Snap Analysis: Ukraine close to crucial IMF deal

By Olzhas Auyezov

KIEV (BestGrowthStock) – A new deal with the International Monetary Fund would offer Ukraine’s cash-strapped government temporary financial relief and support economic recovery but would also force it to commit to unpopular and painful reforms.

An IMF mission to Ukraine said on Saturday it had agreed with the government on a new $14.9 billion stand-by facility for two and a half years that will be reviewed by the Fund’s board later this month.

The former Soviet economy, which relies heavily on commodity exports, shrank by 15 percent last year, putting government finances and the banking sector under stress and triggering a sharp drop in investments.

“The IMF deal is crucial,” said Citi analyst Luis Coasta. “Ukraine’s financing channels are still limited.”

The government’s efforts to finance its budget deficit through domestic borrowing have not been very successful and have limited funding available for the economy. But with the IMF deal in place, Ukraine can expect a more pronounced recovery.

The World Bank said on Thursday it was raising its GDP forecast for Ukraine for this year to 3.5 percent from 2.5 percent.

“We increase our forecast for Ukraine’s gross domestic product in line with improved external market conditions and conditional on the resumption of an IMF program,” the World Bank said in a report.

The IMF stand-by facility will not only bridge Ukraine’s budget deficit, seen at $7.3 billion or 5.3 percent of gross domestic product this year, but will also pave the way for more government and corporate borrowing.

The first issue is likely to be a sovereign Eurobond, the road show for which starts on Wednesday in New York. The sovereign bond will set a new benchmark for corporate issuers that may follow suit, such as miner Ferrexpo (FXPO.L: ).

REFORMS AND ELECTIONS

However, the IMF deal requires Ukraine to speed up fiscal tightening and cut the budget deficit to 3.5 percent of GDP next year. The government has targeted a 4.3 percent deficit, down from a projected 5.3 percent this year.

The tightening can be achieved by “tax and social security structural reforms, expenditure rationalization combined with efforts to improve tax administration,” the IMF said.

That could mean adjustments to the pension system — for example raising the retirement age — and tariff hikes for utilities such as gas, electric power and heating which are heavily subsidized across the former Soviet Union.

Both are sure to hit the popularity of President Viktor Yanukovich’s new government. A tariff hike in the Central Asian ex-Soviet state of Kyrgyzstan was a cause of mass riots that toppled former president Kurmanbek Bakiyev in April.

While Yanukovich does not face the risk of mass unrest, he has to bear in mind that he was elected by just a third of eligible voters and came only 3.5 percentage points ahead of rival Yulia Tymoshenko who is now trying to rally the opposition behind her.

“Stretching out the implementation of unpopular reforms for years is one of the instruments for the current authorities to strengthen their positions on the political landscape,” Russian brokerage Troika said in a note last month.

“Local elections … (set for October 31), might be the reason that the government is trying to avoid radical structural changes (including certain IMF recommendations to limit fiscal spending via energy tariff hikes).”

The IMF last year suspended Ukraine’s $16.4 billion rescue program because the former administration of Viktor Yushchenko, who was at odds with his government, reneged on promises of financial restraint.

(Writing by Olzhas Auyezov; Editing by Richard Balmforth and Susan Fenton)

Snap Analysis: Ukraine close to crucial IMF deal