Fixed Income Snapshot - IMF might split the next disbursement for Ukraine

MACRO: IMF mission has finished its two week stay in Kiev, returning home after numerous discussions with policymakers and business community. A two-year SDR 11 bn stand-by agreement involving exceptional access (802 percent of quota) was approved by the Executive Board (EB) on Nov 5, 2008. So far Ukraine has received SDR 7 bn in three installments. The original timeline has been amended due to tensions between Ukraine and IMF during the first program review. Ukraine is in the middle of the third program review, with SDR 2.5 bn awaiting deployment.

Over the weekend the Fund issued a press-release on Ukraine, disclosing official statement on preliminary results of the third program review. Despite a number of critical points on Ukraine’s economic policy, including non-adjustment of energy prices and lack of progress in a bailout of troubled banks Nadra and Ukrprom, the statement came out in a generally positive tone: “The mission found that the economic and financial situation in Ukraine is stabilizing as a result of policies under this program. Preserving these gains will require policy discipline and corrective actions in some areas. In its discussions with the Ministry of Finance and the National Bank of Ukraine, the IMF mission reached staff-level agreement on such actions…” – said IMF.

The Fund has required from Ukraine to ensure that recent law on adjustment of wages and pensions voted by Ukrainian parliament on Oct 20 be vetoed. The law was voted in a populist spree in order to win electoral support on the eve of upcoming Jan 17th elections. Ukraine does not have resources to pay adjusted pensions and wages subject to this law and would inevitably default on internal social payments should this law come into force.

Fund’s pronounced flexibility, especially in the runup of Presidential elections became a concern. Some have accused the Fund in supporting acting Prime-Minister in the presidential race. Indeed, if IMF is called a doctor, Ukraine could have received too much of freedom in drug selection recently, inspiring calls for “more stick and less carrot” approach. Kenneth Rogoff, a Harvard University professor and former IMF chief economist has recently said: “People think the IMF is tough. The truth is it finds it almost impossible to say no. The IMF is lending in places like the Ukraine and Eastern Europe and over time it’s just going to let them dig a deeper hole.”

Our view: The positive tone of recent press-release suggests that IMF would not drop out of negotiations as was feared by many. By this time, the Fund has invested a lot of cash and most importantly own image into Ukraine, preventing adverse effects across the region. However, in order to avoid another wave of criticism, it would be logical for IMF to either delay the next disbursement or split current stake into two or more parts, pumping up own negotiation power next year. Most likely outcome is deployment of certain amount of funds (so Ukraine remains de-jure on the SBA track), and resumption of talks after presidential elections in Ukraine take place.