Interview Deputy Chief of the IMF Mission to Ukraine Trevor Lessard

Text: Diana Pavlenko

 

Mr. Trevor, my first question will be about our energy system. As we know, russian attacks on energy sector have significant impact on European regional energy market, including driving up prices. And I want to ask you, if there are any specific calculations, showing, how losing by Ukraine, for example, 1 gigawatt of capacity, affects regional GDP?

So one of the things that we mentioned in our reports, and you're right that given the attacks on the energy sector since the spring, we're looking at a potential peak energy gap over the winter of about three to four gigawatts. Of course, that varies a lot, on how cold the winter is, demand, and also there's a lot of installation and repairs that are taking place. So it is an estimate that has a lot of volatility.

Now, one of the parts of the solution in terms of trying to close the energy gap is imports from Europe. There is a technological limit to the volume of electricity that Ukraine can import. So, cap also limits effects on the European economies. And when you look, the amount of energy that Ukraine could import maximum right now, let's say 1.6-1.7 gigawatts (after recording the interview, ENTSO-E decided to extend the electricity import limit for Ukraine from 1.7 GW to 2.1 GW from 1 December 2024 - IF-U), is relatively small.

And it isn't enough for Ukraine.

True. but the most given technological capacity right now is 2 to 2.1 GW, which is not "nothing". But if you look at the size of the Eastern European economies, 2 gigawatts are a rounding error in terms of their energy consumption is. And they also have additional capacity that could come online, including new green energy production. So you might see some price disruptions, as we mentioned in the European Regional Economic Outlook, but in terms of its effects on output, on electricity supply in the region, it is likely very-very small. Now, the other side of that is like we talked about, there is a 3 to 4 gigawatt gap in Ukraines so 500 megawatts additional imports is actually a pretty significant amount, like you're closing about an eighth of that large gap.

So any import side does make a big difference. And I think you're right, most people would agree that if it was technologically possible, it would be nice to increase imports because it's a steady supply, it's a safe supply, it can be counted on, the grid connection is there. But for the winter, it's hard to see how it goes beyond to 2.1 in terms of the maximum Ukraine could import from Europe.

Now, what the gap means for the Ukrainian economy is difficult to say. So not only is there the issue of how much capacity there is to generate and how much you could import, there is also demand. One of the things that's going to be a very difficult decision, and this is why you see a lot of commentators worrying about winter, is: if there is an electricity gap, that gap has to be allocated across the economy, and it probably will not be equally allocated.

So the authorities have previously stated that if there are gaps in electricity coverage, they would probably prioritize critical economic sectors. So while there may be a gap, the effect on GDP may not be as large, because they could ration the electricity to the sectors that are most critical. So health, defense, etc.

Okay, and let me be back to the Regional report. It's mentioned that Ukraine need to adjust its fiscal and monetary policies by 2025 to maintain stability. IMF emphasized, that It's we need implement some fiscal adjustments according to National revenue strategy, but what about monetary policy? How we need to change due to conditions of 2025?

Sure, so the NBU just put out their new monetary policy guidelines, and they outlined their new framework for how they would operate and that policy is effective now. Practically speaking, the NBU, like the Ministry of Finance and the rest of society, is going to have to adapt to the realities of a longer war.

And I think part of that new reality has shown up in the last couple of months. You've seen the data, just like everyone else. Inflation is ticking up, it's a little bit higher than the NBU had originally forecast. Some of that uptick has to do with a very tight labor market, which is pushing up wages, and base effects.

There's also lot of liquidity in the system. I mean, if you have 20% real-wage growth, it's not surprising that inflation is moving up as well. And the NBU has a price stability mandate, so they can't just continue on with the plan that they had six months ago. And there's no way they ever would: this is a central bank with a lot of capacity and good leadership. They have the real-time indicators and can adjust their monetary policy to current conditions, they're data-driven.

If you look at their upcoming MPC and their last MPC, they've been open and transparent about showcasing the changes in the economy and what that means for their outlook. If you've seen recently, the governor and the deputy governor have kind of mentioned that, roughly a year ago, they were thinking about the pace of loosening monetary policy. Now, given the new inflation numbers, there's much less scope to consider loosening and more appropriate to looking at maintaining policy or potentially tightening.

To your mind, currently level of K-rate, it is justified, according to level of our inflation, which is expected to grow?

We agree with the NBU that the key policy rate right now is at an appropriate level. And kind of looking at inflation dynamics, it would be prudent to put off any future monetary loosening until inflation has come down. Now, I think one of the questions the NBU is looking at, and like our team as well, is what are the inflation dynamics? And what's important for any central bank it's not just to look at inflation in November and December, or even next month. The NBU's mandate isn't to stabilize inflation in year one, it is to stabilize inflation over the medium term and to keep price expectations anchored.

So, what's really important is: what are the dynamics driving inflation? are they temporary? are they permanent? how big of a shock is it? Looking now, I think they have a pretty good handle on where they are, I think they're in a good place, and I think as the data comes in, they'll adjust accordingly.

To conclude, can you make an assumption that Ukraine's economy is fully adjusted to war conditions?

The economy has shown incredible resilience. And I think, if you look back to the reports of the first review or the second review (EFF program – IF-U) to see what we thought about the further economy development, we've had a pretty steady experience of having to upgrade our forecasts. So the economy has proven to be more adaptive than we tend to assume, and it's actually tended to be more resilient, especially the agricultural sector, some of the new emerging sectors, the health sector.

Now, it's a difficult question to ask, has it fully adjusted to being a war economy? You'd have to start going into the idea of what would a war economy look like? And it's been three years… how much more needs to change?

There has been a very large shift in the composition of the economy. If you kind of look at just what the composition of GDP is before the war started to now, what are the sectors, what is driving it, fiscal expansion, stuff like that, it's been a shift. Thus I think that now it's been three years of some structural shifts in the economy. Some of them have led to some dynamism, like in the healthcare sector, in the military, defense sectors, there's a lot of innovation there.

But one thing we keep mind of as well is going forward, you want to be able to transition from the war economy now to growth and demobilization and reconstruction later. So like, it would be ideal to the sectors that have flourished and done well now, to make sure they have a good strategy to move into the medium term, and then the ones that have had to take the brunt of the war and its effects, to see how maybe you can energize those sectors.

And I want to ask you about domestic sources to Ukrainian budget, because it is very important, according to that fact that we need to finance our army relying only on our domestic revenues. As known, recently we have already increased taxes, to your mind, which are the next steps we can do to meet our needs?

So we are talking about sort of the adjustments that have had to take place because of a longer war, and one of the most obvious things - it means a massive increase in fiscal expenditures. So you have this very large increase in expenditures to support the war effort and they have to be financed in some way. And if you just think about it analytically, there's three ways to do it: raise domestic revenues, raise domestic borrowing or get external support. Now these three legs have to kind of do as much as they can, and they're different pillars.

The authorities, I mean, have done a lot of efforts in terms of domestic resource mobilization, put together a very comprehensive tax package and they submitted it to Parliament. And I think there was a lot of positive, durable solutions in that tax package that didn't unfortunately make it till the end, in particular the VAT.

And one of the things I want to mention there is when we talk about tax revenue, what we're really focused on is not just 2025, but there's also going to be 2026, 2027, 2028, 2029. When you look at the Ukraine's demographics, at what post-war looks like, it's very plausible that Ukraine is going to be a high expenditure economy. You're going to have high needs for social expenditures, for reconstruction, for people coming back from abroad, you're going to have high needs in terms of demobilization and reintegration war veterans.

It's also very plausible to assume that as the years go on, the level of external support is not going to stay as high as it is now. I mean, it's not going to taper off to zero, support from the international community to Ukraine will be plausible to stay at steady level, but it's challenging to think it's going to stay at the level that it's been in 2023, 2024, and what it's going to be in 2025.

To your mind, where especially we have a space to take some resource from the domestic area?

So I think if you need immediate revenues and you want to do it in an efficient, broad-based way that gets you revenues next month, it's hard to see anything that's a better policy option than raising the VAT rate in terms of how much you can draw in, how it spreads the burden of the tax increase, and all that kind of stuff. But just for the second, let me leave the VAT to the side.

If you look at the National revenue strategy (NRS) and you look at what the idea is, what you're looking for is durable reforms, and one of the objectives is, obviously, to collect more taxes. That is a thing. But other parts of the NRS are also really important. So one of the things is the Ukrainian tax system is inherently inequitable in terms of who pays the tax, who doesn't pay the tax, how much they pay, and these dynamics have socio-political consequences and they have economic consequences.

So the people that are currently paid taxes really don't want to pay more tax until the people that aren't paying taxes start paying a little bit of tax. One of the goals of the NRS, is to improve this equity. And there's a lot of things in there on customs, on the simplified tax, on some other tax reforms that, while they are going to raise revenues, they have a really important part of improving equity.

The other thing I would keep in mind is, while you're increasing tax, you have the chance to improve the investment climate of the country by changing tax policy. So you can make it more equitable, more competitive.

And one of the things that's particularly important to Ukraine, as you look to EU accession, it's important to start aligning tax policies to when you're looking forward to Europe: alcohol, tobacco… But one that doesn't get as much discussion is, Europe is about to implement a carbon border adjustment mechanism (CBAM).

If I was a neighbor to Europe, I would probably not want to get caught in this and having to pay a lot of export duties, because I'm on the wrong side of this border adjustment mechanism. So instead of paying at the border, and if you are doing a revenue strategy, and you are thinking about improving equity, this is an opportunity to also green your tax system, get on the right way in terms of EU accession, and stay on the right side of the border adjustment mechanism. The NRS has a lot of spillovers. It is more than just kind of like raising revenue to GDP.

What is the IMF’s attitude to the fact that the Ukrainian authorities have decided to re-tax bank’s profits?

Windfall taxes by their nature should be only done once. If you do a windfall tax more than once, than people will start reacting, and you'll start losing policy credibility. So, if you do a windfall tax once, you'll probably tax the banks, if you do a windfall tax a second time, you're going tax them again, but they are more prepared. It's a very rational for them to prepare for the third time, there is an issue of what's going to happen there.

I think when we were talking about revenues and we were just talking about the National revenue strategy the thing with windfall taxes is it only applies to a single year.:You pay a political price to raise taxes, you get a lot of pushback, but if you enact a windfall tax you only are solving a problem for one single year. Whereas we were just talking about that Ukraine has revenue need over multiple years. So if you're going to expend a lot of political capital if you're going to go through the challenges of going to Parliament to raise taxes the best choice is - raise taxes in the durable, efficient way, and that'll pay dividends you over the medium term as opposed to doing a one-off and then next year still have a gap.

Current program program is set to end in 2027 and if the risk of the prolonged war will be materialise. Will the IMF continue to support of Ukraine?

All IMF programs have a start and ending date, that is just the context of IMF programs. I think that is completely separate from the IMF's engagement in Ukraine. The IMF was supporting Ukraine before the war and it's guaranteed that the Fund will be supporting Ukraine after.

As you have seen through events this week at the IMF Annual Meeting, including the NBU Governor talk with EUR Director Alfred Kammer, our engagement is multifaceted

So I think the EFF program is part of IMF engagement that gets the most attention. But we also have an approx. $35 mln technical assistance (TA) fund, the Ukrainian Capacity Development Fund (UCDF), that provides TA/CD to Ministry of Finance, Ministry of Justice, the NBU, etc. I think this TA/CD is a good example of how are providing support to Ukraine is multifaceted and expected to continue over the medium-to-long term.

Now for the EFF program, it currently stands to end in 2027. Then, like always in these situations, the authorities will decide what they want to do in terms of next steps, but we are open to any way that we could assist. Right now the commitment is to the current program and the focus right now is on the next review.