Ukraine can ill afford Russia's gas demands

By Guy Faulconbridge and Sabina Zawadzki - Analysis

KIEV (Reuters) - Ukraine's crisis-gripped economy and deadlocked political system mean the former Soviet state can ill afford the more than twofold increase in gas prices Russia is now demanding.

Russia's state-controlled gas firm, Gazprom, halted supplies to Ukraine on New Year's day over gas bill debts and a disagreement over 2009 gas prices. European Union supplies have been disrupted.

Gazprom now demands Ukraine pay $450 per 1,000 cubic meters (tcm), up from $179.5 in 2008.

But as Ukraine's economy heads into its worst recession for a decade and politicians gear up for a presidential election in 12 months, President Viktor Yushchenko and Prime Minister Yulia Tymoshenko would be loath to pay such prices.

They may not even be able to.

"We expect a 4.7 percent contraction of the Ukrainian economy in 2009 assuming a gas price in the $200-220 range," said Svitlana Maslova, an analyst at Barclays Capital in London.

"So agreeing on the price higher than that would lead to a deterioration in already bleak growth outlook and even raise the possibility of a wholesale collapse of the Ukrainian economy."

Sinking world demand has hammered the steel and chemicals sectors, which account for more than half of exports, and popped a domestic consumer boom. Indebted Ukrainians now face rising unemployment as industrial output sank 20-30 percent.

"There is already a big negative shock in the terms of trade for Ukraine due to a plunge in steel prices, so a larger increase in gas prices would mean that the export industry of Ukraine would be more uncompetitive," Maslova said.

Investors started dumping Ukrainian assets in September. Lending ground to a halt and the hryvnia currency hit historic lows. Government finances have also been hampered by the inability to issue any planned Eurobonds.

Yushchenko and Tymoshenko, former allies in the pro-Western "Orange Revolution," have been locked in battle as the economic crisis unfolds.

The Russian gas price dispute thus hits at the very heart of Ukraine's weakness: the economic crisis means finding more money as political divisions in Kiev hamper Yushchenko's and Tymoshenko's ability to do so.

Yushchenko, a former central banker, and Tymoshenko, a former gas trader, have made few comments on the row.

ECONOMIC CRISIS

Ukraine secured $4.5 billion from the International Monetary Fund in November as part of a $16.4 billion loan facility as the hryvnia tumbled, losing half of its value at one point in December. It has since strengthened to about 8/$.