Ukraine extends freezing of residential gas prices for August, still in talks with IMF

Cabinet of Ministers adopted a resolution on July 26
to extend through August the below-market natural gas rates for households and
heating utilities, Interfax-Ukraine reported on the same day. The government is
still in negotiations with the IMF on bringing the gas rates to import parity
levels, the authors of the resolution commented in a supporting letter to the
draft resolution. They recommend to keep the previously set prices until
negotiations are finished.

Recall, bringing natural gas prices for households to
import parity level is a key IMF requirement remaining in the way of agreeing
on a new tranche for Ukraine under the USD 17.5 bln Extended Funds Facility
program. The tranche might be as large as USD 2 bln, which will open for
Ukraine the ability to get loans from the EU and the World Bank for another USD
1.4 bln this year.

Back in March 2017, Ukraine promised the IMF to bring
residential gas prices to import parity levels, and the Cabinet even adopted a
resolution that changes the pricing methodology since October 2017 based on gas
price changes at the EU hub. However, after receiving a USD 1 bln tranche from
the IMF in April 2017, the Ukrainian government choose to ignore its commitment
to the IMF as well as its own resolution and kept residential gas prices frozen
up until now. Having breached its commitment to the IMF under the previous
tranche, Ukraine now has no other choice but to significantly increase gas
prices in order to secure IMF financing, which is vital for the country’s
financial stability.

Alexander Paraschiy: The
postponement of the revision of residential gas rates for just one month
suggests that the Cabinet is still hoping to agree with the IMF on a gas rate
increase plan from September. This means that the negotiations on gas pricing
should be completed in August. If so, by the end of the month, Ukraine could
agree with the IMF staff on all the pre-conditions for the next tranche, which
will allow it to get the tranche in September. So far, such a development is
our base-case scenario.

By failing to increase residential gas rates by 15-19%
in October 2017, Ukraine now needs a much higher increase to fully satisfy the
IMF’s demands (about 60% increase). For instance, as of August 2018, gas prices
for industrial consumers (which are in line with the import parity level) have
increased by 23% since October 2017 and are 87% higher than gas rates for households.
The Ukrainian government is trying to agree with the IMF on some gradual
increase of gas rates (for instance, in its macroeconomic forecasts, Ukraine’s
central bank assumed only a 25% gas rates increase this year), but so far, the
IMF has not agreed this. Nevertheless, we remain optimistic about a positive
outcome of negotiations on gas.

We believe it’s important for Ukraine to get
approval of the next tranche from the IMF by Sept. 15, otherwise the chance for
getting the tranche this year will decrease. Namely, Sept. 15 is the deadline
for the Cabinet to submit a draft 2019 budget to the parliament. The budget
issue is very sensitive for the IMF, so there is a risk that after Sept. 15,
the IMF will chose to wait for final approval of the 2019 budget (which will
correspond to Ukraine’s commitments on budget deficit limits), which usually
happens in December. In December, it might be too late sign a memorandum with
president Poroshenko, as it is a couple of months ahead of the presidential
elections.