News Brief No. 00/15

News Brief: Allegations About the Use of Ukraine's International Reserves

March 14, 2000

1. Various allegations have been made about the use of Ukraine's foreign exchange reserves held by the National Bank of Ukraine (NBU) in 1996-98, before the approval of the current arrangement under the Extended Fund Facility (EFF) on September 4, 1998. At the request of the IMF staff, PricewaterhouseCoopers (PwC) has been commissioned by the NBU to carry out a special examination of the transactions affecting the reserves in 1997-98. When completed, the results will be published. In the meantime, this statement sets out the IMF staff's current understanding of the transactions to which the allegations relate. It explains when the staff learned about the transactions, and the remedial actions that have been taken.

2. In summary, on the basis of the information currently available to IMF staff, it appears that a number of transactions in 1996-98 gave the impression that Ukraine's reserves were larger than was actually the case. Relatively few of these transactions appear to have resulted in Ukraine receiving disbursements that it would not otherwise have been entitled to receive. Pending the final results of PwC's special examination, the view of the IMF staff is that Ukraine appears to have received disbursements from the IMF on three occasions in late 1997 and early 1998 that it would not have done if the true state of Ukraine's reserves had been known at the time. The IMF will review this thoroughly when the results of the special examination are available. Since the approval of the subsequent arrangement for Ukraine under the EFF in September 1998, new safeguards have been put in place and there has been no evidence of similar problems.

3. In recent months, the IMF has been considering ways to strengthen safeguards on the use of Fund resources and also how best to address cases where national authorities misreport information to the Fund. It is anticipated that further safeguards will be adopted after the IMF Board has discussed this issue in the coming weeks.

4. The IMF staff is aware of a number of transactions affecting the NBU reserves between 1996 and 1998 that could have given a misleading impression of the size of Ukraine's useable reserves. They can be grouped under three headings:

a) Transactions whereby the NBU deposited its reserves with a foreign bank, which then onlent the funds to commercial banks in Ukraine and (in one case) Russia. The IMF staff is aware of seven such transactions, amounting to about $360 million. These transactions were initiated from late 1996 to early 1998. In the largest of these transactions, in November 1997 the NBU deposited $150 million with a foreign bank, which onlent the funds to a commercial bank in Ukraine. The commercial bank then deposited these funds with the NBU, with the effect that the same reserves were counted twice. Such "round-tripping" does not appear to have been a feature of the other transactions under this heading.

b) Transactions whereby the NBU deposited its reserves with a foreign commercial bank to promote an artificial demand for government bonds and treasury bills. The IMF staff is aware of three such transactions, amounting to about $275 million, that took place from mid-November 1997 to end-January 1998.

c) Other miscellaneous transactions, including those related to forward exchange (swap and option) operations, and pledges tied to state contracts. These occurred during the period 1996-98, and the aggregate amount was in the order of $300 million. According to the Ukrainian authorities, the swaps and options were related to the need to convert foreign loan proceeds in Ecu and DM into dollars; they were removed from the figures for usable reserves monitored by the IMF staff. The pledges tied to state contracts were, according to the Ukrainian authorities, deposits needed to guarantee Ukraine's export contracts.

5. Some of these transactions may have caused reserves to appear to be higher than they actually were. As the level of reserves was one of the criteria used by the IMF to decide whether to make further disbursements to Ukraine, these transactions might have caused the IMF to disburse earlier or in larger amounts than it otherwise would have done. On at least one occasion, that was the reason why the transaction was made, according to a statement that appears to have been made by the NBU to the Ukrainian parliamentary commission chaired by Mr. Suslov that reported in April 1999. A full determination of whether, and if so to what extent, disbursements made in 1997-98 were based on a misleading picture of the level of reserves will be made when the IMF receives the results of the special PwC examination. A provisional assessment by the IMF staff, based on the information now available, is that there are three disbursements, made in late 1997 and early 1998, that may have been dependent on an overstated level of reserves. This overstatement was due to a few transactions. Without such an overstatement, Ukraine might not have received the disbursements, or would have received them later than it actually did.

6. The IMF staff's current understanding of the above transactions is based on information confirmed by the NBU. The staff believes that the same information was collected by the parliamentary commission but has not been published. Some of the reports published in the media appear to be based on the same information. The staff has received no confirmation of one particular allegation attributed to associates of former Prime Minister Lazarenko. According to this allegation, the NBU's reserves deposited abroad were subsequently used to buy Ukrainian treasury bills, and the interest was diverted to benefit certain Ukrainian leaders and their associates.

7. The NBU's foreign exchange reserves consist of funds received from a variety of sources, including purchases of foreign exchange in the market from exporters and others, and credits from private, bilateral and multilateral official sources, including the IMF. Indeed, IMF credits in 1997 and 1998 together amounted to $675 million, compared with foreign loans from other official sources (including the World Bank and the European Union), and private sources (including Eurobonds), of nearly $3 billion in 1997 and 1998. It is therefore impossible to establish whether it was the foreign exchange provided by the Fund that was used in the above transactions.

8. The IMF staff became aware of these transactions in four stages. First, Ukraine's need to draw on its reserves to stabilize the hryvnia in the aftermath of the Russian crisis of August 1998 revealed at that time that a substantial part of the NBU's reserves were tied up by these transactions and were not liquid. Second, the quarterly audits instituted in September 1998 revealed in March 1999 an additional transaction relating to gold deposits that affected the liquidity of reserves. Third, the IMF staff was notified in April 1999 in a letter from the parliamentary commission of the $150 million round-tripping operation in November 1997 (noted in paragraph 4A above). Fourth, the IMF staff learned in February 2000 of additional transactions that took place in 1996-97, and affected the liquidity of reserves. The transactions revealed in the third and fourth stages were all unwound by August 1998.

Remedial actions

9. Since it became clear to IMF staff in August 1998 that part of the NBU's reserves were tied up, a number of actions have been taken under the current EFF arrangement to correct the situation. First, the NBU ensured that all its liquid reserves were held in first rank international banks. Second, it allowed virtually all of the transactions that had rendered part of reserves illiquid to unwind, and it undertook not to carry out similar transactions in the future. Third, it agreed that PwC conduct quarterly audits of the reserve position of the NBU in the future. While PwC made a brief check on the end-September 1998 position, the first full quarterly audit was undertaken for the reserves at end-December 1998, when the additional transaction referred to above (paragraph 8, second point) was revealed. Subsequent audits have not revealed any further transactions of this nature.

10. Under the EFF arrangement, the IMF staff has been monitoring the level of reserves daily to help ensure that they are liquid, and there has been no evidence of problems similar to those noted above. More specific targets have been set for liquid reserves and decisions about IMF disbursements have related to performance compared with these targets.

11. No remedial action was taken following the revelation to the IMF staff in April 1999 of the $150 million round-tripping exercise in November 1997. At that time, the staff members concerned assumed that the formal requirements of the SBA that was in place in August 1997 through August 1998 were not breached, and they knew that the transaction had been unwound in January 1998. However, it does now appear likely to the IMF staff that there was a breach of the requirements of the SBA as a result of this transaction.

12. The NBU has initiated a special examination of all transactions above $20 million affecting the reserves between December 31, 1996 and September 30, 1998. The results covering the key period from July 31, 1997 to January 31, 1998 are expected by the end of March, and those for the rest of the period by the end of June. The NBU has implemented some improvements in reserve management practices, and is discussing further changes with IMF staff. In the event any future disbursements from the IMF are approved, the Ukrainian authorities have agreed that they will voluntarily keep the proceeds in an account in the IMF. When the results of the special examination are available, the IMF will consider further remedial actions.