Ben Aris in Moscow -

The drama in Ukraine is starting to look like a Hollywood B movie storyline.

Hero wearing tattered clothes, bloodied and battered, staggers towards the sanctuary of the waiting plane/car/spaceship as the pack of ravenous dogs/savages/aliens pursue him with glitter of revenge in their eyes.

Except in the real world it is Ukraine's economy that is battered and bloodied (and in recession). The staggering is due not to the lack of water, but to the lack money, as foreign reserves have sunk by more than $15bn since April to a dangerously low $21bn as of September.

And the pursuers? Well that is Russia, which is furious at Kyiv and looks ready to rip it to pieces. On September 17, Ukraine finally rejected Moscow's offer to join its Customs Union trade club and instead has turned to the EU. The sanctuary Ukraine is making for is to sign off on an Association Agreement and Deep Comprehensive Free Trade Agreement (DCFTA) at an EU summit in Vilnius at the end of November.

"I welcome the adoption of the Association Agreement by the government of Ukraine. This is a clear proof of the European choice," European Commissioner for Enlargement and European Neighborhood Policy Stefan Fuele tweeted on the news that Ukraine had formally accepted the offer to sign the EU deal.

Ukrainian Prime Minister Mykola Azarov said the agreements that should be signed at the November summit in Lithuania raise the prospect of "a European quality of life" for the ex-Soviet republic.

If all goes well, an EU deal will clear the way for structural adjustment loans, easier access to one of Ukraine's most important markets, increased foreign direct investment and, most importantly, it would smooth the way for restarting talks on a crucial $15bn stand-by agreement with the International Monetary Fund (IMF).

But the drama is high. Russia is putting pressure on Ukraine not to make any further moves toward the EU. In the latest swipe at Kyiv, during the Yalta European Strategy conference on September 19-22 an advisor to Russian President Vladimir Putin warned to jeers from the audience that Russia could impose new trade tariffs on Ukrainian goods while Ukraine's trade balance would turn negative as local producers struggle to compete with higher quality EU goods flooding the country, necessitating a €35bn bailout to avoid a sovereign debt default. "Who will pay for Ukraine's default, which will become inevitable?... Would Europe take responsibility for that?" Sergei Glazyev asked, the Financial Times reported.

Warning signs

Clearly, Ukraine's economic situation is precarious. Its $21.6bn of forex reserves are only enough to pay for two and half months of imports, below the level that most economists believe is a minimum to ensure the stability of the national currency.

Added to that is the Treasury has a float of only $300m in cash, enough to pay government expenses for a few weeks at most. The economy has been slowing, the budget deficit ballooning and the current account deficit widening. The government's response has been to simply not pay salaries, with arrears passing the UAH1bn ($123m) mark as of September 9 and still rising. In short, a devaluation is looming that could quickly spin out of control.

Timothy Ash, head of strategy at Standard Bank, released an alarming note in the middle of September saying he had been hounded by the Ukrainian press, who seem to be part of an attempt by the government to prepare the ground for a sharp devaluation and possibly worse to follow. "I think the Rubicon has been crossed," Ash said. "The Ukrainian hryvna has always benefited from being a 'boy that cried wolf' from most... analysts, but the news flow/mood music is just getting really ugly."

Ash was called by several state-owned media outlets and aggressively grilled on his views on the value of the national currency. "All the local press coverage is talking down the hryvna - the sense is that the administration is now giving up the ghost, and recognises that it can now longer support/defend the hryvna," he said.

Ash speculates that Ukraine may sink into crisis before the end of November, however it is likely that the government will manage to muddle through somehow. On the plus side, Ukraine is on course to bring in a record harvest, which is a major export item and the Federal Reserve's decision to delay ending quantitative easing on September 18 means Ukraine could even issue more Eurobonds, albeit at a high price.

Sticking points

So everything will be okay when Ukrainian President Viktor Yanukovych flies into Vilnius at the end of November and signs on the dotted, right?

Well, no. Although Ukraine has signed off on all the legal stuff necessary to make the agreements possible, there is the question of releasing former Ukrainian prime minister Yulia Tymoshenko, who is serving a seven-year sentence for abuse of office. However, the EU has taken the stance that she is a political prisoner and made her release a prerequisite for the DCFTA deal to go ahead.

After Russia badgered Armenia into agreeing to join the Customs Union in September and aggressively threatened tiny Moldova into doing the same (the brave little country has snubbed the Kremlin and promptly had its wine banned), the Tymoshenko issue seems to have been forgotten as tensions escalate dramatically. But it is bound to reappear. "We must make every effort for Tymoshenko to be freed before the Vilnius summit," Iryna Gerashchenko, a deputy for the opposition party UDAR, told Interfax-Ukraine. "Even though the signing is important to the EU and Ukraine, the EU will never be able to close its eyes to the violation of fundamental values such as human rights, including the right of defense in a court and the right to justice."

Fuele fudged the issue in an interview on September 19, saying he was confident "a decision to a large extent will be reached in her interests." Lithuanian Ambassador to Ukraine Petras Vaitiekunas went a step further, saying the EU isn't making Tymoshenko's release a necessary condition for signing the trade agreement.

But even signing off on the deal will not solve Ukraine's biggest problems. What makes the country especially vulnerable to shocks is its $62.1bn of short-term debt. Coupled with a current account deficit of some $13bn-14bn that needs to be financed, Ukraine's total external financing requirement this year will be some $75bn - more than three-times its entire forex reserves - from a total gross external debt of $136bn outstanding.

Kyiv's new pals in Brussels will have to come up with hundreds of millions of dollars to tide the government over, so cutting a new deal with the IMF becomes imperative.

Of course, this all assumes that Russia as the jilted partner doesn't retaliate. The Kremlin has already threatened to raise duties on Ukrainian imports and the state-owned gas monopoly Gazprom is holding a $7bn gas bill over Kyiv's head for a shortfall in deliveries under Ukraine's take-or-pay deal with the company.

The Russians are clearly gearing up for a fight. In the middle of September, Valdimir Putin brought back his former deputy administration chairman, Vladyslav Surkov, an eminence gris and top Kremlin spin doctor, as point man to manage Ukraine affairs. Russia's big guns are being trained on Kyiv.