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Ratings agencies say the decision to increase domestic gas tariffs is an encouraging sign for the new government's political resolve to restore the finances of Naftogaz. Standard & Poor's Ratings Services said on Friday that it had raised its long-term sovereign foreign currency ratings on Ukraine by one notch to 'B+' from 'B' and the long-term sovereign local currency rating to 'BB-' from 'B+' in view of the International Monetary Fund's (IMF) approval of Kyiv's new credit program.

The agency said in a statement: "At the same time, Standard & Poor's removed the long-term ratings from CreditWatch, where they had been placed with positive implications on July 22, 2010. Furthermore, the 'B' short-term local and foreign currency ratings are affirmed. The outlook is stable.

"In addition, Standard & Poor's raised the long-term Ukraine national-scale rating by one notch to 'uaAA-' from 'uaA+'. The transfer and convertibility assessment was also raised to 'B+', in line with the foreign currency rating, and the recovery rating on the unsecured debt remains unchanged at '4'.

"The rating action follows the approval by the IMF's Executive Board of a 29-month ($15.15 billion) stand-by arrangement, providing a policy anchor and giving Ukraine immediate access to around $2 billion of financing".

"We believe that the IMF program will increase the chances of a stability-oriented policy measures that should increase the resilience of the Ukrainian economy and its public finances," Standard & Poor's credit analyst Kai Stukenbrock was quoted as saying. "The government's decision to increase domestic gas tariffs is an encouraging sign for the new government's political resolve to restore the finances of Naftogaz and meet the terms of the IMF program," he said.

The statement said: "The IMF program also reduces the external vulnerability of Ukrainian economy by providing external financing.

"Ukraine's economy is recovering on the back of the normalization of the country's terms of trade. Confidence in prospects for greater policy stability and a return to economic growth are also reflected in the gradual re-access to short-term external funding of Ukraine's corporate sector. In net terms, however, both the corporate and banking sectors continue to pay down external debt, a process that is being offset by the rise in public sector external borrowing. Ukraine's current account deficit is expected to narrow by more than half during 2010 toward 1%/GDP. Nevertheless, over 60% of Ukraine exports consist of chemicals and steel, subjecting the economy (and nominal GDP, which is the tax base) to volatility.

"By successfully negotiating a reduction in the price that Naftogaz will pay on imported Russian gas by 30% and raising domestic gas tariffs by 50%, the government has also improved the state owned gas distributor's financial position. Budget transfers to Naftogas are projected to be 1% of GDP in 2010 and 0% in 2011.

"The revision of the budget in July 2010 was an important step forward. The revised budget is based on more realistic revenue assumptions compared to the initial budget law. This puts the 2010 budgetary result in line with the IMF's budget deficit target of 5.5% of GDP.

"The rating was raised in accordance with our expectations expressed on July 22, 2010, when we put the long-term foreign-currency rating on CreditWatch with positive implications. At that time, we stated that we expect to raise the ratings on Ukraine by one notch when the formal agreement is signed, and once the measures are implemented. The IMF Executive Board approved the financing program on July 28, 2010".

"The stable outlook balances the relatively low level of government debt and significant natural and human resources with the volatility and vulnerability of the economy," Stukenbrock added.

The statement said: "This in turn is fed by the undiversified nature of the economy, a history of political instability, and the consequences of an unprecedented private credit boom leading to high private sector leverage.

"A long-term permanent shift to a more sustainable fiscal position on the back of a permanent improvement in the finances of state-owned utility Naftogaz and the social security system could lead to further ratings improvements, as could a reduction in the country's vulnerability to terms-of-trade and other external shocks. Alternatively, setbacks to political stability, higher-than-projected recapitalization needs for the financial system, or a weakening of the government's resolve to finalize an IMF lending program, could put downward pressure on the ratings".