Saturday, 5 November 2011

Ukraine & The IMF: Nervous Times

KIEV, Ukraine -- Investors have taken in their stride the bad news from Ukraine. International Monetary Fund mission left on Friday without approving the resumption of lending under a vital $15bn financing programme
They are assuming that Kiev will soon settle its differences with the Fund – and bite the bullet on demands for increases in household energy prices.

But if investors are wrong, Ukraine could face a rapid devaluation of the hryvnia, with all that that implies for stability in one of Europe’s more fragile economies.

The authorities have kept the hryvnia pegged at 8 hryvnia to the US dollar, but only thanks to heavy central bank intervention, including $2bn in September.

Traders in the non-deliverable forward market for the hryvnia are betting on a devaluation of about 25 per cent in the next 12 months.

That’s better than the 30 per cent devaluation expected before the IMF mission arrived this week. But it’s still hardly a vote of confidence.

JP Morgan said in a note: “While devaluation should be avoided this year, one next year seems likely; we remain underweight Ukraine external debt.”

Kiev intends to keep talking with the IMF. As Reuters reported, the National Bank of Ukraine said in a statement:

The central bank hopes that the International Monetary Fund and the government will resolve all issues … in the nearest future which will allow (Ukraine) to receive the next tranche which is crucial for the advancement of reforms in Ukraine.

The Fund has supported Ukraine through the global crisis even when the local political turmoil has made maintaining relations difficult.

After the end of a 2008-09 rescue programme, the IMF agreed a new $15bn loan plan last year that was conditional on economic reforms.

The administration of president Viktor Yanukovich promised reforms – including raising the pension age – and the IMF disbursed the first $3.4bn in tranches last year.

But when Kiev baulked at hiking energy prices for consumers, the Fund suspended payouts at the beginning of this year.

With parliamentary polls due in October 2012, it did not want to go into the 2011-12 winter with hefty household bill increases.

Kiev hopes to secure a discount in gas import prices from Russia, the key supplier, but talks with Moscow have not so far produced a result despite months of negotiation.

Without a deal, Ukraine is set for another price increase.

Deputy prime minister Andriy Klyuev said on Friday that Ukraine may have to pay $456 per 1,000 cubic meters in the first quarter of 2012, compared to $414 now.

Since Yanukovich took over last year from pro-west president Viktor Yushchenko, Ukraine has moved closer to Russia.

The jailing of former prime minister Yulia Tymoshenko on fraud charges last month has further alienated the west and increased political dependence on Russia.

But Kiev has so far proved reluctant to accept Moscow’s key conditions for a cut-price gas deal – stakes in Ukraine’s pipelines for Russia’s Gazprom.

So Kiev’s choice remains unpopular gas price rises or the risk of devaluation for lack of IMF support.

Gyula Toth, of Unicredit, says Kiev will do a deal with the IMF, probably in around two weeks.

He told FT: “It’s a better option to raise gas prices than to see the cost of all imports go up because of a 25-30 per cent devaluation.”

Anders Aslund, a a senior fellow at the Peterson Institute for International Economics and author of How Ukraine became a market economy and democracy says the “spectacular mishandling of the economy” has put Ukraine on a “path of devaluation and default”.

Writing in the Kyiv Post last month, he said Ukraine’s gross external debt had climbed from $102bn in 2008 to $130bn, or from 57 percent of GDP to 79 percent of GDP.

“Ukraine is therefore much more sensitive to a sudden stop of international liquidity as occurred in September 2008.”

Public debt is beginning to matter – Ukraine’s public debt was only 20 percent of GDP three years ago, but is now around 40 percent of GDP.

As Aslund wrote: “The present key concern is that the state budget for 2012 calls for $11.3 billion of new borrowings and public debt repayments will amount to $7.3 billion, a total of $18.6 billion. That is a sizeable amount, and Ukraine has difficulties in finding any source of financing.”

Foreign exchange reserves of $35bn might be enough to prevent an immediate crisis but would not last long in the event of serious financial disruption.

The international markets are virtually closed and domestic debt is very expensive at 17-19 per cent.

Fitch, the rating agency, revised down its outlook on Ukraine’s long-term foreign and local currency debt from stable from positive. It said:

The balance of risks facing Ukraine is now better reflected by a stable outlook, following an increase in sovereign external borrowing costs and associated concerns about external financing, as well as the impact of a forecast slowdown in global growth.

Ukraine has few sensible options bar doing a deal with the IMF.

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