Ukraine's government will increase gas prices for households and thermal power by 50 percent starting next month.
The step marks a key concession to the International Monetary Fund in order to seal a $14.9 billion, 2.5-year credit that is seen as crucial to stabilizing Ukraine’s parlous state finances.
The measure follows other important steps to reduce the budget deficit and strengthen central bank independence. But analysts say the price hike could hit the most vulnerable parts of the population, and the opposition looks poised to capitalize ahead of local elections in October.
“I won’t pretend that the conditions Ukraine has taken on itself are not tough, but they all match with our own views on the development of the country.”
– Mykola Azarov, prime minister.
The National Electricity Regulatory Commission of Ukraine announced on July 13 that residential gas tariffs would increase by about 50 percent, effective Aug. 1.
“I won’t pretend that the conditions Ukraine has taken on itself are not tough, but they all match with our own views on the development of the country,” said Prime Minister Mykola Azarov on July 14.
“Is it not in our interests to reduce the budget deficit this year to 5 percent and next year to 3.5 percent? Or are we supposed to live in debt? There is no alternative,” Azarov added.
Ukraine desperately needs the IMF seal of approval, not only for the $14.9 billion, but also to get financial help from the World Bank and European Union, including $500 million from the EU.
The IMF support would also send a positive signal to financial markets mulling over whether to invest in Ukraine’s attempt to raise $2 billion through sales of Eurobonds.
The gas price hike – combined with the reduced budget deficit and bank sector reform – represent some of the first reforms that many believe are needed to pull the nation out of crisis.
Hiking energy prices was a key IMF demand. The staff-level agreement signed between IMF and Ukraine on July 5 stipulated increases in the price of gas charged to households, sufficient to reduce to 1 percent of gross domestic product the deficit run by state-owned gas distribution monopoly Naftogaz.
According to Deputy Prime Minister Sergiy Tigipko, who has overseen negotiations with the IMF, the international lender’s board will now meet on July 28 to decide whether to proceed with the program of cooperation with Ukraine.
The measure follows two other IMF-compliant measures passed July 8 aimed at improving stability of state finances as well as financial oversight: reduction of the budget deficit to 4.9 percent of GDP and a law strengthening central bank independence.
The end of subsidized power and railway tariffs to the chemical and mining sectors, hinted at July 14 by government officials, would constitute another similar reform, if confirmed.
Most analysts calculated that the 50 percent increase for households, combined with a 50 percent increase in the price of gas for thermal power plants, would be sufficient to fulfill IMF conditions by reducing the budget deficit of Naftogaz in 2010 to less than 1 percent of GDP.
“I think that the government has done enough radical reforms to receive the IMF credit,” said Oleksandr Paskhaver, president of the Center of Economic Development think tank.
Whose reforms?
“There are a lot of reforms being done, a lot of laws being passed, but the general impression is that this is more about pleasing the IMF than real reforms.”
– Oleksiy Blinov, an analyst with Astrum Investment Management.
Analysts were, however, skeptical that the reforms were anything more than stopgap measures to appease the IMF. “There is no real Ukrainian ownership of these measures,” said Oleksiy Blinov, an analyst with Astrum Investment Management. “There are a lot of reforms being done, a lot of laws being passed, but the general impression is that this is more about pleasing the IMF than real reforms.”
Government’s revenue targets for the years have also proved overly optimistic. This means that the deficit could still exceed the IMF target. According to Oleh Ustenko, executive director at Bleyzer Foundation, the budget aims to collect 27 percent more taxes in 2010 than 2009, but in fact state budget revenues were up by less than 6 percent year-on-year for January-May.
World Bank financial sector specialist Angela Prigozhina already on July 13 criticized parts of the law intended to strengthen independence of the National Bank of Ukraine, calling them ineffective because they would only be implemented over 2-5 years. As a result, the supervisory board would continue to include individuals with conflicts of interest, she said.
There is also skepticism about the energy price hike.
“We do not rule out the possibility that decisions on household tariffs may be reversed in the face of local elections looming this autumn,” said Blinov.
Head of Ukraine’s National Forum of Trade Unions, Miroslav Yakibchuk, declared on July 14 that the union would appeal the decision to raise gas prices for the population. A previous 20 percent gas price increase in September 2009 was frozen following a similar appeal by the trade unions.
However, Phoenix Capital’s Serhiy Petrenko said that “Ukrainian authorities have consolidated power in all spheres and have the necessary means to pull through the increase.”
Potential backlash
“People with low-and-medium income will feel the gas price hike most.”
– Igor Burakovskiy of the Institute for Economic Research and Policy Consulting.
“People with low-and-medium income will feel the gas price hike most,” said Igor Burakovskiy of the Institute for Economic Research and Policy Consulting. Experts agree the gas price hike will hit the rural population hardest, including many of Ukraine’s most deprived citizens, making it potentially deeply unpopular.
This is because, in contrast to city dwellers, villagers who comprise one-third of the population often rely on gas directly for heating and warm water supply. “Many villagers in fact have to use so much gas to heat their homes and water that they actually find it difficult to remain within the lowest class of gas users who consume less than 2,500 cubic meters annually,” said Ildar Gazizullin of the Independent Centre of Political Studies.
At new prices, 2,500 cubic meters implies a gas bill of roughly $150 per month, compared to currently $100.
Many rural inhabitants are pensioners, and the current minimum state pension is equivalent to the subsistence minimum, of around $92. An extensive process of rural gasification since the 1990s, under conditions of extremely low gas prices for households, greatly increased the number of rural households using gas, shifting their fuel source to gas from traditional peat and wood, and improving standards of living. “Many will not be able to switch back to alternative forms of fuel such as wood,” said Gazizullin.
In contrast to villagers, urban dwellers receive heat and hot water from thermal power plants, and often have gas bills of no more than $1 or $2 per month. However, with the gas price for thermal power plants hiked by 50 percent as well, there will be a more gradual knock-on effect for related utility rates. “This means that the budget-financed sphere [schools and hospitals etc] could run into difficulties as well, since many are already now experiencing difficulty paying utility bills,” said Burakovskiy.
The government has promised financial support to those now affected by the price hike. Currently, if utility bills exceed 20 percent of income for the employed, or 15 percent for pensioners and the disabled, the government pays the difference. Minister of Labor and Social Politics Vasily Nadraga announced July 14 that this maximum threshold would be lowered to 15 percent for the employed, and 10 percent for pensioners and the disabled. He added that “80 percent” of the population will be covered by some degree of subsidy, without giving further details.
However, with an opposition eager to capitalize on any sign of government weakness, the IMF-compliant measures could well hurt the government’s popularity. Opposition leader and former Prime Minister Yulia Tymoshenko said on July 14 that Naftogaz was in a stable financial condition, and there were “no reasons and no necessity [to raise prices].” Tymoshenko said she was intending to go to court to prevent the gas price hike.
Kyiv Post staff writers Graham Stack can be reached at [email protected] and Yuriy Onyshkiv at [email protected].
