Ukraine: an inch at a time

Ukraine IMFUkraine has inched a bit closer to unlocking billions of dollars in fresh loans from the International Monetary Fund that are crucial to shore up investor confidence and patch stretched state finances.

All is set for President Viktor Yanukovich’s government next month to push through unpopular pension reforms after parliament last week gave the planned legislation a first reading.  Without the reforms,  the IMF won’t disburse more loans from last summer’s $15bn programme. Without the money, Kiev will struggle.

Gradually raising the retirement age for women from 55 to 60 and introducing a three-pillar pension system were last year set in stone under the terms of the IMF package.

But while promising to deliver on pension reform, Kiev is now trying to back out of promises to further raise household utility prices.

Officials argue inflationary pressures and economic pain following a 50 percent hike on gas prices last summer could be too much for cash-strapped citizens.

With parliamentary elections a year away and Yanukovich’s popularity plunging as inflation bites, fiscal prudence will be hard to deliver. But Kiev, which faces increasingly higher import prices on Russian natural gas later this year, may not have a choice.

Ukrainian officials are desperate for the next tranche of $1.5bn-3bn in coming months. But it doesn’t expect any fresh IMF cash to pour into Kiev this summer.

After a Ukrainian delegation visited IMF headquarters in Washington, prime minister Mykola Azarov said on June 21 said he expected the next IMF mission to arrive in Kiev no sooner than September.

John Lipsky, the Fund’s acting managing director, was blunt this week in pointing out that a deal hangs on reforms.

Optimists say the tough IMF approach should squeeze necessary austerity measures out of Kiev’s government, with up to $3bn arriving this autumn.

If talks collapse, the bears don’t expect Ukraine to deteriorate economically as fast as Belarus has in recent weeks. Kiev today has central bank reserves of $37bn. That’s a stockpile it could have only dreamed of in 2008, when its currency plunged by 50 percent in the wake of the global financial crisis.

“With central bank reserves at a nearly historical high and the government boasting a strong liquidity position, failure to revive cooperation with the IMF will carry no immediate negative implications for the Ukrainian economy,” said Olena Bilan, an economist at Kiev-based investment bank Dragon Capital. “Yet, without the external anchor the IMF has been, fiscal consolidation will likely lose momentum, becoming a major macroeconomic concern for 2011-2012.”

Ukraine CDS spreads






What position to take on Ukrainian eurobonds? The benchmark 2016 bond trades at a spread of 470 basis points above US Treasuries.

Bilan says “higher fiscal risks will feed into Ukrainian eurobond prices if no visible progress” is achieved with the IMF.

“Sovereign Eurobond yields may widen by up to 100bp as investors will start repricing Ukraine’s sovereign  risk. This will increase government borrowings costs but we still expect the Finance Ministry to tap the eurobond market later this year to cover its budget deficit,” Bilan added.