Ukraine's leading English-language newspaper since 1995

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.

Gazprom now demands Ukraine pay $450 per 1,000 cubic metres (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 $16.4 billion loan facility as the hryvnia tumbled, losing half of its value at one point in December. It has since strengthened to about 8/$.

Gazprom initially offered Ukraine a price rise to $250/tcm but it now says Ukraine should pay $450 per tcm. Ukraine's current account deficit has widened fast since 2005, mainly as a result of gas price hikes.

"The $450 price is a threat that is meant to bring Ukraine back to the negotiating table. A price like that would put industry into deep recession," said Dmitry Gourov, analyst at UniCredit. "It would make the recession twice as painful."

Ukraine imported about 47.9 bcm in 2008 at a cost of $8.61 billion but Kiev says the contracting economy means it will need less gas next year as industrial consumption falls.

Still, higher prices would put politicians on the line as they gear up for the presidential election. Yushchenko and Tymoshenko would be keen to face off against Russia but also eager to gain popularity by securing a favourable deal with Moscow.

Ukraine has to stick to IMF conditions, such as a deficit-free budget and foreign currency reserves requirements. Ukraine said on Tuesday its foreign currency reserves fell to $31.54 billion in December. Ukraine also plans a budget deficit for this year.

"One way to cut the budget deficit is to cut social spending but it would be political suicide to even talk about cutting social spending when presidential elections are coming soon," said Maslova from Barclays.

Oleksander Shlapak, the president's top economic aide, said a gas price of $250 per tcm would be "tough medicine" for the Ukrainian economy but it could still survive.

But he warned a rise in Russian gas prices could feed through to higher heating bills and domestic prices for energy.

Ukraine has long planned to move from Soviet-era subsidies for energy to a more market-based formula, but politicians have moved cautiously for fear of a public backlash.

"Public finances are to be strained if politicians fail to show a will to pass on gas costs to consumers," said Alexander Valchyshen, head of research at Invest Capital Ukraine.

"Still, with high political rivalry, those in power are likely to be tempted once again to save households from higher energy costs on the eve of presidential elections," he said.

And that would put Ukraine's public finances under the spotlight even more. (For more stories on the Russian gas dispute, click on)) (Editing by Janet McBride)