Ukraine slips towards disaster

By bne IntelliNews February 10, 2009

Ben Aris in Berlin -

Ukraine is slipping toward disaster as its politicians concentrate more on scoring points against each other than acting to halt the slow-motion economic collapse.

Only three months after negotiating a $16.4bn bailout loan from the International Monetary Fund (IMF), Prime Minister Yulia Tymoshenko said February 9 that the government had been put in the humiliating position of appealing to Russia for a short-term, multibillion-dollar loan because the state is rapidly running out of money.

Moreover, an IMF mission to Kyiv left last week, threatening to stop further payments unless the government lives up to its promises made when the loan was granted; the first tranche of $4.5bn was transferred immediately after the deal with the IMF was done in November, but it comes with strings attached and the government has failed to do what it promised at the time.

Cash is becoming increasingly scarce in Kyiv. The National Bank of Ukraine (NBU) reports that deposits are leaving banks, while the population has recently bought some $500m of hard currency in anticipation of more instability and a possible systemic collapse of the bank system. The NBU estimates that a third of the country's banks are in trouble and the top 17 need at least $3bn of fresh capital to keep going. At the same time, tax receipts are down by at least a fifth, while export duties - another major source of revenue for the state - have also collapsed due to the fall of commodity prices.

And worst of all, the devaluation of the hryvnia hasn't ended. Unlike Russia, many Ukrainians have taken out loans denominated in dollars and so are exposed to the falling value of their national currency. After spending close to a decade at the rate of UAH5 per dollar, the currency has last over half its value in the last months and some analysts predict that the rate could fall as low as UAH12-UAH15 by May.

Russian debt

The Ukrainian government has also appealed to the Kremlin for up to $5bn to tide it over, though exactly what was asked for and what the reply was is confused by a welter of conflicting reports.

Alfa Bank's Denis Shauruk reports: "Plans to borrow money from the Russian government were first disclosed by pro-presidential forces, who claimed that the Ukrainian delegation arrived in Moscow for negotiations last Friday [February 6]. Yulia Tymoshenko confirmed this at a Munich security conference on February 7. According to the directives for the Ukrainian delegation, Ukraine was prepared to consider the ratification by the Ukrainian Parliament of a "zero outcome" agreement signed in December 1994 about sharing former USSR debt and property rights. According to unconfirmed information, the provision of the agreement may also concern disputed property within Ukraine. The parameters of the loan, according to the Russian Minister of Finance Victor Kudrin, are expected to be as follows: up to $5bn at an interest rate of Libor plus 8-9% over five to seven years. The final decision on the loan provision should be made by February 14. We see the news as generally 'Positive' for Ukraine as a pro-active fiscal policy to fight the financial crisis should alleviate pressure on the monetary authorities and reduce pressure on the UAH/USD exchange rate. Moreover, according to government officials, the negotiations on the provision of the loan are held in Saudi Arabia, Japan, the EU and other countries."

However, the news of a potential Russian loan started a flood of statements. The Ukrainian foreign ministry denied it was involved in any talks with Russia. However, the Russian foreign ministry issued a statement saying it had started talks with its Ukrainian counterpart.

At this point, it appears the approach to the Kremlin was done on Tymoshenko's own initiative; Ukrainian President Viktor Yushchenko immediately lashed out at what he calls an "illegal" deal, should it go through, which was reportedly broached on the sidelines of the Munich conference.

"The consultations, as they call them today, on a $5bn loan from Russia continue the lame-duck policy of the Ukrainian government. This loan leads to the destruction of both the economic process and the process of forming the budget. The fact that the government is inclined to [taking] loans from abroad and brings political connotations to this, proves a badly thoughtout and dangerous policy, which poses a threat to Ukraine's national interests," Yushchenko told a news conference in Ivano-Frankivsk on February 9.

The president thinks it's unacceptable that issues with strategic importance to the country are solved on the sidelines in violation of established legal provisions and with "obvious signs of corruption," Yushchenko's press secretary Iryna Vannykova said at a briefing.

IMF bad books

Kyiv has been waiting impatiently for a second tranche of the IMF standby facility, but the Fund has been griping about the lack of commitment by the Ukrainian state, which has delayed the payout of another $1.9bn.

The IMF announced it positively appraised the Ukrainian government's actions in supporting the economy. However, because the overall economic slowdown is greater than expected, the IMF is proposing regular reviews of Ukraine's economy and will continue negotiations on releasing the second tranche of the IMF loan very soon.

In plain speak, this is the same as the IMF saying it's not happy with the government and won't pay out any more until it sees real evidence that the government is going to stick to the terms of the deal signed in November.

"The IMF delegation has completed monitoring Ukraine's withholding standby agreement memorandum conditions and left Ukraine, postponing its decision about the second tranche until an unspecified date," says Alfa Bank's Shauruk. "The most critical breach of the memorandum's conditions was the vote in parliament for an unbalanced budget with a 3% deficit for 2009. IMF requirements stipulated that social spending in the budget should be frozen and the budget should be approved with a zero deficit. However, Ukrainian politicians are unlikely to accept these conditions one year before presidential elections, which signals that the terms of loan agreement with IMF will be reconsidered. The second tranche was expected to amount to $1.9bn."

President Yushchenko said February 9 that signing off on the deficit-budget was "a big mistake," which he now regrets. Analysts at Foyil Securities say they expect the government to revisit the budget in coming weeks and cut the offending social spending items, but this is not certain to go through - especially if Tymoshenko can get some cash from somewhere other than the IMF.

"In the meantime, according to Interfax , Prime Minister Tymoshenko is negotiating a $5.0bn loan from Russia to help cover the UAH31.1bn 2009 state budget deficit," says Volodymyr Gabriyelyan of Foyil Securities said. "We believe Mrs. Tymoshenko is motivated by her desire to patronize the electorate before the presidential election, scheduled for late 2008/early 2009, and so is not willing to curtail social welfare benefits. Should Russia agree to give such a loan, we can expect Ukraine to give something in exchange, although so far nothing has been suggested."

Tymoshenko has followed populist policies whenever she gets into power. Previously, when she cut budget spending last year, the investment portion of the budget spending was slashed to some 40%, say analysts at Ukrsibbank, whereas the state paid out around 99% of the social portion.

However, the NBU is holding out for changes to the IMF deal that would leave some of the spending in, pointing out that things have got a lot worse since the deal was first negotiated in October. "The memorandum is not a sacred cow," National Bank of Ukraine Council head Petro Poroshenko said in an interview published in Dzerkalo Tyzhnya. "The possible revision of the agreements was precisely among the purposes of the current IMF mission's visit. Since October last year, when the memorandum conditions were negotiated, the situation has worsened significantly, not only in Ukraine, but also in the neighbouring countries in Central and Eastern Europe, just as in the entire global economy. New challenges have emerged, and it is virtually impossible to find appropriate responses to them within the framework agreed upon earlier. I think the IMF delegates also understand this."

Other sources of funds

The Ukrainian state is also tapping various other friends for money. It is in talks with the World Bank and EU for money. Ukraine is expected to negotiate the provision of a €2.6bn loan with representatives from the European Commission on March 23. The funds are expected to be used to modernize Ukraine's gas transportation system.

If things go well, the government could potentially raise more than $10bn this year, which in combination with expected proceeds from privatization and funds raised by the private sector, should cover short-term capital flight expected in 2009 of $18.6bn. "Out of this amount, only $1.75bn is attributable to government debt, which excludes any possibility of a government default on external debt this year. For the private sector, solvency issues will be resolved on a case-by-case basis, and, except for Naftogaz, they will not have a spill over effect on government obligations," says Alfa Bank's Shauruk.

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