Ukraine grabs IMF lifeline

By bne IntelliNews March 27, 2014

bne -

Battling economic meltdown, Ukraine was thrown a lifeline on March 27 as the International Monetary Fund (IMF) announced a deal to hand the country up to $18bn in loans. The accompanying demands on the interim government in Kyiv to implement reform only adds to the long list of challenges it faces.

As pressure from Moscow mounts on the interim government in Ukraine in the wake of Russia's annexation of Crimea - both in the form of a huge military buildup on the border and economic pressure on exports - the IMF said it will provide Ukraine with $14bn-18bn in financing. The "Stand-By Arrangement" loan, which means disbursements will be contingent on reform, is set to be approved by the IMF board in April.

"A broader reform effort is being promised by the government, including banking sector reform, fiscal consolidation, energy sector reform, and anti-corruption efforts," reports Tim Ash at Standard Bank. "The government and [National Bank of Ukraine] has also accepted a more flexible exchange rate regime as part of the program; the hryvnia still probably needs to go weaker."

Although delayed by a few days from the original plan, the IMF announcement has come swiftly in the wake of the collapse of former president Viktor Yanukovych's regime at the end of February, sparked by his refusal to sign off on a pact with the EU and instead take a $15bn deal from Russia with unknown conditions attached. The Washington-based lender has often been bitten by Kyiv's failure to honour the reforms demanded by previous deals designed to help the rocky economy, and with uncertainty still reigning over the extent of the damage inflicted by the fleeing Yanukovych and cronies, it has clearly taken somewhat of a leap into the dark, pushed by the western determination to support the interim government.

The level of support offered falls short of the total that Kyiv is thought to need over the next couple of years in order to pay off huge volumes of debt and unpaid bills, particularly of gas from Russia, with estimates varying between $20bn-35bn. However, as it makes no call for holders of government debt to help out, it should ease market pressure on the country

At the same time, it should also help unlock other financing. The IMF programme matches the €20bn until 2020 pledged by the EU, note analysts at Commerzbank. Of that, a "large portion would come from the EBRD/EIB in cash," they note, "which together with the IMF funds would add to around $30bn-35bn in cash over the coming years, more than enough in our view to calm markets."

The financial support from the broader international community that the program will unlock amounts to $27bn over the next two years, the IMF statement states. "All in all," suggests Capital Economics, "the IMF package should be sufficient to prevent the country falling into a full-blown balance of payments crisis, in which the hryvnia would drop sharply and output would collapse."

Ukrainians are in for a tough time, however. Anticipating those difficulties, Prime Minister Arseny Yatseniuk reiterated that the country is on the brink of bankruptcy and has little choice but to accept the terms of the IMF deal. He predicts a 3% GDP contraction this year, with inflation at 12-14%. He estimated that total state debt now amounts to $75bn, or 53% of GDP.

Life's no gas

A prime ingredient of the IMF programme is a drastic rise in regulated gas prices for Ukrainian consumers. In its statement, the international lender said a key element would focus on cleaning up national gas company Naftogaz, which imports gas from Russia's Gazprom. The role of Naftogaz, both in the parlous state of Ukraine's economy and the murky gas trade on the border with Russia, has long been questioned.

"The program will focus on improving the transparency of Naftogaz's accounts and restructuring of the company to reduce its costs and raise efficiency," the IMF said. The company's former head was led away last week in handcuffs.

Moscow has regularly used gas prices as a means to apply pressure on Kyiv. Since Yanukovych was deposed on the back of his refusal to sign off on a free trade and association pact with the EU, Russia has said it intends to raise gas prices to $400-500 per 1,000 cubic metres. At the same time, since the annexation of Crimea, Kyiv risks losing a $100 discount that is linked to Russia's lease of the Black Sea fleet base there.

Meanwhile, the interim government will now face up to the threat of social discontent that Moscow has dangled over Ukraine for so long. Kyiv has long bought off the population by subsidizing the cost of gas. That practice delayed international aid to Ukraine during Yanukovych's regime, and has helped bring state finances to its knees. The interim government announced on March 27 that it will raise domestic gas prices by 50%.

Andriy Kobolyev, the new head of Naftogaz, said on March 26 that in the best case scenario the company will add UAH80bn (€5.2bn) to the government's deficit this year. "A 50% hike in household gas prices and 40% for distributors would likely cut this deficit by maybe one quarter," suggests Tim Ash at Standard Bank, "but it would still leave a pretty big shortfall."

The gas price hike is also presumably the least the IMF would accept.

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