut by around UAH 80 billion, or 15-17% in
2014. In addition, the gas import price from Russia will be increased on 1
April to at least 400 USD per 1000 cubic meters, putting significant strain on
the budget. However, the Minister of Finance has made assurances that gas
tariffs for households and district heating companies will be increased before
the 25 May elections, alleviating this pressure. An additional issue is
arrears, both of VAT refunds to corporates and overdue subsidy payments to
utility companies, amounting to UAH 12bn and UAH 8bn respectively. 
There
has been strong pressure on the local currency since the outbreak of the
crisis. The NBU has allowed the hryvnia to depreciate significantly (by about
25%) in February. Part of this was a deliberate devaluation of the official
exchange rate on 7 February from the 7.99 UAH/USD that had been kept since July
2012 to 8.708 UAH/USD. Later the depreciation of the currency sped up as a
result of the NBU's inability to intervene due to very low foreign exchange
reserves. In agreement with the IMF, the NBU is now pursuing a policy of
non-intervention, except in cases of significant exchange rate movements. It is
also maintaining a number of capital controls, but says it will refrain from
introducing new ones. The hryvnia remains volatile, despite these measures.
Further significant devaluation of the currency would risk deterioration of
credit portfolios and capital of banks and would not necessarily rebalance the
current account as much of exports are dependent on imported inputs. In
addition, the Ukrainian economy is consumption-driven (75% of GDP) and
devaluation with accompanying inflation would likely have a contractionary
effect on GDP. 
The
current account deteriorated significantly in 2013
to an estimated deficit of 10% of GDP reflecting mostly decreased exports. The
NBU expects a significant narrowing of the current account deficit in 2014 as a
result of adjustments connected to the foreseen IMF arrangement, including
fiscal consolidation. Yet, current account financing needs will remain
substantial in the short run – at least USD 4 billion before the end of the
second quarter of 2014. Net FDI is estimated to have dropped further from 5.0%
of GDP in 2012 to 2.6% of GDP in 2013 and was near 0% in January 2014. 
External
debt was estimated at 76.7% of GDP at
end-2013. Only about one-third of it is owed or guaranteed by the public
authorities (including debt of the National Bank to the IMF). In addition to
publicly guaranteed liabilities of some Ukraine's corporate borrowers, e.g.
State guaranteed Eurobonds issued by Naftogaz, other external liabilities of Ukraine's corporates may have a systemic importance for the country. In particular,
Naftogaz' debt (in arrears) for gas shipments from Russia's Gazprom has direct
implications for the country's current account as Gazprom sets its price
depending on Naftogaz' debt payment record.
Official
reserves declined by 16% to USD 20.4 billion in
the course of 2013, as a result of the large current account deficit, pressure
on the hryvnia and significant debt repayments in 2013. This negative trend
continued in January and February when reserves dropped a further 13% per month
to USD 15.5 billion at end-February (2 months of 2014E import cover). This
development clearly reflects an increased balance-of-payments vulnerability.
At
41% of GDP (end-2013), public debt is below the high-risk benchmark. At
the same time, public debt servicing obligations, in particular on external
debt or on foreign currency denominated domestic debt, weigh heavily on public
finances and international reserves in the near future. Total debt service of
the government and the NBU for the rest of 2014 amount to about USD 10 billion.
Debt payments peak between June and September. In the period March-May debt
service amounts to approximately USD 2 billion. In addition, the outstanding
Naftogaz' debt to Gazprom amounts to another USD 2 billion. Debt payment
obligations in 2015 are about USD 10 billion.
According
to the NBU, there is sufficient liquidity in the banking sector, but no
credits are extended to corporates since February. Deposit erosion amounted to
some 2% in January and about 8% in February. Possible further currency
devaluation would present problems for the banking sector and asset quality has
the potential to fall quickly. The banking sector is in need of a thorough
asset quality review. Beyond short-term risks, the banking sector in Ukraine presents some structural weaknesses that are likely to be a focus of a reform
programme supported through the foreseen IMF arrangement. There are clear
weaknesses in bank supervision and corporate governance in the banking sector
and a lack of protection of creditor rights.
Reliable
data on external financing needs are difficult to obtain at this point. Public
F/X liabilities consist of debts to International Financial Institutions (IFIs
– IMF, EBRD, WB, EIB), Eurobonds (issued by both the government and by Naftogaz
and guaranteed by the government), F/X-denominated domestic treasuries (held by
around 20 private companies) and a state-guaranteed loan to Naftogaz by
Gazprombank. Total debt service of 2014 of the government and the NBU amount to
between USD 9.7-13.8 billion, of which 1.6 billion appear to have been already
paid in January-February, leaving USD 8.1-12.2 billion for the rest of 2014.
Debt payments peak in June (total 1.3 billion of which 1 billion in Eurobonds
maturing on 4 June), July (total 1.1 billion of which 0.7 billion to IMF) and
September (total 2.1 billion of which 1.6 billion in Naftogaz-issued Eurobonds
guaranteed by the State). In the next three months (March-May) debt service
amounts to approximately USD 2 billion consisting mainly of payments to the
IMF. In addition, the outstanding Naftogaz' debt to Gazprom for gas deliveries
amounts to USD 1.9 billion (USD 1.3-1.47 billion for 2013 + USD 0.2-0.4 billion
for February 2014), whereas the January debt was paid on 6 March. Gas imports
in February should have been paid by 7 March.

1.3.                
Structural reform challenges

Despite
an ambitious Programme for Economic Reforms for 2010-2014 (PER), implementation
of key structural reforms were below expectations under the former government.
Notwithstanding the declared policy goal of an improved business climate in Ukraine, there were a number of adverse trends, such as an increase of corruption,
insufficient progress in public finance management reform, and increased
pressure on business from tax and customs administrations. 
Fiscal
consolidation is a major challenge for the new
government to deal with. The general government deficit equalled 6.5%-7.5% of
GDP in 2013; it is largely due to energy price subsidies and to the
quasi-fiscal deficit of the energy company Naftogaz (around 2% of GDP in 2013).
Payment discipline in the utilities sector is an issue. Energy tariffs
for households and district heating companies must be increased as soon as
possible. Tariff increases should be complemented by a targeted social
assistance programme to support the poorer parts of the population.
Corruption
is widespread in Ukraine, especially in the area of taxation and customs where,
until now, there is an almost complete lack of transparency. These challenges
are reflected in Ukraine's low ratings, by regional standards, in a number of
comparative studies. There is a clear need for an audit control system of tax
and customs to get rid of this structure. The new government has made
anti-corruption one of its top priorities leading up to the 25 May elections.
The government has already announced it will return Tax Revenue and Customs to
the Ministry of Finance after they were joined last year under former Minister
Klymenko. The justice system is weak and unable to deal with the significant
backlog of court cases on business malpractice. Tackling corruption should
improve investor confidence and the overall business climate in the medium to
long term. 
The
financial sector would benefit from a thorough
asset quality review of individual banks to determine their vulnerability
(especially systemically important banks) to further destabilisation of the
economy, including further devaluation. The NBU should be strengthened in its
role as bank supervisor. Regulatory forbearance is a major problem and
enforcement of creditor rights is extremely weak, which has a significant
impact on the business climate.
Over
the short-to-medium term, Ukraine's government needs to deliver on key reforms,
improve fiscal sustainability while addressing the investment climate, rein in
corruption, and diversify the economy. In addition, the exchange rate policy
should gradually move towards a free float in order to avoid a further widening
of the current account deficit and a continued drain of the country's
international reserves.

1.4.                
International support to Ukraine

In 
early March 2014 the IMF sent a fact finding mission to Ukraine to assess the latest economic developments and external financing needs and to
establish initial contact with the new government. The mission started also
preliminary discussions on the priority policy measures to be adopted by the
authorities and on a possible financing arrangement with the IMF. It is
expected that such an arrangement will be put in place in the near future, but
at the time of the preparation of the proposal its main parameters, timeframe
and the amount of IMF financing were still not determined. 
The
World Bank intends to provide to Ukraine support of up to USD 3 billion
in 2014. Out of this amount, one-third would be in the form of budget support,
under two Development Policy Loans (DPLs) of USD 500 million: a general DPL and
a financial sector DPL. Further USD billion under the same operations would be
available in 2015. 
The
EBRD's active portfolio in Ukraine currently amounts to some €4.5bn and
183 projects. Ukraine is the EBRD’s second largest country of operations. In
2013, there were 31 signings to the value of €798m, all of them non-sovereign
with the exception of the Nuclear Safety project (€300m). Indicative Annual
Bank Investment (ABI) in 2014 has been structured at between €550-750m.
As part of the international community’s help, the EBRD would have the capacity
to invest around €800 million to a billion annually in Ukraine over the next few years.
A
EURATOM Loan Facility and a Guarantee agreement of EUR 300 million was
signed in July/August 2013, to be complemented with a EUR 300 million loan from
the EBRD (referred to above). 
In
2012 and 2013, the US provided over USD 200 million in foreign
operations assistance to Ukraine. In 2014, a similar annual amount of
cooperation assistance is foreseen; however the US has also announced it will
support Ukraine through a USD 1 billion loan guarantee scheme.
In addition to the MFA,
the EU assistance will be also provided through the European Neighbourhood
Instrument (ENI).
The Commission is currently funding a number of
on-going sector budget support and technical assistance programmes
(approximately €400 million) which will provide input to the new Government in
key areas such as economic development, public financial management and justice.
The Commission is currently preparing a €300 million
Annual Action Programme 2014 including a State Building Contract to assist the
Government of Ukraine in promoting sustainable and inclusive growth, and
consolidating and improving democratic and economic governance. This will be
complemented by actions in favour of civil society.

For the remaining period of 2015-2020, a yearly
bilateral envelope of approximately €130 million is currently foreseen as part
of the ENI with an additional €40-50 million per year from the afore-mentioned
umbrella programme ("more-for-more") subject to proven progress in
deepening democracy and respect of human rights and further significant funding
from the Neighbourhood Investment Facility (NIF) described below.
The NIF will be mobilised in favour of bankable
investment projects in Ukraine. Experience with the implementation of the NIF
in the East over the past programming period has shown that, for an amount of
€200-250 million of grants foreseen for Ukraine for blending, one could expect
a leverage effect that would generate loans of up to €3.5 billion. The
participation of IFIs will be crucial to allow this leveraging and to exploit
its full potential. 
The Instrument contributing to Stability and Peace
(IcSP), formerly the Instrument for Stability, could be deployed to target
urgent actions, for example, on police reform and electoral support. Up to €20
million could be mobilised quickly if appropriate actions are identified and a
further €15 million could be added from the Common Foreign and Security Policy
(CFSP) budget to support measures in relation to security sector reform. 
Additional support to non-state actors will also be
delivered through thematic programme such as the Civil Society Organisations
and Local Actors and the European Instrument for Democracy and Human Rights
(EIDHR). 
Finally, Ukraine is the most important country for
the EU for operations in the area of nuclear safety and security. Currently,
projects are being implemented under the Instrument for Nuclear Safety
Cooperation for a total amount of €50 million, in the field of nuclear waste
management and social projects in the affected area around the Chernobyl exclusion zone. In addition, a further envelope of €36.5 million can be
contracted in the short term for actions in this field. The programming period
for the new financial 
The
EIB currently operates in Ukraine under the Eastern Partner Countries
Mandate 2007-2013 which provides an EU guarantee to EIB lending (within a
regional ceiling of EUR 4.05 bn for the Eastern Neighbourhood and Russia
following the reallocation of additional EUR 200m, and a climate change mandate
estimated at around EUR 300m for the region) and under the Eastern Partners
Facility (EPF – facility at the own risk of the Bank) with EUR 1.5 bn (out of
which up to EUR 500 m for Russia). Under the future External Mandate
(2014-2020), the regional ceiling for the Eastern Countries amounts to EUR 4.83
bn.
In order to help ensure effective delivery and
maximise the impact of the international economic and development assistance to
  Ukraine, the Commission is exploring avenues to enhance international donor
coordination by setting up, together with the international community and IFIs,
an ad hoc donor coordination mechanism. Such a mechanism could take work
forward on the basis of a needs assessment and of the reform programme prepared
by the Ukrainian authorities with the IMF support, and provide a sustainable
way out of Ukraine’s difficult economic situation supporting economic and political
transition.
In donor coordination mechanism proposed by the
Commission would take the form of an international platform based in Kiev which would meet regularly to closely coordinate donor efforts to address the economic
situation of the country. The political guidance will be provided by high level
coordination meetings of the international platform. The Commission is willing
to host the meetings in Brussels. This mechanism is open to the participation,
namely, of EU Member States, IMF, World Bank, EBRD, EIB, and interested third
countries.

1.5.                
Ukraine's external
financing needs

Based
on the available preliminary indications, in 2014 and 2015 Ukraine will be
facing significant external financing needs reflecting in particular a still
substantial current account deficit, large external debt payment obligations
and the need to re-build a minimum buffer of foreign exchange reserves. Also,
private capital inflows, in the form of foreign direct investments or private
credits, will remain extremely low. It is expected that preliminary projections
of Ukraine's residual external financing needs will become available in the
coming weeks, in view of the results of the on-going technical discussions the
Ukrainian authorities are conducting with the IMF. But already now it is
anticipated that a wider international support will be required to cover these
needs and create conditions for a successful implementation of the reforms in Ukraine. The proposed EU MFA would contribute to cover part of the residual financing gap
for the 2014-2015 period.

2.                      
Objectives and related indicators of the
macro-financial assistance
2.1.                
Objectives

The
objectives of the proposed MFA operation are to: 
·      Contribute to covering the external financing needs of Ukraine in the context of a significant deterioration of the country's external accounts
brought about by the on-going political and economic transition. 
·      Alleviate Ukraine's budgetary financing needs.
·      Support the fiscal consolidation effort and external stabilisation
in the context of the foreseen IMF programme.
·      Facilitate and encourage efforts of the authorities of Ukraine to implement measures identified under the EU-Ukraine Association Agenda, while
reinforcing the EU's economic policy dialogue with the authorities.
·      Support structural reforms aimed at improving the overall
macroeconomic management, strenghening economic governance and transparency,
and improving conditions for sustainable growth.

2.2.                
Conditionality

In
view of the critical need for Ukraine to implement strong macroeconomic
policies and ambitious reforms, it is not deemed appropriate to disburse the
new programme without specific conditionality. The assistance will be
conditional to an IMF arrangement being in place and to the implementation by Ukraine of specific structural reform measures that will be agreed by the Commission on behalf of
the EU and Ukraine in a Memorandum of Understanding, to be negotiated between
the Commission and the Ukrainian authorities. The preparation of the Memorandum
of Understanding will start in the very near future, already before the
adoption of the Decision on the assistance. It will be made in coordination
with the IMF and the World Bank.
In
the preparation of the list of conditions or prior actions for the release of
the assistance, the Commission will target structural reforms aimed at
improving the overall macroeconomic management and the conditions for
sustainable growth (e.g. targeting the transparency and efficiency of public
finance management; fiscal reforms; governance and supervision of the financial
sector; reforms to strengthen the social safety net; and reforms to improve the
regulatory framework for trade and investment).

2.3.                
Indicators

The
fulfilment of the objectives of the assistance will be assessed by the
Commission, including in the context of the ex-post evaluation (see below), on
the basis of the following indicators: 
·      Progress with macroeconomic and financial stabilisation, notably by
assessing the degree of adherence to the IMF-supported programme. 
·      Progress with the implementation of structural reforms, notably the
specific policy actions identified as conditions for disbursement of the
assistance, which will be included in a Memorandum of Understanding.

2.4.                
Delivery mechanisms

The
proposed new MFA would amount to up to EUR 1 billion. Regarding the form of the
assistance, the Commission proposes to disburse the full amount in the form of
medium-term loans, in one or two instalments. The decision on the number of
instalemnts will be taken in view of a more complete information on Ukraine's financing needs and the timing of financial support reflecting the parameters of
the future stabilisation and reform programme to be agreed with the IMF.
The
preferred option is to disburse the assistance in two tranches, with the first
tranche being conditional to the IMF arrangement being in place, and the second
tranche – being also conditional to the implementation of the agreed
conditions. There will be a delay of at least three months between the two
tranches. The disbursement of the first instalment (possibly EUR 500 million)
is expected to take place in June 2014, and the disbursement of the second
instalment – in autumn of the current year. In case, however, the Commission
decides that in view of the extreme urgency of the financing needs the disbursement
of the assistance should be made in one tranche, the Commission would still
condition it to the completion of some critical prior actions. 
The
proposal, which is consistent with the methodology for determining the use of
grants and loans in EU MFA endorsed by the Economic and Financial Committee in
January 2011[1],
is based on the following considerations: 
Firstly,
  Ukraine is a middle-income country with a relatively high per capita
income level. Ukraine's per capita Gross National Income (GNI) of USD 3,500
(2012).[2]
For comparison, in April 2014 the European Parliament and the Council is
expected to approve an MFA loan of EUR 300 million to Tunisia (GNI per
capita of USD 4,150), while an MFA grant of EUR 90 million was provided to
Moldova (GNI per capita of USD 2,070) in 2010. An MFA loan of EUR
180 million to Jordan (with a GNI per capita of USD 4,670) is currently
under approval process.
Secondly,
  Ukraine's public debt ratio remains at a manageable level (41% of GDP
at the end of 2013). Moreover, under an adjustment scenario, the ratio is
expected to decline from 2015 onwards. External debt, for its part, is expected
to peak at 84.6% of GDP in 2014 and then gradually decline from 2015 onwards. 
The
proposal to provide the full MFA in the form of loans is also consistent
with the treatment granted by the World Bank and the IMF to Ukraine. Indeed,   Ukraine is not eligible for concessional financing from either the IDA or the
IMF.
MFA
is an untied and undesignated macroeconomic support instrument, which helps the
beneficiary country meet its external financing needs, and may contribute to
alleviating budgetary financing needs. The funds would be paid to the National
Bank of Ukraine. Subject to provisions to be agreed in the Memorandum of
Understanding, including a confirmation of residual budgetary financing needs,
the funds may be transferred to the Ministry of Finance of Ukraine as the final beneficiary. 

2.5.                
Risk assessment

There
are fiduciary, policy and political risks related to the proposed MFA
operation. 
There
is a risk that the macro-financial assistance, which is not dedicated to
specific expenses (contrary to project financing, for example), could be used
in a fraudulent way. In general terms, this risk is related to factors such as
the quality of management systems in the central bank and the Ministry of
Finance, administrative procedures, control and oversight functions, the
security of IT systems and the appropriatedness of internal and external audit
capabilities. 
To
mitigate the risks of fraudulent use several measures will be taken. First, the
Memorandum of Understanding and the Loan Agreement will comprise a set of
provisions on inspection, fraud prevention, audits, and recovery of funds in
case of fraud or corruption. Also, the assistance will be paid to a dedicated
account at the National Bank of Ukraine. Moreover, alongside reaching an
agreement on the Memorandum of Understanding, the Commission services will
conduct, with the support of external consultants, an Operational Assessment,
in order to assess the reliability of financial circuits and administrative
procedures that are relevant to this type of assistance and will determine whether the framework for sound
financial management of macro-financial assistance is sufficiently effective in
Ukraine. Ideally this Operational Assessment would be made before the
Memorandum of Understanding is agreed, however, given the urgency of the MFA
programme, the assessment can only be carried out in parallel with negotiations
and recommendations can only be made at a later stage. In the light of this
assessment, specific mechanisms applying to the management of the funds by the
beneficiaries may be introduced in agreement with the national authorities. The
Commission is also using budget support under the European Neighbourhood
Instrument to help the Ukrainian authorities improve their public finance
management systems and these efforts are strongly supported by other donors.
Against this background, special conditionalities on improving public finance
management will potentially be required. Finally, the assistance will be liable
to verification, control and auditing procedures under the responsibility of
the Commission, including the European Antifraud Office (OLAF), and the
European Court of Auditors. 
Another key risk to the operation stems from the
economic and political uncertainty, notably due to the unprovoked Russian
violation of Ukrainian sovereignty and territorial integrity. On the domestic
front, the main risk is instability related to difficulties in the political
and economic reform process. The full implementation of the stabilisation and
reform measures supported by the international community, including the
proposed MFA operation, might be undermined by social dissatisfaction
potentially leading to unrest. A derailment of the adjustment process could put
the objectives of the IMF-supported programme in jeopardy, endanger
macroeconomic stability and prevent the effective disbursement of the MFA.
Finally, there are risks stemming from a possible weakening
of the European and global economic environment (taking into account Ukraine's high dependence on both the EU and Russian markets), which would have an important effect
on Ukraine's fiscal consolidation efforts if the necessary reforms have not been
put in place.
Having
made a thorough assessment of the risks, the Commission services consider that
there are sufficiently strong grounds to proceed with the MFA to Ukraine. 
The
Commission services will maintain close contacts with the authorities during
the implementation of the macro-financial assistance in order to address
quickly any concerns that may arise. 

3.                      
Added value of EU involvement

The
European Union's financial support to Ukraine reflects the country's strategic
importance to the EU in the context of the European Neighbourhood Policy. The
instrument of macro-financial assistance is a policy-based instrument directed
to alleviate short- and medium-term external financial needs. As a part of the
overall EU package of assistance, it would contribute to support the European
Union's objectives of economic stability and economic development in Ukraine. By helping the authorities' efforts to establish a stable macroeconomic framework,
the proposed assistance would help improve the effectiveness of other EU
financial assistance to the country, including budgetary support operations.
By
helping the country overcome the economic difficulties caused by the political
transition, the proposed MFA will contribute to promoting macroeconomic and
political stability in the country. By complementing the resources made
available by the international financial institutions, bilateral donors and
other EU financial institutions, it contributes to the overall effectiveness of
the financial support provided by the international community. 
In
addition to the financial impact of the MFA, the proposed programme will
strengthen the government's reform commitment and its aspiration towards closer
relations with the EU. This result will be achieved, inter alia, through appropriate
conditionality for the disbursement of the assistance. In a larger context, the
programme will signal to the other countries of the Eastern Partnership that
the EU is ready to support countries like Ukraine, embarking on a clear path
towards political reforms, in moments of economic difficulties.

4.                      
Planning of future monitoring and evaluation

This
assistance is of exceptional and macroeconomic nature and its monitoring and
evaluation will be undertaken in line with the standard Commission procedures. 

4.1.                
Monitoring

Monitoring
will involve the review of reports and data provided by the authorities and by
review missions to Ukraine by Commission staff. To monitor the fulfilment of
the objectives of the programme throughout the implementation period of the assistance,
the Commission will use two types of indicators: 
·      Adherence to the IMF-supported programme, including compliance with
macroeconomic performance criteria and structural reform benchmarks identified
under the future IMF programme, as reported by the IMF in the context of the
regular review of the programme. 
·      Progress in the implementation of structural policy indicators,
which are to be agreed with the Ukrainian authorities in a Memorandum of
Understanding. It is foreseen that the Commission will conduct the negotiations
on the Memorandum of Understanding already before the formal adoption of the
decision on the assistance. Ahead of the disbursements of the assistance, the
authorities will be asked to submit a compliance statement in relation to the
agreed policy conditionalities or prior actions. In addition, under the
Memorandum of Understanding monitoring system, the authorities will be required
to submit regular reports on certain economic and reform indicators. 
Although
this assistance is centrally managed, where appropriate, the EU Delegation in Ukraine will also be called to provide reporting. An annual report, as well as regular
information on developments in the management of the assistance, to the
European Parliament and to the Council are foreseen. 

4.2.                
Evaluation

Ex-post
evaluations of macro-financial assistance operations are foreseen in the
Multi-Annual Evaluation Programme of the Commission's Directorate-General for
Economic and Financial Affairs. An ex-post evaluation of the proposed macro-financial
assistance to Ukraine will be launched within a period of two years after the
completion of the operation. A provision for the ex-post evaluation is included
in the proposed Decision for the assistance, and will also be included in the
Memorandum of Understanding. Budget appropriations from the macroeconomic
assistance budget line will be used for this evaluation. 

5.                      
Achieving cost-effectiveness

The
proposed assistance would entail a high degree of cost effectiveness for
several reasons: 
·      First, since the assistance would be leveraged by the assistance
provided by the international financial institutions, with which, as noted, it
would be closely coordinated, its ultimate impact could be very significant
compared to its cost. Moreover, in negotiating specific policy conditions, the
Commission will be able to draw on the expertise of those institutions,
including the International Monetary Fund and the World Bank, and to influence
their conditionality as well in ways that will take into account the EU's
views. 
·      Second, providing a coordinated macroeconomic support to Ukraine on
behalf of the EU Member States, the MFA would be more cost efficient than the
provision of a similar total amount of financial support by EU Member States
individually. 
·      Third, all of the assistance would be provided in the form of loans,
the budgetary impact of which is more limited.
·      In addition, the Commission will aim at achieving synergies with
other EU policies and instruments used to support the implementation by the
beneficiary of the relevant measures (notably in the area of public finance
management). 
ANNEX
    EUROPEAN EXTERNAL ACTION SERVICE 
     
Brussels, 13 March 2014
EEAS.III.B.2/SP/gdg (2013)       
Assessment on
  Ukraine's political reforms
1. The decision by the Cabinet of Ministers of Ukraine
on 21 November to suspend the preparations for the signing of the Association
Agreement, including a Deep and Comprehensive Free Trade Area, triggered a
prolonged period of mass demonstrations in Kyiv and other Ukrainian cities. The
situation saw a grave escalation in the beginning of 2014, including with the
adoption of measures that significantly restricted the Ukrainian citizens'
fundamental rights, violence against demonstrators with several casualties and
injured, disappearances and reports of torture.  On 20 February 2014, the worst
violent events in Ukrainian modern history took place, resulting in more than
80 deaths. 
On 21 February, then President Yanukovych and the
leaders of the opposition signed an agreement to end the conflict, witnessed by
the Foreign Ministers of Germany and Poland and a representative of the French
MFA for the French Foreign Minister. However, President Yanukovych left Kyiv
the following night and did not fulfil his commitments under the agreement. 
In the aftermath, the Verkhovna Rada took a number of
important decisions, by constitutional majority, including on the restoration
of the 2004 Constitution pending a comprehensive constitutional reform,
appointment of a new Government, and the calling of early presidential
elections. 
2. The new Government led by Prime Minister Yatseniuk
adopted a governmental programme with the overall objective of integrating Ukraine into the European Union, notably through signing the Association Agreement/DCFTA
and through the adoption and implementation of economic and financial reforms.
The Government sent a formal request for assistance to the IMF and invited the
EU to assess the needs, committing to respect the criteria set by the IMF
related to exchange rate policy and the gas tariffs. 
3. In its 3 March 2014 conclusions on Ukraine, the Foreign Affairs Council expressed the EU's support to the efforts of the new
Ukrainian Government to stabilise the situation and pursue the course of
reforms. The EU also reaffirmed the necessity of further constitutional reform
in Ukraine and to hold free, fair and transparent Presidential elections.
Furthermore, the Council conclusions stressed the utmost importance of ensuring
inclusiveness at all levels of the government by the Ukrainian authorities,
including through steps designed to reach out to all Ukrainian regions,
population groups and to ensure full protection of national minorities in
accordance with Ukraine’s international commitments.
In their Statement of 6 March 2014, the EU Heads of
States and Governments reiterated the EU's commitment to signing the
Association Agreement/DCFTA, and decided to sign, as a matter of priority, very
shortly all the political chapters of the agreement. The Heads of State and
Government also committed to provide strong financial backing to Ukraine and welcomed the comprehensive assistance package presented by the European
Commission, which foresees inter alia a new Macro Financial Assistance
programme of up to €1 billion and the mobilisation of €610 million loans under
the already approved MFA programme. 
4. On this basis, the EEAS considers that macro
financial assistance to Ukraine is in line with, and supportive of, the EU’s
overall political and economic engagement with Ukraine.
[1]“Criteria for Determining the Use of Grants in EU Macro-Financial
Assistance”, note of the European Commission to the EFC, January 2011.
[2] World Bank’s Atlas 2011 figures. GNI per capita is the gross
national income, converted to US dollars using the World Bank Atlas method,
divided by the midyear population.