The budget parameters for 2022 enable us to identify positive changes and assess future risks in debt financing. Budget deficit, public debt and borrowings will decrease, but debt service and the burden of government guarantees will increase.
In 2022, a tighter fiscal policy is projected compared to the current and previous years. The government plans to completely withdraw fiscal stimulus in 2022 and move to a policy of fiscal consolidation. The draft budget provides the deficit threshold of UAH 188 billion, or 3.5% of GDP, while this year it is UAH 246.6 billion, or 5.1% of GDP.
The primary deficit of the state budget (the difference between revenues and expenditures without interest payments) next year is to be reduced to zero, i.e. the impact of fiscal policy on aggregate demand will be close to neutral. Such policies poses risks of economic stagnation and slowing the economy out of the crisis as the COVID-19 pandemic continues. However, on the other hand, it will restrain the growth of public debt.
In 2022, of the total amount of government borrowing (UAH 571.1 billion), 73.5% is to be received from domestic loans. The emphasis on domestic borrowing is correct, as it reduces the foreign exchange risks of public debt and dependence on the international capital market.
Table 1 shows the comparison of the projected amounts of government borrowing in 2019-2020 (fact) and 2021-2022 (project) from different sources. The rate of reduction of the absolute amount of borrowings in 2022 compared to 2021 is to reach 26.4%, and compared to 2020 – 12%.
Table 1. Sources of financing the state budget deficit in 2019-2022, billion UAH
|By budget financing classification||Total||General fund|
|2019||2020||2021 projection||2022 projection||2019||2020||2021 projection||2022 projection|
|Financing by debt operation||80. 48||245.1||253.39||177.8||64.54||227.03||228.86||152.26|
|Financing from state property privatization||-0.04||-29.74||-18.76||2.21||3.74||-12.81||-20.00||2.21|
|Financing from active transactions||-0.04||-29.74||-18.76||2.21||3.74||-12.81||-20.00||2.21|
|Changes in deposits and securities used for liquidity management||9.12||-4.84||-18.79||2.21||9.12||-6.84||-20.00||2.21|
|Placement of budget funds on deposits, purchase of securities||0.00||-6.84||-20.79||-0.79||0.00||-6.84||-20.00||-0.79|
|Purchase of securities||0.00||-6.84||-20.79||n/a||0.00||-6.84||-20.00||n/a|
|Changes in budget funds||-9.16||-24.9||0.04||0.00||-5.38||-5.97||0.00||0.00|
The draft budget for 2022 envisages a decline of the external borrowing by almost 40% compared to 2020. As a percentage of GDP, the volume of external loans in 2022 (2.8% of GDP) will be significantly lower than in 2021 and 2020 – 4.3% and 6% of GDP.
Gross domestic borrowing in 2022 is to be UAH 420 billion, or 7.8% of GDP, which means a decrease by 3 percentage points of GDP compared to the planned in 2021. At the same time, net domestic financing (reduced by debt repayment) will amount to UAH 99 billion, which is 1.5 times less than the actual and planned indicators of 2020–2021. Next year’s net domestic financing is to amount to 5.2% of assets of Ukrainian banks and 9.6% of bank loans to legal entities and individuals. Obviously, these ratios point to low threats to the implementation of the “crowding-out effect” of bank loans by public borrowings.
Next year, the government is going to place mainly one-year, two-year and long-term government issued bonds on the domestic market, which will allow attracting UAH 380 billion into the budget. The weighted average yield of government issued bonds in hryvnia, according to the Ministry of Finance forecast, in 2022 will be 11.7% per annum. This yield exceeds both the average of 2020 – 10.2% per annum, and the figure of January-September 2021 – 11.4% per annum.
External borrowings to the general fund of the budget are projected to amount to USD 4.5 billion, including USD 1.5 billion from the placement of Eurobonds and USD 3.0 billion from the IMF. The average interest rate of external commercial borrowing in 2022 is projected at 7.5% per annum.
Assessing the risks of debt financing of the budget deficit, the following should be mentioned: implementation of plans for gross placement of government issued bonds in the amount of UAH 420 billion and net borrowing in the amount of UAH 99 billion is quite a feasible task, especially in the case of increased participation of individuals in purchasing government issued bonds.
It may be more risky to attract USD 1.5 billion from the placement of Eurobonds. The world’s leading central banks have already announced the possibility of moving to a tighter monetary policy in 2022, which will cause a rebalancing of global capital flows and increase the cost of borrowings for emerging market economies. Raising market rates on Ukraine’s external loans to over 7% per annum should encourage the government to reorient from the external capital market to the domestic one (where foreign currency government issued bonds are placed at rates of up to 2.5% in euros and 3.8% in US dollars) .
Due to the inflation rise, there is a risk of increasing domestic interest rates on government issued bonds to more than 11.7% per annum (as is projected in the budget for 2022). Increasing the burden of debt interest payments will force the government to reallocate budget funds for debt purposes, which will have a destructive effect on the social sphere, the functioning of the public sector and investment opportunities of the state.
According to the forecast of the Ministry of Finance, public and publicly-guaranteed debt as of December 31, 2022 will amount to UAH 3,093.3 billion, or 57.6% of GDP. The debt burden as a percentage of GDP will decrease slightly compared to 2020, but will increase relative to September 2021 (see Table 2).
Table 2. Debt indicators of Ukraine as of the end of the year
|Debt indicators||2013||2015||2016||2017||2018||2019||2020||8 months 2021||2022 draft budget|
|Public and Publicly-guaranteed Debt, % of GDP||38.4||79.1||81.0||71.8||60.9||49.8||60.9||51.7||57.6|
|Public and Publicly-guaranteed Debt, % of Budget Revenues||172.4||294||313.1||270||233.7||200.2||237.2||217.2||244.1|
|Interest Payment on Public Debt (% of Budget Expenditures)||8.5||15||14.2||13.2||11.7||11.1||9.2||10.6||12.6|
|Interest and Principal Payment on Public Debt (% of GDP)||7.5||10.8||10.2||8.8||15.9||10.0||11.6||11.6||10.7|
The growth of public and publicly-guaranteed debt relative to budget revenues will be one of the negative trends in 2022. This ratio will increase from 217.3% in January-August 2021 to 244.1% at the end of 2022 at the threshold of 200%. At the same time, an increasing share of budget resources will be withdrawn for debt interest payment. This item of expenditure was 9.2% of total expenditures in 2020 and is to be increased to 12.6% in 2022.
Public debt service in 2022 will absorb 181.4 billion UAH of budget funds. In nominal terms, public debt service will increase by 14.3% compared to 2021 and by 51.5% compared to 2020. The relative value of budget expenditures on debt service will reach 3.4% of GDP, while among emerging market economies it was on average 2% of GDP. A change in the debt structure in favor of market loans, an increase in the nominal amount of debt and a rise in the effective interest rate on its service will cause higher expenditures. For example, in 2022 the effective rate will reach its maximum value in the last five years – 7.2% per annum.
The high level of debt burden on public finances will keep the risks of debt refinancing high, which points to the possibility of debt complications in the event of external shocks or political destabilization in Ukraine. In addition, the sustainability of public finances will deteriorate due to the increase in the cost of government borrowing and the intensification of payments on guaranteed loans.
The maximum amount of state guarantees in the draft budget for 2022 is established at UAH 78.25 billion, which is 10.4 billion less than provided by the budget-2021. This threshold is more than 6% of state budget revenues, although according to the Budget Code, the limit of state guarantees must not exceed 3% of general fund revenues.
Article 7 of the draft law on the budget for 2022 allows for the provision of state guarantees in the following areas: a) on the implementation of investment projects for the reconstruction and modernization of engineering infrastructure of reclamation systems; b) on the portfolio of bank loans provided to micro, small and medium enterprises; c) to finance programs related to improving the defense and security of the state; d) on loans of the State Agency of Motor Roads of Ukraine for the development of the network and maintenance of highways of national importance.
Targeted state support for certain sectors of the economy or financing of state functions using loan guarantees is a forced response of the government to the distortions of the domestic market and the unavailability of credit resources for long-term investments of national importance. However, decisions on the provision of government guarantees should not replace a prudent assessment of the fiscal risks associated with the provision of such guarantees. Indeed, in 2022, the government will pay UAH 6.9 billion for publicly-guaranteed debt given to enterprises, which is 1.4 times more than in 2021 and 7 times more than in 2020. In the future, the burden of payments on guaranteed loans will increase even more.
Financial theory states that government guarantees create the following significant problems in public finance management:
– “moral hazard” in the behaviour of creditor banks and borrowers-recipients of guarantees and the lack of strict budget procedures usually lead to a waste of budget funds;
– the motives for providing state guarantees, which are associated with the possibility to avoid adequate reflection of the relevant costs in the budget, generate significant risks to the stability of public finances.
In view of this, important steps to reduce the fiscal risks of state guarantees are the following:
• formation of a system of accountability, controllability and transparency of state guarantees on loans;
• restriction of state guarantees with potentially self-sustaining investment projects of national importance;
• implementation of partial guarantees mechanism to most state guarantee programs.
The government’s guarantee of only part of the debtor’s obligations would ensure the distribution of credit risks between the government, the lender and the borrower and would eliminate the problem of moral hazard. International experience shows that providing limited guarantee coverage to 60–80 percent of a loan by state is an effective way to minimize fiscal risks.
Scientific Director of the Growford Institute, Doctor of Economics Tetiana Bogdan for “Dzerkalo Tyzhnia”.