Ukraine’s memorandum with IMF signals commitment regarding fiscal consolidation

The Letter of Intent signed by Ukraine’s Prime Minister and the Head of the National Bank of Ukraine to the International Monetary Fund to secure the second USD 1.6 bln tranche was released yesterday to the local media. The government stated its commitment to keep the budget deficit at 6.5% of GDP in 2010 and 3.5% in 2011. Mykyta Mykhaylychenko: Although we see the number for 2010 as feasible, the 2011 commitment looks to be somewhat too optimistic and we expect the budget deficit to be at some 4%-5% of GDP in 2011. Among the specific points, we underline two: (i) the Finance Ministry promised not to issue any further VAT Bonds and to reimburse VAT exclusively in cash from now on. At the same time, it asked for permission to have UAH 2 bln in VAT reimbursement arrears as of end-2010 (earlier it was supposed to have zero VAT debt as of end-2010). This may put additional pressure on budget expenses at the beginning of 2011; and (ii) gas prices for households will be increased by 50% as of April 2011, which will be negative for inflation (we expect it to be around 10% in 2011 after ~11% in 2010F), but definitely positive for the budget/Naftogaz. Overall, we expect the IMF to approve and disburse the second tranche to Ukraine by year-end.