Open letter from IMF chief Christine Lagarde makes clear the IMF will continue to provide funding to Ukraine regardless of whether or not Ukraine's Western creditors agree to restructuring

The IMF has now made it official: it will go on lending to Ukraine regardless of whether or not it defaults on its private Western debt.

The IMF’s statement, made in the form of an open letter published on its website (full text below) makes the fact clear.

IMF going against its own rules

The key words in the letter are:

“The IMF, in general, encourages voluntary pre-emptive agreements in debt restructurings, but in the event that a negotiated settlement with private creditors is not reached and the country determines that it cannot service its debt, the Fund can lend to Ukraine consistent with its Lending-into-Arrears Policy.”

The idea seems to be that, as Ukraine is due to pay £23 billion to its Western creditors over the next four years, defaulting on this debt will plug the $15 billion hole in the funding the IMF is providing Ukraine, which it has identified.

That this is a blatantly political decision showing a willingness to lend to a country that is bankrupt, hardly needs saying. What the IMF is in effect doing, since it is not willing to increase the amount it is lending, is fund Ukraine at the expense of its creditors. It is a significant --- and dubious --- departure from IMF practice. However the political pressure from the Western powers that control the IMF for it to continue its support for Ukraine has overridden all other considerations.

For the IMF this is a high-stakes gamble. It is known that back in 2010 all the non-Western representatives on the IMF’s board, as well as the Swiss representative, vigorously opposed the planned bailout of Greece, seeing it as a blatantly political attempt to rescue the euro by piling debt on Greece which it could never repay. On that occasion the decision was rammed through by the Western majority, only for the criticism of the non-Western representatives to be proved true later.

It is likely that something very similar is going to happen now. The IMF board is due to meet in July and it is likely the decision will be rammed through then, probably once more against the opposition of the non-Western representatives.

Unless the creditors now buckle, which is possible, it is likely that there will also be a flood of litigation challenging this decision in various national and international courts around the world. Although some of the debt might be subject to Ukrainian law, recent decisions in the U.S. courts concerning Argentina call into question whether a moratorium of the sort that is being proposed is internationally enforceable. It is not difficult to see how the IMF could find itself a party to some of this litigation, which could prove embarrassing.

In theory this decision does not concern Ukraine's liability to Russia, which as public debt remains payable, irrespective of the moratorium. The next interest installment due on that debt --- of £75 million --- is due for payment on 20th June 2015. If the Ukrainians default on that payment there will be more legal action, this time from Russia, which could call into question the IMF program, since IMF rules expressly prohibit support to a state that defaults on its public debt.

As for the IMF, if Ukraine’s bailout fails then there will be more criticism of the IMF leadership at a time when the non-Western powers are busy setting up their own alternative institutions. Suffice to say that in that case it is unlikely the IMF would be able to justify yet another Ukrainian bailout.

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From the IMF’s Website

IMF Managing Director Issues Statement on Ukraine

Press Release No. 15/272

June 12, 2015

Ms. Christine Lagarde, the Managing Director of the International Monetary Fund (IMF), addressed the following letter about Ukraine to Members of the Financial Community on June 12, 2015:

The Ukrainian authorities have embarked on an ambitious economic program for 2015–18 aiming at deep-reaching macroeconomic adjustment and structural reforms. It includes a substantial fiscal consolidation and energy sector reforms, the rehabilitation of the banking system, the build-up of the National Bank of Ukraine’s (NBU) international reserves to prudent levels, and the improvement of the business environment to enhance the productive potential of the economy. The economic program is being supported by exceptional financing from the IMF under the recently approved extended arrangement (EFF) as well as by financial assistance from the EU, U.S., other International Financial Institutions, and bilateral partners.

For completion of the first program review, and in general for the program to go forward, IMF policies require, among other things, an assessment that the program is fully financed and public debt is sustainable with high probability. Achieving this depends critically on financial support from Ukraine’s private creditors, in addition to the significant assistance already committed from official partners. In this context, the IMF attaches great importance to reaching the three objectives under the debt operation announced by the authorities, namely (i) generating $15.3 billion in public sector financing during the program period; (ii) bringing the public and publicly guaranteed debt/GDP ratio to under 71 percent of GDP by 2020; and (iii) keeping the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–25.

To ensure economic and financial stability, these objectives need to be achieved in a manner consistent with maintaining a strong international reserves position over the medium term, in line with projections under the program. In this regard, the NBU’s international reserves cannot be used for sovereign debt service without the government incurring new debt, which would be inconsistent with the objectives of the debt operation. Ultimately, Ukraine’s debt repayment capacity is limited by its fiscal capacity.

Rapid completion of the debt operation with high participation is vital for the success of the program, since Ukraine lacks the resources under the program to fully service its debts on the original terms. The IMF, in general, encourages voluntary pre-emptive agreements in debt restructurings, but in the event that a negotiated settlement with private creditors is not reached and the country determines that it cannot service its debt, the Fund can lend to Ukraine consistent with its Lending-into-Arrears Policy.

The Ukrainian authorities are fully cognizant of the large challenges ahead—including substantial macroeconomic risks stemming from the unresolved conflict in the East––and have reaffirmed their steadfast determination to tackle economic imbalances that held Ukraine back in the past, and deepen structural reforms in order to achieve robust and sustainable growth. I believe that their program warrants the support of the international community, including the private sector, which is indispensable for the success of this program.