Economic Battle Over Ukraine Heats Up

A woman passes by a barricade in a street heading to Kiev's Independence Square, Ukraine, Tuesday, March 4, 2014. Relieved investors sent stocks sharply higher Tuesday after Russia pulled troops back from the border of Ukraine. The rally erased steep losses from Monday caused by fears an escalating conflict.

KIEV, UKRAINE (ASSOCIATED PRESS) — The battle over Ukraine's future is also economic: on Tuesday, Russia cranked up the pressure by saying it would end discounts on its natural gas supplies, while the U.S. and European Union offered quick-fix aid to the beleaguered government.

To help Ukraine in the longer term, International Monetary Fund experts began work here on a plan to stabilize the near-bankrupt country's finances and failing economy. The IMF's help is expected to come with conditions that will be tough, but at this point unavoidable.

"Without the expected financial assistance from Western donors, Ukraine is likely to default," Lilit Gevorgyan of IHS Global Insight says in a research note. Concerns over Ukraine's financial condition — whose treasury account is, by its own admission, almost empty — rose after Russian state gas company Gazprom said it would cancel a substantial discount on natural gas granted in December. President Vladimir Putin, meanwhile, noted Ukraine's state gas company Naftogaz will owe $2 billion for gas, including February's bill.

The Russian position is a shift from last year, when Moscow tolerated Ukraine piling up unpaid bills. The discount was granted under a $15-billion Russian bailout in December — but that was halted following the ouster of pro-Russian President Viktor Yanukovych by a protest movement by people who want closer ties with the European Union.

Putin said the decision to raise the gas prices for Ukraine was not political. "There was an agreement," Putin said. "We give you the cash and a discount on gas, and you pay us on time. We have given them money, we have cut the price, but there have been no payments."

To counter Moscow's tougher stance, U.S. Secretary of State John Kerry, who was visiting Kiev on Tuesday, offered $1 billion in loan guarantees. The European Commission, the European Union's executive arm, will decide on a package of support measures on Wednesday, spokeswoman Pia Ahrenkilde Hansen told reporters in Brussels without providing details. Ukraine's parliament signed off on the terms of 610 million euros from an earlier EU aid package — but that money won't be paid until Ukraine seals a bailout deal with the IMF.

That short-term support is key because a full financial assistance program from the IMF may take time to conclude. Analyst Gevorgyan said that for the IMF to commit any substantial assistance the country would need a more stable government, which was only likely after a new president is elected May 25.

That still leaves Ukraine some time, as major debt repayments are not due until June. The key risk until then is whether Russia actually demands prompt payment for its gas. That could put more pressure on the country's finances.

A Ukrainian debt default would have a limited impact on economic activity in the rest of Europe, analysts say. But it could hurt stock prices and have an impact on individual banks and countries that are heavily exposed to the region.

Vasyl Yurchyshyn, director of economic programs at the Razumkov Centre research institute in Kiev, as the IMF likely realizes that circumstances are dire and may provide at least some money within several weeks.

"Here I think you can be an optimist... It's clear the IMF may take a softer position regarding the first tranche," or payout, Yurchyshyn said. Even then, however, the basic conditions from the past two IMF aid programs will remain: mainly, abandoning the practice of charging consumers only about one-fifth of the price that state gas company Naftogaz pays for imported Russian gas.

Ukraine has agreed two previous IMF loan programs only to see the aid cut off after the government balked at that condition. The current government, however, will likely comply. "We have no choice," Prime Minister Arseniy Yatsenyuk said Monday.

Yurchyshyn noted any IMF deal would likely make the increase in the gas price gradual and include a program to offer targeted welfare assistance to the poor, who would be hit hardest. A recent World Bank report said that most of the spending on the gas subsidy benefits people who are above the poverty line. The cheap gas policy costs the Ukrainian government the equivalent of 7.5 percent of annual economic output.

Raising home heating prices may cost the new government popularity. But economists say Ukraine's decades-old addiction to cheap gas has helped stunt its economy by deterring energy efficiency and supporting older and less efficient industries.

Analyst Timothy Ash at Standard Bank said the Russian demand might ironically help the Yatsenyuk government sell higher gas prices to the public politically: "It can now directly link these to the hike in the import price from Russia — thank you Vlad," Ash wrote in an email.