CELEX: 51994PC0487
Language: en
Date: 1994-11-04
Title: Proposal for a Council Decision providing macro- financial assistance to Ukraine

COMMISSION OF THE EUROPEAN COMVIUNITIES
                                      C0M(94) 487 final
                                      Brussels, 04.11.1994
                                      94/0256   (CNS)
                           Proposal
                    for a Council Decision
             providing macro-financial assistance
                          to Ukraine
                (presented by the Commission)
 ---pagebreak---                                             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.
 ---pagebreak--- On the basis of thefinancingassurances 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 thefirsttranche 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.
 ---pagebreak--- 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 residualfinancinggap 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 externalfinancialrelations 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).
 ---pagebreak--- 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 substantialfinancingneeds 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 residualfinancingneeds 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.
 ---pagebreak---                                               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 externalfinancialobligations towards
the Community;
 ---pagebreak--- Whereas a Community long-term loan to Ukraine is an appropriate measure to help
easing the countries' externalfinancialconstraints, 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.
 ---pagebreak---                                          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
 ---pagebreak---                                    FINANCIAL RECORD
 1. Budget line concerned
     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.
 ---pagebreak---                                                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           Provisioning of      Reserve
                              Calculation            The Fund (U          Margin
                                                                                318(2)
Project related assistance
EEB/CEEC                            765                    107                  211
EEB/MED                             100(3)                  14                  197
EEB/PVDLA                           500(4)                  70                  127
EURATOM                             150                     21                  106
Macro-financial assistance
Moldova                              45                      6                  100
Bulgaria                             40(5)                   6                   94
Romania                             125                     18                   76
Algeria                             200(6)                  28                   48
Slovakia                            130(6)                  18                   30
Ukraine                              86(6)                  12                   18
(1)    According to the provisioning rules agreed in the Council's common position of 13
      September 1993
(2)   Reserve amount in 1994 under thefinancialperspective
(3)   Including amounts of estimated disbursements in 1993 and operations for Cyprus
      and Malta
(4)   Including amounts of estimated disbursements in 1993
(5)   Commission proposal to increase the amount of assistance (ECU 110 million)
      decided in 1992
(6)   Commission proposal
 ---pagebreak---                                      y/C?
wt
                                 Catalogue number : CB-CO-94-516-EN-C
                                                             ISBN 92-77-81912-X
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