Ukraine's hryvnia currency continues to slide after recent regional elections as uncertainty grips the country over the security of its International Monetary Fund (IMF) credit flows.

The hryvnia slid past the psychologically important UAH25 to the dollar mark on November 23 for punters on the streets of Kyiv, its weakest since a currency collapse at the end of February 2015 caused the National Bank of Ukraine (NBU) to impose stringent capital controls on the war-torn economy. 

On the interbank market the UAH fell to UAH24. The currency is now around down 10% since nationwide local elections were held on October 26. The main source of pressure on the hryvnia are fears over continuation of IMF funding, as additional harsh austerity measures required by the IMF face a hostile reception in a parliament full of lobbyists demanding a cut in business taxes.

"[T]he recent shift in FX demand is driven by the lack of progress with the IMF's decision to disburse the next payment, pending the adoption of the 2016 budget law," write analysts at the Investment Capital Ukraine brokerage.

IMF conditions require Ukraine to cut its budget deficit to 3.7% of GDP in 2016, down from 4.2% deficit in 2015. But even the conservative tax reform proposed by Ukraine's Finance Ministry envisages a drop in budget revenues of over 2.7% of forecast GDP for 2016, according to analysts.

And this is nothing compared to the tax reform proposed by head of the parliamentary tax committee Nina Yuzhanina – a member of the presidential Bloc Petro Poroshenko party and former accountant to President Petro Poroshenko's business. Her plans for sweeping tax cuts to support business are backed by Poroshenko's chief of staff and business partner Borys Lozhkin – and have the IMF running for cover.

IMF rattled

In a recent interview, the IMF's man in Kyiv Jerome Vacher unusually went public to tear the parliamentary plan apart. Vacher argued that the measures would cause budget revenue to collapse by the equivalent of 9-10% GDP, which he described as "almost unprecedented for a revenue loss within a single year when looking at international experience".

"It is extremely difficult to see how this could be offset by compensating measures in the 2016 budget, which already faces the loss of temporary revenues and needs to cover important expenditure priorities for next year," Vacher said, urging Ukraine's government to "explain the risks of these tax proposals to the Parliament".

The IMF review mission to Kyiv left Ukraine on November 20 issuing a veiled warning over the parliamentary tax reform proposal. "It is now important that the government submits to parliament a budget that is consistent with the program objectives of further reducing the budget deficit and state debt to safer levels, and that parliament adopts such a budget," Ron van Rooden, IMF mission chief for Ukraine, said in a statement.

But the presidential administration is still pushing for business-friendly tax cuts – and may be using the parliamentary proposal as a bargaining chip to soften up the IMF in talks over the budget parameters for 2016.

"The authorities even in current circumsqnces regularly say no to the IMF," Lozhkin said in an interview on November 13. "In fact, the IMF conditions are open to change, they are not a dogma," Lozhkin added. "Any final version of the proposed tax reform will propose liberalisation of a number of taxes, primarily in the size of the unified social tax, which is a problem for business. I am very much counting on it being cut," he said. A possible compensation would be "shock therapy" through raising the pension age to 65 for men and 60 for women, Poroshenko's chief of staff added.

New year cliffhanger

Analysts predicted the tax issue will create a cliffhanger at the end the year with a taxation showdown between factions in parliament in the final session in late December, pushing the further disbursement of IMF funds into 2016.

"[T]he government faces the challenge of getting parliament's approval for a bill with painful spending cuts and modest tax reduction initiatives for business. We believe the parliament will only agree with such initiatives in a last-minute, New Year's Eve vote for the budget," Aleksandr Paraschiy of the Concorde Capital brokerage wrote in a research note. "Therefore, we continue to expect that the third IMF tranche of $1.7bn won't arrive this year, nor will support from other donors," Paraschiy warned.

"My sense is that this could come to the wire, and we may end up seeing some key reformers having to put their own jobs on the line - either an IMF compliant tax/budget plan is approved in the Rada, or some key reformers might opt to exit," Tim Ash of Nomura International commented in a note.

"No IMF disbursements would leave Ukraine on the edge, and then even a modest upturn in fighting in the East could see another weight of domestic capital flight, weighing on the hryvnia," Ash adds.