IMF advises Ukraine to lower share of govt bonds in reserve requirements and phase out three-month certificates of deposit

MOSCOW. Oct 22 (Interfax) - The National Bank of Ukraine's decision to increase reserve requirements (RR) by 5 percentage points and the share of RR that can be met with domestic government bonds from 50% to 60% is appropriate under the circumstances, but distortionary as a means managing liquidity, and increases risks by reducing the scope for domestic market financing to absorb shocks going forward, International Monetary Fund experts said.

"Whereas the RR has been an effective tool in encouraging primary bond uptake under the extenuating circumstances, the use of the RR in this way is not an effective way to manage the large liquidity surplus, distorts the functioning of the RR as a monetary policy tool, and may increase the dependence of the government bond market, which has been increasingly functioning on market terms, on such support," Ukrainian media reported, quoting the updated Extended Fund Facility program following its fifth review.

This change will increase demand to UAH 131 billion in primary government bond purchases through the end of 2024, whereas reserve requirements are estimated to increase by UAH 170 billion. The resulting impact on liquidity would be more muted given the large marginal share that would likely be met with government bonds, the IMF said.

The impact of this measure on liquidity conditions as it takes effect should be carefully monitored to ensure consistency with the monetary stance, the IMF said. "The share of government bonds allowed to meet RR should be phased out over time as conditions permit," it said.

The IMF also said that after substantial net issuance this year, the authorities plan significantly less reliance on the domestic government debt market next year, allowing room to support credit for the recovery.

The IMF said the NBU should continue adjusting its operational design to ensure adequate monetary policy transmission given prevailing high liquidity. In September, the NBU lowered the rate on three-month certificates of deposit (CD) to 15.5% percent and on refinancing loans to 16% to further support transmission in line with the easing cycle, the Fund said.

"Gradually phasing out the three-month CDs (currently a third of outstanding CDs) would increase the role of overnight CDs (which since October 2023 have been remunerated at the key policy rate) for open market operations and liquidity absorption, thereby ensuring stronger monetary policy transmission," the IMF said.

It said adjustments to three-month CDs should be gradual, permitting an assessment of their impact on hryvnia term deposits, in view of risks to the outlook.

"Going forward, the NBU should continue normalizing the conduct of monetary policy, for example, by considering instruments beyond overnight maturity to increase the average maturity of sterilization operations," the IMF said. Ukraine itself talks about such plans in the updated memorandum.

Ukraine reiterated that it would request monetary financing from the NBU only as a last resort and in strictly limited amounts, underpinned by a framework that has been mutually agreed between the Finance Ministry and NBU in consultation with the IMF, and for which an NBU resolution was adopted in September 2024.

"We will also avoid indirect forms of monetary financing that are outside the core functions of the NBU, such as through the directed provision of liquidity to banks for the purchase of government securities on the primary market. Direct financing of off-budget programs by the NBU will be avoided altogether," the memorandum says.

The 2024 state budget amendments adopted in mid-September allocate a further UAH 216 billion to be raised on the government bond market to finance the budget deficit by the end of the year with borrowing raised to UAH 742.02 billion and redemptions at UAH 386.01 billion.

The government's draft 2025 state budget calls for the placement of UAH 579.22 billion of government bonds and redemptions of UAH 561.98 billion. There are also plans raise $38.4 billion in external funding and to finance UAH 1.876 trillion of the budget deficit with this.

The interest of banks in benchmark government bonds, which can be used to form required reserves, pushed the rate on them at the last auction on October 8 below that for shorter-term market bonds: the Finance Ministry put its rates up for 20-month and 32-month bonds from 15.1% to 15.25% and from 16.1% to 16.25%, respectively, but lowered rates for 25-month and 36-month benchmark bonds from 15.6% to 15.1% and 16.59% to 16.1%, respectively.