Ukraine Cabinet presents 2015 spending plan

Ukraine’s Cabinet of Ministers submitted its 2015 draft budget to parliament on Dec. 23, which presumes a 31.6% yoy increase in central budget revenue to UAH 475.2 bln and outlines a deficit of 3.7% of GDP (UAH 63.7 bln). The draft is based on assumptions of a 4.3% decline in real GDP, nominal GDP of UAH 1,721 bln (+11% yoy) and a UAH 17/USD exchange rate in 2015.

The budget revenue increase is based on reallocating personal income tax (collected by local budgets) to the central budget, increased taxes and almost tripled support from the NBU (to UAH 65.4 bln from UAH 22.8 bln in 2014). In addition to the declared deficit, the authorities targeted UAH 88 bln in financing (through the issue of state bonds) of quasi-fiscal operations. In particular, UAH 31.5 bln has been earmarked to support state natural gas monopoly Naftogaz, up to UAH 36.5 bln has been allocated for banking system recapitalization and up to UAH 20 bln for the deposit guarantee fund. As a result, the effective fiscal gap (including quasi-fiscal operations) was suggested at the level of 8.8% of GDP (UAH 151.7 bln).

The main spending increases occurred in debt-servicing expenses (UAH 74.7 bln, up from UAH 46.3 bln in 2014), defense (UAH 40.2 bln, up from UAH 15.2 bln in 2014), and the Internal Affairs Ministry (UAH 32.5 bln, up from UAH 17.9 bln in 2014).

Alexander Paraschiy: The suggested spending plan does not look realistic, in our view. The tax collection increase the authorities are planning (+27% yoy, excluding personal income tax) has very poor chances at fulfillment, given the already high tax pressure in the economic system. To make matters worse, the Finance Ministry plans to rely heavily on hryvnia printing in 2015. Even net of the potential revenue shortfall, the NBU will have to print nearly UAH 200 bln (including a UAH 65.4 bln direct wire from the NBU) to cover the fiscal needs outlined by the Finance Ministry for 2015 (it has printed about UAH 150 bln this year, YTD).

Against this backdrop, the chance for successfully extending IMF cooperation is under threat, in our view. In its September memorandum, the Fund made it clear that the overall fiscal gap (including Naftogaz) for 2015 should not exceed 5.8% of GDP. For sure, a lot has changed since then and we cannot rule out the Cabinet has new hints from the Fund. However, a fiscal gap amounting to 8.8% of GDP with high chances of revenue underperformance does not look encouraging.

What’s more, the UAH 17/USD exchange rate for the next year (which is broadly in line with the current market rate) does not look sustainable any more, given that the NBU will have to print an extra UAH 200 bln in 2015. Further devaluation looks inevitable in what will trigger extra funding needs both for the budget and the banking system, stimulating further an inflation/devaluation/budget deficit spiral.

The parliament is working on the budget to prepare it for approval by Dec. 30, which offers a chance the spending plan will be adjusted to better fit reality. In the way the spending plan looks now, it only raises the probability of a sovereign default in 2015.