Ukraine parliament to consider key budget changes, Cabinet’s future today

Ukraine’s Verkhovna Rada will convene an extraordinary session on July 31 to vote for important changes to the state budget and tax code that will increase certain taxes and royalties proposed by the government. The changes are critical to secure more funds to finance the anti-terrorist operation in the Donbas region and restoration work in the war-afflicted territories, as well as keeping the budget deficit within the limits agreed with the IMF.

The proposals also include increasing the charter fund of Naftogaz (NAFTO) by UAH 63.3 bln (after already boosting it by UAH 33.4 mln this year), restructuring Naftogaz and selling a non-controlling stake in the gas transit system to EU and U.S. companies. The last question on the agenda will be whether to approve the resignation letter of Prime Minister Arseniy Yatsenyuk, which he submitted on July 25. The July 31 session will be closed to journalists.

Alexander Paraschiy: A similar package of the Cabinet’s legislative initiatives was submitted to the Rada on July 21, but two of the three coalition factions avoided voting on them on July 24, prompting Yatsenyuk to announce the Cabinet’s resignation in protest. This time, we believe the Cabinet’s initiatives will be supported by the Rada, as (1) the Cabinet amended the bills to consider business interests (reducing some of the more painful taxes, as compared to the July 21 proposals); (2) MPs discussing the bills in private adds optimism that they will not act out of populism; (3) over the last week, increasingly more MPs became aware of possible negative consequences that may follow from the failure to adopt a new budget and taxes.

Among the bigger risks is that the IMF will reject providing a new tranche to Ukraine, which will increase the country’s sovereign risk and add pressure on the currency.

Approval of the budget and tax code as drafted on July 30 will ensure a positive vote of the IMF board regarding a new tranche for Ukraine (possibly by the end of August). It will also push Ukraine’s sovereign bond curve down and strengthen the Ukrainian currency, which lost 4.2% in the four days after the failed Rada vote. It will also ensure that Naftogaz (NAFTO) will have enough money to repay its USD 1.6 bln Eurobond in two months.

Among the sectors that will suffer from the amendments (though there might be some minor adjustments during the today’s discussion in the Rada) will be: (1) private gas producers, who will face a 3.2x increase in the production-based tax, or up to 55% of the market price of gas; (2) iron ore miners, whose production-based tax might increase 1.6x to 8% of the iron ore price; and (3) grain traders, who will have no ability to get their VAT reimbursed for an additional third quarter.

Among others that might be targeted are all income earners (who would pay an interim 1.5% “war tax”), as well as state officials, who will face a reduction in bonuses and other non-salary payments. For more details on the possible legal changes, please refer to our note of July 30: All eyes on the Rada voting on Cabinet initiatives.