Ukraine appeared to deliver three of the four prior conditions required to unblock the fresh IMF bailout loans (related to developing an foreign exchange swap market, dealing with independence of the central bank and pension reform), stalled since March 2011. But Ukraine has still failed to deliver on the final prior action, hiking domestic gas prices.

The Fund had originally demanded a 50 percent natural gas price hike this year, but this was subsequently revised back to a commitment to hike by 20 percent in April and a further 10 percent in July. The increases were not delivered.

The Fund sees the price rises as key both to ensuring quasi-fiscal deficit targets are met (3.5 percent of gross domestic product, inclusive of state-owned natural gas company Naftogaz) and for driving through broader efficiencies in the gas market and use of energy.

The government is clearly mindful of electoral consequences … given that parliamentary elections are to be held October 2012.

The government is clearly mindful of the electoral consequences of the move, given that parliamentary elections are to be held October 2012, and fears that any move to hike gas/energy prices will see its popularity further decline. Support for President Viktor Yanukovych and his government is already on the wane, with a Razumkov think tank poll in August putting support for the ruling Party of the Regions down to just over 15 percent, half the level it secured at the last election.

Reports suggest that the government has offered to cover any budget shortfall from delayed energy price hikes by finding savings elsewhere in the budget, plans which have been rejected by the Fund.

The problem for the government is that its previous financing strategy was based on the assumption that it could tap the Eurobond market again this year – with reports of up to $2.5 billion in new issuance in the pipeline, and a further $3.5 billion in 2012. The weight of issuance reflects the government’s stated intention to repay a $2 billion bridging loan from a Russian bank, and to cover a $600 million Eurobond falling due in December.

However, Ukraine’s ability and willingness to finance itself from the Eurobond market must now be in some doubt, given that spreads have widened out by over 400 basis points in recent weeks, with Ukraine 5-year credit default swaps now trading up at 878 basis points.

For Ukraine’s Finance Ministry, this makes IMF financing appear as a relatively cheap option – cheaper, relative to only a couple of months ago at least. The alternative option for Ukraine would be to seek another loan extension from the Russian bank for the $2 billion facility – already rolled several times. The downside herein is that this could well undermine its own position in on-going discussions with Moscow over the re-pricing of natural gas imports.

Commentary from Ukraine’s deputy prime minister with responsibility for economic reform, Sergiy Tigipko, has suggested that the government might well now revisit the issue of gas price hikes, given the new found importance of IMF financing – and limited market financing options. Note though that it is unclear how much political capital Tigipko still enjoys within the cabinet, given his previous attempts to kick start the program – even threatening to resign at one stage – have largely failed.

Ultimately the decision on gas price hikes seems set to rest with President Yanukovych and his assessment of the balance of risks between domestic politics, and budget external financing when set against a much more challenging global financing backdrop. Earlier this month, Yanukovych had appeared to signal a willingness to gradually hike gas prices, in recognition of rising import costs.

The Fund’s willingness to play tough this time around probably reflects frustration at the slowing of broader reform momentum in Ukraine over the past year, plus also a feeling that the risks to Ukraine this time around are perhaps not as extreme as in late 2008-2009 when the prior IMF program was put together. Herein we would highlight a much reduced current account deficit (likely 2-3 percent of GDP this year versus 7-8 percent in 2008), lower burden of external debt liabilities falling due (probably half the $40-45 billion due in 2008-2009), rebuilding of foreign currency reserves (back to $36 billion) – IMF estimates suggest the external financing requirement will drop to around $33 billion in 2012, from around $45 billion in 2009.

We would also highlight that risks in the banking sector are much reduced, given efforts by the government, supported by the IMF, to root out weak banks, and to recapitalize the sector more generally.

Timothy Ash is global head of emerging markets research at the Royal Bank of Scotland in London.