Exclusive: Ukraine to propose new gas price formula to IMF as reforms stumble

KIEV (Reuters) - Ukraine will make new pricing proposals to the IMF next week that would leave gas prices unchanged until July, a source close to the matter said on Friday, a move that suggests political rather than fiscal calculations are driving policy-making.

FILE PHOTO - Ukraine's finance minister Oleksandr Danylyuk speaks to a Reuters journalist during an interview in London, Britain July 5, 2017. REUTERS/Hannah McKay

Sustainable gas pricing and an overhaul of the pensions system are among conditions Ukraine must meet to qualify for a long-delayed next loan tranche under its $17.5 billion program from the International Monetary Fund.

Slow progress on reforms has raised doubts about Kiev’s appetite for structural change now the economy has recovered from a recession following the 2014 annexation of Crimea and the outbreak of a Russian-backed insurgency in eastern regions.

If Finance Minister Oleksandr Danylyuk and the IMF cannot reach a common understanding in talks next week in Washington, the source told Reuters, Ukraine has two options, the first of which is for Kiev to comply with the IMF’s demands.

“Option two is to say we can live without the IMF, that Ukrainians are worth more than the IMF, not to care about this cooperation and take a political decision, approve the formula and that’s it,” said the source, who spoke on condition of anonymity.

He said the new formula would avoid an around 15 percent increase in household gas prices that could stoke social unrest.

The proposal is among a series of policy decisions that have prompted Ukraine’s international backers to question if Kiev is reneging on its promises to modernize its economy and tackle endemic corruption, especially with elections looming in 2019.

On Wednesday, the World Bank’s country director, Satu Kahkonen, told Reuters Ukraine was at a make-or-break point in terms of the reform agenda.

“What we have seen in the past and this is an unfortunate pattern that we have seen in Ukraine, is that every time the economy is getting better, the country is coming out of the crisis, reforms stop,” she said in an interview.

“I see the next six months, the next year as a very crucial time for Ukraine,” she said.

The World Bank and the IMF wrote to the government in September to express their concern over hundreds of amendments to a previously agreed draft pension law.

“We had a big surprise,” Kahkonen said. “From a fiscal perspective we saw that this is not going to be fiscally sustainable. The second concern that we had is that this is socially unequal.”

The Ukrainian parliament approved the pension bill on Tuesday, but the World Bank does not yet know if the final version of the legislation contains the amendments it and the Fund found most concerning.

These included a delay to the implementation of pension indexation and the introduction of pension rights for some students that would place a major additional strain on the state budget, Kahkonen said.

The IMF has not yet commented on the law.

Since its 2013-14 pro-European uprising, Ukraine has received $8.4 billion from the IMF and over $5 billion from the World Bank among other backers, helping it to return to growth of over 2 percent in 2016.

In September, the government found an additional source of external financing with a successful $3 billion Eurobond placement.

Reform advocates worried this could be disincentive for the government in terms of its commitment to push for politically sensitive legislative and policy changes required by the IMF and others.

Meanwhile, some hard-won progress appears to be unraveling.

Last year, the modernization of state-owned gas firm Naftogaz was a bright spot in the government’s broader reform program. But in September, the remaining members of its independent supervisory board resigned, citing government obstruction and political meddling.

Kahkonen said she remained optimistic.

“If they would move forward with these big reforms that are now on the agenda, then they would turn the page and they would be in a very different position,” she said.

“This time, let’s break the cycle.”

In Ukraine, complicated gas subsidies agreed under previous governments kept prices down and put a heavy strain on the state budget.

The current gas price for households is around 7,000 hryvnias ($262) per thousand cubic meters, based on the IMF-backed formula of a German benchmark plus transport costs, currently calculated at more than $30 per 1,000 cubic meters.

Under the government’s new proposal, gas prices would rise 4.8 percent compared with an increase of 17.6 percent required under the existing system, according to the source and a document seen by Reuters.

The IMF and Ukraine previously agreed that the government is allowed to leave prices unchanged, provided that gas costs change by less than 10 percent. Under Ukraine’s proposed formula, this would effectively mean no gas price hike.

Writing by Matthias Williams and Alessandra Prentice; Editing by Richard Balmforth