GO
Loading...

Ukraine and IMF announce up to $18 billion bailout

The International Monetary Fund (IMF) announced a $14 billion to $18 billion bailout for Ukraine on Thursday morning, as the country's prime minister warned of the depth of its problems.

The IMF's Mission Chief Nikolay Gueorguiev announced that the bailout will use a "stand-by arrangement," a type of bailout similar to that used in Iceland and Greece after the credit crisis of 2007. International funds of up to $27 billion over two years will be available, including $14 billion to 18 billion from the IMF.

Ukraine's interim Prime Minister, Arseniy Yatsenyuk, warned that Ukraine's economy would shrink by 3 percent this year in a best case scenario, and that it could fall by 10 percent without IMF help.

Read MoreUkraine: What next for battered economy?

Yatsenyuk told reporters: "If we were a commercial entity, we would be bankrupt."

This would mean a "bailout" rather than the "bail-in" model used in Cyprus, which meant that creditors were forced to take a write-down on the value of their debt. It also means that the IMF will be able to impose reforms to bring the country back to financial stability.

Bailout negotiations have taken weeks as the parties involved thrashed out the terms of the deal, and as the precariousness of Ukraine's economic situation unfolded.

"Ukraine's macroeconomic imbalances became unsustainable over the past year," Gueorguiev said.

"The (until recently) pegged and overvalued exchange rate drove the current account deficit to over 9 percent of gross domestic product (GDP), and a lack of competitiveness led to the stagnation of exports and GDP."

Hiking heavily discounted household natural gas prices is a key tenet of the deal—but this will go alongside "scaled up social protection" according to the IMF.

"Reforms to strengthen governance, enhance transparency, and improve the business climate," were also promised by Gueorguiev. Ukraine had become notorious for corruption in both business and politics. There will be particular focus on the accounts of Naftogaz Ukrainy, the state-owned oil and gas company, alongside a new law to tackle corruption in the awarding of government contracts.

The deal could help Ukraine's pro-EU contingent in May's presidential elections. However, the IMF does not want to be seen to back any particular Ukrainian horse, as there are allegations of corruption against most Ukrainian politicians who have experience of government.

Read MoreWhy Crimea matters

"An IMF program will be acutely difficult under any circumstances," Timothy Ash, head of emerging markets research at Standard Bank, pointed out.

Russian paramilitaries stand guard outside of a Ukrainian military base in the town of Perevevalne near the Crimean city of Simferopol on March 11, 2014 in Perevevalne, Ukraine.
Getty Images
Russian paramilitaries stand guard outside of a Ukrainian military base in the town of Perevevalne near the Crimean city of Simferopol on March 11, 2014 in Perevevalne, Ukraine.

Ukraine may need more than the mooted amount, particularly after Naftogaz announced a worse-than-expected 80 billion Ukrainian hryvnia ($7 billion) deficit, Ash warned. Earlier in March, the country's finance minister had mooted a figure of $15 billion to $20 billion.

Part of the problem is an existing part-bailout by Russia in the form of buying $3 billion worth Ukrainian bonds. If the IMF bailout hikes Ukrainian debt-to-GDP levels above the agreed 60 percent, Russia may be able to demand early repayment of the bonds.

Read MoreUkrainian aid may go straight to...Russia

In the wider context of how Ukraine will affect the rest of the world, much will depend on how far-reaching and potentially damaging sanctions against Russian President Vladimir Putin's Russia by the West are. U.S. President Barack Obama hinted at stronger sanctions than those already in place in a speech Wednesday evening.

Read MoreRussia sanctions: Who's losing out so far

"The spillovers from the Russia-Ukraine crisis are likely to keep geo-political tensions high near term, and probably create additional downside risks for growth in Russia and closely-linked neighboring countries," according to a team of analysts at Citi led by Willem Buiter, the bank's global chief economist. "Nevertheless, Europe's high reliance on Russia for oil and gas (and Russia's reliance on the revenues from fuel exports to Europe) gives both the EU and Russia an incentive to avoid outright trade sanctions."

"Russia, whose overriding objective is to ensure that Ukraine is not drawn into the western fold—militarily as well as politically—is already making it extremely difficult for Kiev to launch and, more importantly, sustain the reforms being demanded by the Fund," Nicholas Spiro, managing director at Spiro Sovereign Strategy, told CNBC. "That Russia's economy, a crucial trading partner for Ukraine, is also deteriorating rapidly makes things doubly difficult."

By CNBC's Catherine Boyle

Contact Europe News

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More

Europe Video

  • A yes vote in the upcoming Scottish independence referendum could lead some insurers to move their headquarters to London, says Mark Nicholson, associate director at Standard & Poor's Rating Services.

  • The U.S. Federal Reserve remains data dependent and will not bow to hawks, says Mark Haefele, global chief investment officer at UBS, as Janet Yellen continues to make the argument that there is slack in the labor market.

  • European shares closed lower on Friday as tensions in Ukraine flared up once again. It comes after stocks fluctuated as U.S. Federal Reserve Chair Janet Yellen spoke about the labor market in Jackson Hole, Wyoming.