Graham Stack in Moscow -

With the hryvnia depreciating rapidly due to a soaring trade deficit, and banks downgraded across the board, the International Monetary Fund is in town to bail out Ukraine. But only if its politicians finally get their act together.

On Wednesday, October 22, the hryvnia fell on the interbank market from $5.45-$5.55 to $5.7-5.75 at close of trading, a drop of 4.3% on the day. At some exchange points, dollars were being sold for UAH6. This, despite National Bank of Ukraine (NBU) intervention that has seen reserves fall $3.2bn in October to $34.3bn, the NBU head Vladimir Stelmak said. $34.3bn covers three months imports.

UkrSib analyst Evgeniya Afonina said that the dollar was expected to rise to UAH6 on the interbank market Thursday, meaning the hryvnia will have depreciated by one-third since reaching its peak of UAH4.5 per dollar in June this year.

The hryvnia's difficulties are due to a trade deficit that has widened hugely in the second half of 2008 as Ukraine's key steel sector was hard hit by the collapse in world prices. Exporters have few dollars to sell, and importers are desperate for dollars at any price to keep up payments on credits.

Demand for dollars is also increasingly coming from the population transferring their savings into hard currency as their hryvnia deposits mature. NBU's Stelmak said today that individuals had withdrawn UAH13.5bn in the course of October.

The NBU has now imposed a ban on preterm redemptions, which will cover the lion's share of savings accounts. Analysts are calling for the ban to be extended to all deposit withdrawals. "If narrow money continues to explode via deposit withdrawals, the NBU may have difficulties since it would need to kill excessive supply by one hand and provide refinancing to ailing banks by another, virtually printing UAH," wrote UkrSib analysts.

UkrSib's Afonina emphasizes that the situation in the country was still "quite civilized," with no long queues in front of banks or exchange booths. However internet forums are full of semi-hysterical premonitions of a looming meltdown.

It's not just punters who are getting edgy. Anders Aslund, a sometime advisor to Russian and Ukrainian reformers, circulated a note Wednesday calling for an immediate disbursal of an IMF rescue package to Ukraine. "Speed is vital," wrote Aslund. "Everyday, Ukrainian companies fall off the financial cliff for no good reason. Their only fault is that they have taken a foreign loan. The slightest delay in an IMF agreement can lead to a run on the Ukrainian currency, the collapse of the Ukrainian bank system, mass bankruptcies, a double-digit fall in output, mass unemployment, and undoubtedly political unrest."

Storm clouds

The clouds have been gathering since mid-October. Yields on Ukraine's Eurobonds have shot up to 20%, a level characteristic of countries in external default.

On Friday, October 17, Standard & Poor's put Ukraine's foreign and domestic currency ratings on a global and domestic scale on CreditWatch with a 'Negative Outlook'. S&P cited Ukraine's high level of private foreign currency debt against the background of currency instability, depreciation of the financial sector's asset quality and a reversal of the country's international trade flow. This was followed by Moody's and Fitch downgrading 10 Ukrainian banks, making it hard for them to roll over short-term debt.

Now the fall in the hryvnia is going to add further pressure on companies with payment due on foreign debts. Ukraine has only $15bn public foreign debt. However, it had $85bn private foreign debt as of July 1, making gross external debt around 50% of GDP. Citibank analysts estimate Ukraine's 2009 external financing requirement at $55-66bn, of which $32bn-40bn is in the private sector. Most worryingly, the NBU has said it expects banking sector debt worth $1bn-1.2bn to mature in the final quarter of this year.

There are some straws to clutch at. For instance, 25% of short-term banking debt is owed to the big foreign parent banks that own 40% of banking assets. And in the first two weeks of October, there was a sharp drop in imports, as banks froze retail lending and the falling hryvnia raised prices.

On the other hand, all this is taking place against a homemade backdrop of political crisis and personal feuding on an operatic scale. Preterm elections were called for December 7, postponed to December 14, then to January and then apparently cancelled. All in the course of a week. Then on Thursday, President Viktor Yushchenko said the elections could take place on December 7 after all. His prime minister, Yulia Tymoshenko, bitterly opposed to the elections, is refusing to pass anti-crisis laws she suspects contain hidden measures for funding them.

And looming on the horizon is a major gas price hike from Russia come the new year. As yet nobody knows how large. Worst-case scenarios say the hike could be from the current $175 per 1000 cubic meters to $400, which would really sink the hryvnia.

Steel - Ukraine's Achilles' Heel

The root of Ukraine's problems - in the context of the global financial meltdown - is the collapse in world steel demand and prices. The Industry Ministry earlier in October officially declared the crucial metallurgical sector to be in crisis, with 17 of 36 steelmaking furnaces out of play, as steel prices have fallen by half.

Steel is for Ukraine what oil and gas are for Russia, accounting for 27% of GDP and 39.9% of the export revenues. But there is an important difference: over years of soaring oil and gas prices, Russia has cannily channelled much of the revenues into rainy day stabilization funds it can draw on now; Ukraine has no such "air bag" to cushion the blow.

A further crucial difference is that the oil price will get political support from Opec to break its fall. Obviously there is no such safety net for steel - and due to the soaring prices all last year right up to a few months ago, there is now surplus capacity in the world. This leaves Ukraine looking horribly exposed to the plummeting steel prices. The current account deficit, which in 2007 amounted to 4.2% and was easily covered by FDI, is set to widen to $21.3bn, 11.1% of estimated 2008 GDP, according to Dragon analysts. And this is before any gas price hike kicks in.

IMF to the rescue

Most analysts are still hopeful that the IMF rescue packet being negotiated now in Kyiv could still pull Ukraine out of hot water. Dragon analysts quoted PM Tymoshenko as saying Wednesday that the loan agreement was 90% finalized, with the loan amount expected to be $10bn-15bn. And newswires quoted Tymoshenko as saying the IMF would announce the loan and conditionality that day. However, this did not happen. "We do not expect the IMF package to be finalized until next week," reckons UkrSib's Afonina.

When such a package does come through, it will still depend on Ukrainian politicians implementing the conditions. And with the current fractured political situation in Kyiv, even this can't be taken for granted

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