By Graham Stack, Kyiv Post, Kyiv, Ukraine, Friday, May 28, 2010

KYIV - The IMF is apparently concerned that the government is hiding a large budget deficit. Ukraine's deputy prime minister, Sergiy Tigipko, has confirmed what many had guessed. 

Despite the self-congratulatory fanfare with which the government announced its budget for 2010, the International Monetary Fund - a critical lender to the nation -- seems unimpressed. Apparently, the IMF suspects a hidden budget deficit larger than declared, which may imperil lending frozen last year over similar concerns.

The government is hoping to secure a $19 billion lending program from the IMF, but the international lender seems to be playing hardball as the country's economy starts to strengthen, and may demand further cuts and market-oriented reforms from the recalcitrant Ukrainian side.

The government engineered the budget to comply with the IMF's demand for a maximum deficit of 6 percent of gross domestic product. But the government did so by avoiding any social spending cuts that could undermine the government's populist rhetoric.

The official budget deficit in the budget law passed by parliament April 27 is 5.3 percent of GDP. But skeptics argued that the government's revenue forecasts were massively over-optimistic and spending forecasts understated.

Now Tigipko confirmed that the IMF is among the ranks of the skeptics. "The main problem between us and the IMF is that we must confirm a projected deficit of 5.3 percent," he said on May 21. "What is projected by the Ukrainian government is a rather ambitious program, and the international organizations don't really believe it. They have doubts, first of all, about our arguments," he confessed.

Serhiy Lyovochkin, President Viktor Yanukovych's chief of staff, said on May 26 that the main bones of contention are the government's plan to issue bonds to compensate business owners who have not received value-added tax refunds, which the IMF sees as indirect budget deficit, and the refusal to raise gas tariffs for households.

The IMF announced that it has yet to fix a date for starting its mission in Kyiv, which observers take as confirmation that it does not agree with the declared budget parameters.

Former Finance Minister Viktor Pynzenyk, who resigned in 2009 over then Prime Minister Yulia Tymoshenko's wildly unrealistic budget, wrote in the Dzerkalo Tyzhnia weekly that the real budget deficit for 2010 could reach a staggering 16 percent, which includes the costs of bank recapitalization that the government kept separate from the budget law passed by the Verkhovna Rada on April 27.

Analysts see the real consolidated budget deficit, including bank recapitalization to shore up Ukraine's shaky financial system, at closer to 10 percent.
According to Oleh Ustenko, chief economist at The Bleyzer Foundation: "Ukraine's total hidden budget deficit is at a very minimum 10 percent of GDP.

This includes 5.3 percent primary revenue deficit, 3 percent for [gas distribution monopoly] Naftogaz, if there is no increase in utility tariffs, 1.5 per cent for the Pension Fund deficit, and 2.8 per cent for bank recapitalization."

"The budget has obviously been designed to meet IMF requirements on paper," said Vitaliy Vavryshchuk, an analyst at brokerage BG Capital. ,,Our calculations put the real budget deficit at 7 percent, and 9-9.5 percent, including the costs of bank recapitalization."

Olena Bilan from brokerage Dragon Capital similarly forecasted a deficit of 7.5 percent of GDP, with an additional 1.4 percent needed for bank recapitalization, making an overall 8.9 percent.

On the revenue side, analysts are skeptical about the government's targets. "The budget is based heavily on a surge in revenues (19 percent on the year) on the back of higher tax collections (36 percent on the year) in order to finance inflated social expenditures and rising public sector wages," said Vavryshchuk, who forecasted instead 22-25 percent tax growth.

According to Pynzenyk, for the first four months of 2010, tax revenue growth on the year only reached 10 percent instead of the forecast 40 percent, taking into account the practice in 2009 of not refunding VAT.

For the government forecasts for VAT revenue to come true, imports would have to increase by 40 per cent, according to Ustenko, instead of the 25 percent that is likely, leaving 11 percent of the predicted VAT revenues unaccounted for.

According to Ustenko, to rectify the situation, the IMF will demand that Ukraine hike utility tariffs to mitigate the Naftogaz deficit, and reform the pension system, by raising the average pension age, in particular by abolishing privileges such as early pensions for particular groups.

The government is likely to resist such demands that would be deeply unpopular in the short term, although crucial over the long term.

With export-led economic growth surging in the first quarter to 5 percent on the year, and reaching 8 percent on the year in April, Ukraine's government has a stronger footing in talks with the IMF when it comes to budget revenue forecasts. The budget is based on a modest growth forecast of 3.7 per cent. ,,They [the IMF] most of all question planned budget revenues. But the dynamics in April and May show that the figures will be achieved," Tigipko claimed.

The government has penciled in roughly $2 billion of IMF money to fund the deficit. An IMF deal would serve as a clean bill of health for markets and also for other international financial institutions, making other borrowing such as a planned $1.3 billion Eurobond cheaper. According to Vavryshchuk, the government could get by over the short term without the IMF money by expensive borrowing on the market and by monetizing the deficit - effectively printing money.

At the same time, with Ukraine having stabilized and even strengthening, it is now easier for the IMF to walk away without a deal, instead of jeopardizing its principles internationally, said Vavryshchuk. This means a deal with the IMF may not be signed until later in the year.

The IMF surprised many in 2009 with its lenient attitude towards embattled countries like Ukraine. Many countries, especially in Eastern Europe, received IMF funding while running large budget deficits and increasing social expenditure as stimulus spending in the face of economic meltdown.

But those days seem to have past. With a nervous eye on the spreading Greek debt crisis, the IMF is reverting to its deficit-cutting form of the 1990s. A policy review released May 14 called for governments to exit stimulus spending and launch fiscal consolidation.

"It is now urgent to start putting in place measures to ensure that the increase in deficits and debts resulting from the crisis … does not lead to fiscal sustainability problems," wrote IMF head Dominique Strauss-Kahn in the introduction to the report. "In many countries, fiscal adjustment will require a sizable, and sometimes unprecedented, effort," he said.

True to its word, the IMF has already downsized neighboring Romania's 2010 budget in April, leading to 15 percent cuts in pensions and 25 percent in public sector salaries. Romania, like Ukraine, has a comparatively low level of national debt, but was running a high structural budget deficit as a result of the crisis.

The IMF in autumn 2008 agreed to disburse about $17 billion. Ukraine received three tranches worth almost $11 billion. The allocation of the fourth tranche, worth $3.8 billion, was scheduled for November 2009, but was stalled after social spending hikes were passed into law.

Ukraine's government already took drastic steps to cut the budget deficit when it negotiated a 30 percent reduction in the price paid by Ukraine for imported Russian gas, in exchange for a 25-year extension of the lease for the Russian Black Sea fleet naval base in Sevastopol, due to expire in 2017.

The controversial agreement was signed in Kharkiv by President Viktor Yanukovych and Russian President Dmitry Medvedev April 21, and ratified on the same day as the budget was passed, on April 27.

NOTE: Kyiv Post staff writer Graham Stack can be reached at Kyiv Post editor Katya Gorchinskaya contributed to this report.