A hard-landing scenario is now the most likely outcome for Ukraine, which took advantage of excessive global liquidity in an environment of low interest rates and high current-account surpluses fueled by booming exports of commodities.

Its young and undiversified economy is facing large imbalances: a disproportionately large import-to-gross domestic product ratio, large trade deficits because of plummeting steel exports and unsustainable spending on imports as easy credit dries up. This, coupled with the unwinding of private-sector leverage, will lead to a rapid fall in growth rates, inflation and a weaker currency.

Five-year sovereign credit default swaps work as protection against the default of the underlying instruments. Ukraine’s instruments are priced at 2,100 basis points, or nearly four times higher than Hungary, itself under large financial strain. Ukraine’s probability of default is, thus, highest in the region at 80 percent.

It is not difficult to see why.

The economy is short on liquidity. The central bank will likely see a drop below $30 billion in its reserves from nearly $40 billion held earlier in 2008. This will bring its “import cover” to critical levels, at which point further losses in reserves will accelerate. Foreign direct investment inflows will be non-existent next year.

Even if long-stalled privatization of big state companies such as fixed-line telephone company Ukrtelecom and Odessa Portside Plant proceeds, little money can be expected.

Then there is a $20-billion rollover of short-term debt, a $15-billion current account deficit to fund and some $1.7 billion of foreign debt repayment in 2009. This will leave the country with a shortfall of about $6 billion, equivalent to 3 percent of GDP. Its not a catastrophic number, but it needs to be dealt with.

Few options are left for the government besides tackling the overall deficit through currency devaluation. The extent of it will be a function of how fast imports collapse as loan growth turns negative. At worst, we evaluate a 3-percent shortfall correction would need a hryvnia-to-dollar rate of 7.3, at worst. With this in mind, Ukraine, as many other countries, has imported a substantial amount of cheap credit related to debt.

One should, nevertheless, differentiate the emerging issues. They are starkly different for developed economies and emerging markets. The debt-to-GDP ratio is some 30 percent in Ukraine, compared to 350 percent in America. The banking leverage is four times lower than in Europe, at about nine-fold assets-to-equity. Rather than having to deal with the systemic issues of G7 economies, which will take years to unwind, Ukraine has to deal with the first down economic cycle since 1998, albeit a heavy one, and with no visibility for 2009.

There is no question that a large International Monetary Fund package is fundamental at this stage, as it would alter the numbers substantially. How hard average Ukrainians will get hit by the economic and financial turmoil depends much on the conditions set by the IMF. Expect a freeze on pension hikes and other social expenditures.

Overall, the amount of financing promised by the IMF is sizable. It represents 8 percent of gross domestic product. It should cover the liquidity needs in Ukraine’s banking sector and even leave some surplus. But it will nevertheless not alleviate the pressure on the domestic currency to devalue. It will just soften the blow, allowing time for the currency to devalue slowly, effectively delaying the process and avoiding panic.

The maximum pressure point is likely to come in the next three months. It is key that the disbursement was large and should be swiftly released. Ukraine is indeed now getting hit hard by falling steel prices and still high imports. Large monetary outflow is also expected at the end of December on the deposit side and gas pre-payments will be required.

It is quite clear that the timing of further devaluation of the domestic currency is tied up with politics. It is most likely that we should see the largest fall in the hryvnia right after the new year, as the central bank slows interventions. This will help to return to equilibrium as imports deflate substantially from the current 60 percent of GDP. This process will, in turn, gradually narrow the widening trade deficit.

The equity market is buried for the moment. Liquidity is non-existent and forced sellers dominate. Current valuations imply an unjustified write-off of Ukraine's investment case, representing, thus, a great entry point for long-term holders such as us.  We have seen Ukraine credit default swaps stopping to widen for a couple of days from the 3,000 points (which means you pay $3 million to get insured $10 million), implying an exhausted pattern of the worst-case scenario being priced-in.

The only immediate beneficiaries of the IMF financial assistance are, indeed, selected sovereign debt instruments. Two issues are overhanging. One is the liquidation of sovereign debt by funds before year-end where, no matter the fundamentals, funds are selling out. Secondly, next year may also need further recapitalization in the banking system as non-performing loans start to appear. Given that loan growth has been tied up to real estate, the impact on banks will be severe.

Long-term, Ukraine remains among the most attractive opportunities globally as, by most comparisons, its economy is still largely underdeveloped. GDP per capita stands at a mere $2,500 per head. The country is relatively resource-rich and home to a sizable and under-penetrated consumer market.

Neighboring Europe will continue to invest and provide a large amount of long-term capital.  Finally, importantly, a well-established pragmatic leadership is needed more than ever today to accelerate reforms. Unfortunately, it has been very disappointing so far.

Based in Kyiv, Anton Khmelnitski heads the Eastern Europe investment team at Polar Capital. Born in Moscow, Khmelnitski grew up and received his education in Switzerland. He has 10 years of experience covering Eastern European equities.