A revised budget and related party lending laws are the key elements

Early this week, Ukraine's parliament adopted legislation required as prior actions under the new IMF-Ukraine EFF program. Amendments to the budget law are not critical and largely reflect the worsened macroeconomic outlook, including higher inflation and a weaker hryvnia. The budget deficit is now planned at 9.4% of GDP. The second piece of legislation focuses on banking activities – it toughens regulations on related party lending and enhances accountability measures for bank bankruptcies.

Budget law amendments reflect new macroeconomic outlook

The new budget law is based on a projection of nominal 2015E GDP of UAH 1,850 bln, a 20% yoy increase. This is highly optimistic – in our view, nominal GDP is unlikely to exceed UAH 1,750 bln. The government's tax collection targets are simply too ambitious and may fall short by 5-10%.

The government is planning to collect revenue of UAH 498 bln – 28.5% of 2015E GDP, based on our GDP projection, far above the 24% average over the past decade. Of that total, tax collections are projected at UAH 393 bln and NBU net income transfers at UAH 60.5 bln (up from UAH 22.8 bln in 2014).

Expenditures are projected at UAH 575 bln (+32% yoy), implying a state budget deficit of UAH 76 bln (4.3% of GDP). In line with past practice, the government will also be authorized to spend another UAH 88 bln to support state entities, including UAH 36.5 bln on bank recapitalization, UAH 20 bln on transfers to the Deposit Guarantee Fund, and UAH 29.7 bln to capitalize Naftogaz. Those outlays are not treated as budget expenditures in the law; they will be financed via T-bill issuance and will effectively increase the budget deficit to UAH 164 bln (9.4% of GDP). Needless to say, the NBU will need to finance a considerable part of the fiscal shortfall since raising money in local markets is largely impossible.

On a separate note, the new budget law allows the government to enter into restructuring negotiations with holders of Ukraine's external sovereign debt. The law also permits the Kyiv city council to restructure its two Eurobonds by extending their maturities by not less than one year. Yesterday the Kyiv authorities started the restructuring process.

Related parties law changes the landscape for banking activities

The 2nd piece of important legislation passed pertains to related party lending – the law intends to introduce more transparency into commercial bank activities and enhances accountability of bank management, shareholders, and related parties for bankruptcies. The law is a step in the right direction, but it may cause trouble for banks and borrowers in the short-term. We highlight two key takeaways from the law:

• The NBU will have the power to identify individuals and companies as related parties to banks based on a wide range of criteria. If exposure to related parties exceeds the NBU-set maximum, banks will be required to develop a credible plan to cut the exposure. If a bank deviates from the plan more than twice, the NBU will automatically be empowered to declare a bank insolvent. With the law, the central bank gains powerful leverage to influence the activities of banks through its right to approve/decline plans on reducing related party exposure.

• A bank's related parties (including management and beneficiary owners) will be obligated to compensate depositors' and creditors' losses if found responsible for an insolvency. The responsibility also extends to borrowers identified by the NBU as related parties to the bank. In some cases, this could lead to unjustifiable penalties even for diligent borrowers.

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