Anastasiya Golovach, bne Ukraine Daily List, Berlin, Germany, Tue, June 1, 2010

BERLIN - Over recent weeks, Ukrainian press sources have reported disagreements in negotiations between the IMF and the Ukrainian government, sparking concerns about delays to the fund's approval of a new $19bn standby arrangement for the country, and even a refusal by the IMF to assign the funds at all.

Yesterday (31 May), Ukrainian magazine, Expert, published information about a disagreement between the Ukrainian government and the IMF, centred on the country's budget deficit and fiscal policy.

Specifically: - Despite Ukraine having adopted a more realistic macro forecast than that in the first version of its 2010 budget law, the IMF still thinks planned budget revenues are unrealistic. We believe the fund's concerns are justified (see Ukraine adopts 2010 budget: More realistic, but still very ambitious, dated 27 Apr), while the government hopes to boost revenue through better tax administration and higher excises.

The IMF, in addition, has suggested a further increase in the taxation base, including the cancellation of VAT subsidies for agricultural and pharmaceuticals producers.

In this light, the IMF will clearly need further proof that Ukraine can raise its announced volume of budget revenues this year. This issue will be a point of further discussion, as Ukraine is trying to avoid implementing a very tight fiscal policy this year, in order to support economic growth.

The IMF requires the central government's consolidated deficit, including Naftogas and the bank recapitalisation programme, to be no higher than 6%/GDP. The country is currently running almost this level of deficit without Naftogas's needs and bank recapitalisation.

In this light, the IMF seems dissatisfied with the new government, which undertook to optimise budget spending this year, but did not do so. The IMF has suggested restraining payrolls and starting pension reforms, to help cut budget spending this year.

It has also insisted on an increase in gas tariffs for households and utilities, in order to cut Naftogas's deficit. The Ukrainian government, for its part, has already announced that it is not planning any such action this year, in light of lower gas prices. No urgent need for additional funding.

The reported disagreements are important, but in our view they are not critical, unlike the situation in autumn 2009, when the IMF suspended its cooperation with Ukraine. We believe the current delay could reflect the fact that the Ukrainian government has no urgent need for additional capital, giving it time to negotiate.

Ukraine posted a budget surplus in April, for the first time since the start of the year. Although this largely reflected the National Bank of Ukraine (NBU) injecting UAH3.7bn of its profits in to the budget, the Ukrainian authorities seem to have no serious liquidity gaps at present.

The Ministry of Finance's unwillingness to raise yields at primary auctions of local government bonds seems to support this view. According to its 2010 budget, Ukraine will ask the IMF for only $2bn to cover its budget deficit this year, with the remainder of the proposed IMF funds earmarked by the NBU to increase the country's foreign reserves.

Most of the government's financial needs are hryvnia-denominated, and the country's biggest single foreign-currency repayment is a eurobond redemption (about $600mn), scheduled for Dec 2010. Delay, not refusal.

The IMF's technical mission left Ukraine a few weeks ago, and a visit by its main mission has yet to be scheduled (Interfax has reported that the Ukrainian authorities expect the mission to arrive in June). Fund representatives have said the IMF is waiting for Ukraine to come up with additional proposals on strengthening government finances and shoring-up its financial system.

We think the Ukrainian government is likely to seek a new programme with the fund, as it will need additional funds latter this year and next year. Moreover, for the past year, this has appeared to be an important factor shaping investor sentiment on Ukraine. Over the next few months, the Ministry of Finance plans to tap external markets with a new eurobond issue, making a renewal of cooperation with the IMF even more important.

Accordingly, we think the government will try to meet the key IMF's requirement, or find reasonable grounds to defend its position on arguable issues, in order for the IMF to agree a new standby programme.

Negative newsflow about difficulties in the negotiations has not affected Ukrainian sovereign eurobonds, which are currently more sensitive to events in the European market. Despite some turbulence, yields on Ukrainian eurobonds and CDS quotes remain close to historical lows.