Running out of options, Ukraine set to comprise with IMF

Ukraine, pressed by the IMF to enact unpopular reforms, is likely to seek a compromise on some of the Fund's tougher demands in a bid to retain political capital ahead of parliamentary elections next year, analysts say. An IMF mission arrived in Kiev on Tuesday for talks to kick-start a $15 billion aid programme agreed in July 2010.
The programme has been suspended since the start of this year after Kiev refused to implement reforms to cut its budget deficit, including abolishing gas subsidies by raising household gas prices by 50 percent. The IMF has also repeatedly urged the former Soviet republic to loosen its currency peg to the dollar and allow some devaluation of the hryvnia to ease pressure on the balance of payments. Both steps would jeopardise the chances of President Viktor Yanukovich's Party of Region winning an overall majority in next year's vote. The party is seen retaining power but in a TNS poll in September, only 18.4 percent of Ukrainians said they would vote for it, down from 28.9 percent a year earlier. However, faced with a looming balance of payments crisis and little investor appetite for its debt, Kiev will need to start getting IMF cash again soon unless the global economy quickly improves or Russia agrees to supply its import-reliant neighbour with cheaper gas.
Talks with Moscow have so far not produced any tangible results and Ukraine's gas bill continues to rise. "The current account deficit is widening and, without any foreign money (IMF or Eurobonds), the foreign reserves may decline significantly by the elections of October 2012," said Ivan Tchakarov, analyst at Renaissance Capital.
Another recession in the euro zone, which looks increasingly likely given latest economic data, would hit Ukraine hard as Europe is a key export market and West European banks normally would be expected to roll over more than half of the $52 billion public and private debt Ukraine must repay to foreigners next year. "(If the European Union goes into a recession and Russia refuses to cut energy prices) there would be no other option but to acquiesce to IMF demands for higher domestic gas prices and receive money until the elections of October 2012," said Tchakarov.
Ukrainian Prime Minister Mykola Azarov, quoted by Interfax news agency on Tuesday, was braced for difficult negotiations with the IMF. "The talks will be tough but we hope to find mutual understanding," he said. Tchakarov expects the two sides will agree to a compromise by the time the talks wrap up on November 4 and the IMF payments will resume.
"In my opinion, the Party of Regions and the IMF will agree to a more moderate gas price increase that will serve both parties well," he said. "To the electorate, the Regions can still claim that it fought bravely for its rights, so that a much more modest gas price hike was agreed to. The IMF can also save face as it is under enormous pressure not to give money without any gas price increase."
Kiev had been due to receive about $1.5 billion each quarter under the $15 billion IMF facility, which set a budget deficit target of 3.5 percent of GDP this year and 2.5 percent in 2012. Analysts say Kiev will miss the deficit target but the government says it is on track as economic growth is expected to increase to 4.7 percent from 4.2 percent last year.
As well as maintaining generous gas subsidies for households, Ukraine has also kept the hryvnia pegged to the dollar. That policy has boosted Ukrainians' purchasing power but cost the central bank billions of dollars in reserves to defend the hryvnia, which is considered overvalued. It is pegged at around 8.0 to the dollar whereas six-month hryvnia non-deliverable forwards are trading at 9.2/9.7 to the dollar.
The central bank says allowing a significant devaluation would trigger panic among consumers and a run on the currency. But analysts say maintaining the peg is also politically motivated because a devaluation would hit consumption of imports and hurt Yanukovich. The current account deficit widened to $5.5 billion in January-September, from $506 million a year earlier, as imports surged and HSBC analyst Alexander Morozov said the central bank cannot keep running down its reserves to cover the deficit.