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With Ukraine's presidential elections just around the corner, the International Monetary Fund (IMF), spooked by the rising political risks in the country, could well decide to suspend the next tranche of the badly needed stand-by loan.

As it stands, the IMF mission left Kyiv on October 26 without saying whether the next $3.4bn disbursement of the stand-by agreement would be disbursed, though it was demanding the president vetoes a law passed by parliament that would raise the minimum wage. During the trip, however, Ceyla Pazarbasioglu, head of the IMF's Ukraine mission, suggested the Fund might decide to delay or cancel the next $3.4bn disbursement.

The IMF mission had been in Kyiv from the start of October to review how the government is performing under the terms of the $16.4bn stand-by agreement, which was agreed late last year to help stabilise the country during the global economic crisis, as it has repeatedly broken its promises to the Fund. The IMF also wanted to check the figures Kyiv is putting out after the government was accused of cooking the books to keep the aid tap open.

The main problem is the persistent political risks that have plagued the country since the "Orange Revolution of 2004/05. Gallup found earlier this year that the 4% approval rating for Ukraine's current government is the worst recorded level the pollster has ever found in the nearly 200 years it has been conducting such polls around the world. Prime Minister Yulia Tymoshenko has shown herself unafraid to wave the populist flag when it suits her purposes and the Rada has already persuaded the IMF to allow it to run up a general government deficit target of 6% of GDP, or 8.6% including the unpaid gas bills of state gas firm Naftogaz. And although the government promised to hike domestic gas tariffs - which are half the price the government pays Russia for it - conveniently, the increase has got bogged down in the courts.

Campaigning for January's presidential elections officially began on October 19, although it's actually been going on for months. President Viktor Yushchenko's popularity is less than the margin of error in the polls and will almost certainly be ousted, while Arseniy Yatsenyuk, an outsider who was once parliamentary speaker, is now polling at 10% or less. That leaves the race as a contest between Tymoshenko and leader of the opposition and ex-PM Viktor Yanukovych.

Yanukovych has a clear lead in the polls, with an approval rating of about 24%, while Tymoshenko is trailing at about 15%. However, as neither leader has anywhere near the 50% needed for a simple victory, the elections will almost certainly go to a second round. Then things are harder to call: many observers in Kyiv are predicting that Tymoshenko would win a second round. "Yanukovych has a solid quarter of the vote, but that is all he has. Faced with a choice of reinstalling the old regime and voting for Tymoshenko, we are pretty confident that the voters would rather see they devil they know than the devil they already had," says one seasoned Ukrainian watcher, who didn't want to be named talking about politics.

Budgetary blues

Tymoshenko and Yanukovych are already sparring in the parliament as the PM's minority administration tries to secure approval for the 2010 budget. Yanukovych's opposition Party of the Regions finally unblocked parliament in October though only on condition that there would be big hikes in both the minimum wage and pensions. Analysts say that such spending will make it that much more difficult for the government to put together a budget which is likely to win IMF-approval. More far-reaching reform of the tax regime and pensions systems also being demanded by the IMF, though those will almost certainly have to be put off until after the presidential elections. What all this means, says Fitch Ratings in its note affirming Ukraine's 'B+' rating with a negative outlook, is that the fiscal deficit could expand to 11% of GDP or more.

"Even with the IMF in very generous mode at present, it is difficult to see the Fund lending into an election campaign," says Tim Ash, emerging market analysts with Royal bank of Scotland. "The most likely outcome would be for the Fund to delay disbursement, perhaps even awaiting the outcome of the elections."

The one brighter spot is the banking sector, where Ukrainian authorities are making better progress in reforming it and bankers say they are seeing signs of some improvement.

On October 20, the head of Swedbank, which has had operations there since 2007, said the level of bad loans would likely be lower in the fourth quarter than in the third, as most of the pain had already filtered through. Swedbank revealed in its third-quarter figures that the level of impaired loans in Ukraine was now almost half of the book, with SEK2.3bn in the third quarter pushing the gross impaired loans level in Ukraine to SEK6.59bn. "The market condition in Ukraine is still weak," Wolf told reporters. "But the positive of all this - having taken so many impaired loans - is we are seeing the end of the tunnel in respect to that."

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