- 59 - References Government of Ukraine, 2004, “On the National Program of Reforming and Developing the Sector of Housing and Communal Services for 2004-2010,” Law # 1869 (Kyiv: Government of Ukraine) Grant, H., 2003, “Pay and Benefits and Performance Management in the Ukraine Civil Service,” mimeo (Kyiv: United Kingdom Department for International Development). International Monetary Fund, 2003, “Public Debt in Emerging Markets: Is it too High?” Chapter 3 in World Economic Outlook (Washington: International Monetary Fund). International Monetary Fund, 2004, “Ukraine: Report on the Observance of Standards and Codes Fiscal Transparency Module,” (Washington: International Monetary Fund). Reinhart, Carmen, Kenneth Rogoff and Miguel Savastano, 2003 “Debt Intolerance,” in Brookings Papers on Economic Activity: I, Brookings Institution, pp. 1-62. World Bank 2002, “The Health Sector in Ukraine: Discussion Paper on Selected Health Care Reform Options,” mimeo, (Washington: World Bank). World Bank, 2003, “CEM Pension Note: Reforming Ukrainian Pension System,” mimeo, (Washington: World Bank). World Bank, 2004, “Equal Access to Quality Education Project,” Project Appraisal Document (Washington: World Bank). ©International Monetary Fund. Not for Redistribution - 60 - 50 V. CAPITAL MARKETS IN UKRAINE 120. While financial intermediation through the banking system has grown rapidly over the past four years, capital markets remain small and illiquid. Capitalization, trading activity, and the range of financial instruments are very limited in all segments of regulated capital markets in Ukraine. The paper provides an overview of the markets for domestic government securities, corporate bonds, and equities, and discusses issues to foster their development. 121. More developed capital markets would be an important ingredient for a stable and well-functioning financial system. Fixed income markets would help strengthen the monetary transmission mechanism, facilitate risk diversification for investors, in particular for the banking sector, and provide funding in case access to international capital markets would be limited or prohibitively expensive. Policies that would foster the development of those markets include reducing the fragmentation of government securities and developing benchmark issues and establishing a strong legal and regulatory framework that provides a more transparent and certain environment for investors. This is also a crucial component for the development of the equity market. A. Domestic Government Securities Market 122. The stock of domestic government securities is low and secondary markets are thin. Following the government bond restructuring in 2000, a lack of appetite and high risk premiums for government securities constituted a financing constraint that forced the government to maintain a tight fiscal stance. With the recently regained access to international capital markets―the government issued $2.1 billion Eurobonds in 2003 and 2004―the government has resorted predominantly to external financing. Moreover, investors tend to hold domestic securities until maturity so that secondary market turnover has been low. Figure 1. Stock of Tradable Government Securities Stock of government securities (In percent of GDP) 1/ 30 123. Domestic 25 government securities held 20 outside the central bank 15 amounted to just over 10 1½ percent of GDP at end-2003 5 0 (Table 1) which is at the bottom Hungary Czech Poland Latvia Bulgaria Romania Russia Ukraine end in international comparison Republic (Figure 1). The vast majority Sources: National authorities, ECB (2002), and staff estimates. (more than 90 percent) of 1/ 2003 for Bulgaria and Ukraine, Sept. 2003 for Romania, 2002 for Russia, Hungary, and P oland, 2001 for Latvia and Czech Republic. 50 Prepared by Andrea Schaechter. ©International Monetary Fund. Not for Redistribution - 61 - securities is held by banks. In 2004, nonresident investors have returned to the market—for the first time since the crisis—attracted by comparably high maturities and Ukraine’s strong macroeconomic performance. While their share remains low at less than 1 percent they have acquired 13 ½ percent of new issuances in the first six months of 2004 (Table 2). Table 1. Ukraine: Stock of Domestic Government Securities, end-June 2004 Volume Interest Rate Type Maturity (Millions of hryvnias) (In percent) Regular securities Up to three months 0 ... Three months to one year 322 9.3 More than one year to 18 months 1,113 11.4 More than 18 months 2,360 9.3 Other 1/ 99 16.0 VAT refund securities Five years 365 9.0 2/ Restructured securities Monthly repayment until 2010 6,906 8.7 3/ Total 11,165 Sources: National Bank of Ukraine; and Ministry of Finance. 1/ Savings bonds issued to retail investors. 2/ The coupon rate of the VAT refund securities is set at 1.2 times the NBU's discount rate, which at end-June 2004 was 7.5 percent. 3/ The coupon rate is indexed to past and expected inflation (see Box 1). Table 2. Ukraine: Investors in Government Securities, 2001-04 (In percent of total stock) End March 2001 2002 2003 2004 Commercial banks 10.7 20.0 22.6 21.2 NBU 83.1 78.5 75.0 67.5 Institutional investors 0.0 0.0 0.0 0.0 Other residents 6.1 1.4 2.4 10.7 Nonresidents 0.0 0.0 0.0 0.6 Sources: National Bank of Ukraine; and Ministry of Finance. 124. Delays in the securitization of the government’s VAT refunds arrears have not yet given the expected boost to the stock of domestic public bonds. At end-2003, VAT refund arrears amounted to Hrv 1.9 billion and the government has begun since January 2004 to offer taxpayers securities as compensation. The securities have a nominal value of Hrv 1,000 each and a maturity of five years. Coupon payments are annual at a rate of 1.2 times the NBU’s discount rate. Twenty percent of face value is amortized annually beginning end-2004. As of end-June, 2004, about Hrv 400 million securities had been issued to taxpayers.51 51 Preliminary data indicate that until end-August 2004 VAT refund arrears of Hrv 1.9 billion had been securitized. ©International Monetary Fund. Not for Redistribution - 62 - Box 1. Restructured Government Securities Restructured bonds were first issued in February 2000 to replace existing government securities and are held by the NBU. Three types of securities exist (see table below). The bulk of restructured securities held by the NBU bears a coupon rate that was determined annually by the Ministry of Finance and linked to expected inflation. Effective 2005, the coupon rate formula will be linked to actual past inflation. Eliminating the uncertainty and discretion in the papers’ yield should make them more marketable. The second type of securities was issued in September 2000 in the process of restructuring accrued interest on Ukrainian government debt securities. The notes mature in 2009 and 2010 and bear no interest. The NBU also holds euro-denominated government securities which mature in 2007. It received these bonds as compensation for liquidity support provided to a Ukrainian bank in which it intervened. Ukraine: Restructured Government Securities 1/ Government Securities State Treasury Notes Issued in Converted Government Issued in Oct. 2000 Sept. 2000 Securities Issued in Feb. 2000 Origin Acquired as a result of Received from the Ministry of Originally US$-denominated restructuring government Finance in the process of government bonds that were securities issued in 1998– restructuring accrued interest on issued to the Russian 2000 government securities maturing “Gazprom” in 1995. The in 2000–2004 NBU received those securities as compensation for liquidity support provided to a Ukrainian bank in which it intervened. Currency Hrynvnia Hrynvnia Euro denomination Face value 2003 Hrv 7,438 million Hrv 395 million Hrv 113 million 2002 Hrv 8,500 million Hrv 395 million Hrv 121 million 2001 Hrv 8,809 million Hrv 395 million Hrv 114 million Maturity 2010 (monthly repayment of 2009: Hrv 196 million 2007 Hrv 90 million) 2010: Hrv 199 million Coupon rate Inflation-indexed 2/: Zero 10 percent 2004: 8.7 percent 2003: 0.0 percent 2002: 5.2 percent 2001: 17.0 percent 1/ At end-June 2004, the entire stock was held by the NBU. ⎡⎛ e ⎞ e ⎤ 2/ The coupon rate is calculated as: i = 1.03* ⎜CPI − CPI ⎟/ CPI −100 ; ⎣⎢⎝ t t −1⎠ t −1 ⎦⎥ e e with CPIt ,CPIt−1 = Official projections of the consumer price index. Effective 2005, the formula for the coupon rate will be as follows: i=(CPI-100)*1.03 if CPI>100; i=1.03 percent if CPI≤100. Sources: National Bank of Ukraine and Ministry of Finance. 125. In an attempt to tap household savings, the government has offered savings bonds. An initial offer of Hrv 50 million bearer certificates in small denominations (Hrv 50) ©International Monetary Fund. Not for Redistribution - 63 - went on sale in May 2002. By May 2004, the sales of two series (Hrv 150 million) were completed with the authorities hoping to sell a total of Hrv 400 million. The savings bonds yield a nominal interest of 16 percent, with the effective yield currently around 12 percent. Primary market 126. Frequent auctions, which often failed to find buyers, have left the primary yield curve with significant gaps (Figure 2). Until June 2004, the Ministry of Finance held weekly auctions with maturities being decided week by week and ranging from 3 to 24 months. Emphasis has shifted towards 18 and 24 months maturities since the beginning of 2004 (Table 3) and the Ministry of Finance announced that in 2005 it would only issue debt with a maturity of at least three years. Largely due to low yields offered at the short end, the Ministry of Finance could not finds buyers for its papers in more than half of all auctions since 2003 (Table 4). The number of Figure 2. Ukraine: Primary Market Yield Curve for Domestic Government outstanding papers is Securities (In percent) large while each volume 14 is low since the Ministry 12 of Finance does not 10 reopen any issuance of 8 government securities.