September 4, 1998

Dear Mr. Camdessus:

1.  The last few weeks the government of Ukraine has been making vigorous efforts to implement the policies that underlie our adjustment program and request for an EFF arrangement that was formally communicated to you on August 11. The government remains firmly committed to the measures specified. At the same time, however, the external environment has become increasingly difficult and we were not able to roll-over the debt service payments that we had to make in August. Failure to make these payments would have seriously damaged Ukraine’s credibility and would have had adverse consequences for access to international capital markets in the future. Nevertheless, we were able to raise some new financing in mid-August, although not sufficient to prevent a decline in reserves of the National Bank of Ukraine (NBU).

2.  Furthermore, related to developments in Russia, the hryvnia has been under considerable pressure. In response, we raised the Lombard rate by 10 percentage points to 92 percent and let the hryvnia depreciate within the band, although we still had to intervene heavily to keep it from moving outside the exchange rate band. At the same time a careful review of external reserve position also indicates that usable reserves are significantly lower than anticipated. As a result of these two developments, our international reserves are now lower than we had expected when we requested the EFF arrangement.

3.  To address the problems and in view of the recent developments in the region, effective September 4, 1998 the present exchange rate band of Hrv 1.8–2.25 per U.S. dollar will be replaced by a new band of Hrv 2.5–3.5 per U.S. dollar. We will continue to closely monitor developments in the foreign exchange market and will be prepared to make additional changes in consultation with Fund staff if necessary. In view of the difficulties in our exchange market, we have decided to re-introduce, on a temporary basis, a 50 percent export surrender requirement. This surrender requirement will be removed as soon as our situation improves and no later than end-October. Surrendered export earnings will be converted at the market exchange rate. By end-1998, we will undertake an audit of the international reserves of the NBU by an internationally reputable firm and ask this firm to maintain to monitor these transactions throughout the program period.

4.  We are also engaged in active discussions with our external creditors (in particular with Merrill Lynch and Chase Manhattan Bank), and we expect that our payments to them that fall due in the remainder of 1998 can be rolled over. A scheme for a voluntary rescheduling of treasury bills held by nonresidents has been worked out in cooperation with Merrill Lynch and will be offered to the investors shortly after the Executive Board consideration of our request for an EFF arrangement. In addition, we already have initiated a voluntary rescheduling of government debt held by residents, which should lead to savings on interest payments. These savings will be used to further reduce the budget deficit in 1998.

5.  However, given the difficult external environment, we are not sure that we will be fully able to raise sufficient financing to compensate, within the near future, for the recent decline in the gross international reserves of the NBU. In fact, we expect that foreign financing in 1998 may fall short of the amount we had earlier envisaged. In view of this, the government and the NBU have taken measures to strengthen the program. To better monitor the program, we propose that purchases related to performance criteria in the first half of 1999 will be subject to monthly performance criteria. Given the delay in the presentation of our request, we also propose that the end-August targets be indicative. We will continue to work with our creditors to obtain foreign financing. Nevertheless, we propose that the purchase linked to the observance of end-September performance criteria would also be contingent upon the completion of a financing assurances review to assess progress in this area. Moreover, given the uncertainties in capital markets, we realize that we may not be able to raise any international financing for 1999, contrary to what we had envisaged. This would unfortunately result in our reserves being significantly lower than initially targeted. We intend to partly compensate for this by strengthening our fiscal adjustment and reducing our deficit targets to 2.8 percent of GDP for 1998 and to about 1.0 percent of GDP in 1999. The prospects for financing for 1999 will be assessed at the time of the second review, and additional fiscal measures will then be taken, if necessary.