Russia and West crank up economic pressure on Ukraine

Russia has cranked up the pressure by ending discounts on its natural gas supplies, while the US and European Union offered quick-fix aid to the beleaguered government.

To help Ukraine in the longer term, International Monetary Fund (IMF) experts began work here on a plan to stabilise the near-bankrupt country’s finances and failing economy. The IMF’s help is expected to come with conditions that will be tough, but at this point inevitable.

“Without the expected financial assistance from Western donors, Ukraine is likely to default,” Lilit Gevorgyan of IHS Global Insight said in a research note.

Concerns over Ukraine’s financial condition – whose treasury account is, by its own admission, almost empty – rose after Russian state gas company Gazprom said it would cancel a substantial discount on natural gas granted in December. Meanwhile Russian president Vladimir Putin noted Ukraine still owes some two billion US dollars for gas.

The Russian position is a shift from last year, when Moscow tolerated letting Ukraine pile up unpaid bills. The discount was granted under a $15bn Russian bailout in December that was halted following the ouster of pro-Russian president Viktor Yanukovych by a protest movement by people who want closer ties with the EU.

To counter Moscow’s tougher stance, US secretary of state John Kerry, who is visiting Kiev, offered a billion US dollars in loan guarantees.

The European Commission, the EU’s executive arm, will decide on a package of support measures tomorrow, spokeswoman Pia Ahrenkilde Hansen told reporters in Brussels.

Ukraine’s parliament signed off on the terms of €610m from an earlier EU aid package, but that money will not be paid until Ukraine seals a bailout deal with the IMF.

That short-term support is key because a full financial assistance programme from the IMF may take time to conclude. Analyst Gevorgyan said that for the IMF to commit any substantial assistance the country would need a more stable government, which was only likely after a new president is elected on May 25.

That still leaves Ukraine some time, as major debt repayments are not due until June. The key risk until then is whether Russia demands prompt payment for its gas. That could put more pressure on the country’s finances.

A Ukrainian debt default would have a limited impact on economic activity in the rest of Europe, analysts say. But it could hurt stock prices and have an impact on individual banks and countries that are heavily exposed to the region.

Vasyl Yurchyshyn, director of economic programmes at the Razumkov Centre research institute in Kiev, as the IMF likely realises that circumstances are dire and may provide at least some money within several weeks.

“Here I think you can be an optimist... It’s clear the IMF may take a softer position,” Mr Yurchyshyn said.

But even then, the basic conditions from the past two IMF aid programmes will remain – mainly, abandoning the practice of charging consumers only about one-fifth of the price that state gas company Naftogaz pays to Ukraine.

Two previous Ukrainian governments agreed to IMF loan programmes only to see the aid cut off after they balked at that condition. But the current government will likely comply. “We have no choice,” Prime Minister Arseniy Yatsenyuk has said.

Mr Yurchyshyn noted any IMF deal would likely make the increase in the gas price gradual and offer targeted welfare assistance to the poor, who would be hit hardest.

A recent World Bank report said that most of the spending on the gas subsidy benefits people who are above the poverty line. The cheap gas policy costs the Ukrainian government the equivalent of 7.5% of annual economic output.

Raising home heating prices may cost the new government popularity. But economists say Ukraine’s decades-old addiction to cheap gas has helped stunt its economy by deterring energy efficiency and supporting older and less efficient industries.

Analyst Timothy Ash at Standard Bank said the Russian demand might ironically help the Yatsenyuk government sell higher gas prices to the public politically: “It can now directly link these to the hike in the import price from Russia, thank you Vlad,” Mr Ash said.