Ukraine’s Far East Unravels as IMF Warns More Cash May Be Needed

May 01, 2014 2:12 pm ET

(For more on the Ukraine conflict, see EXT2.)

May 1 (Bloomberg) -- Ukraine’s easternmost regions are slipping from the government’s grasp as separatists take over more official buildings, with the International Monetary Fund warning extra financing may be needed if control of the industrial heartland is lost.

Armed men stormed the Donetsk regional prosecutors’ office today, throwing stones and stun grenades. Pro-Russian rebels in nearby Slovyansk said they’d begun talks to swap international monitors abducted last week, the Interfax news service said. Acting Ukrainian President Oleksandr Turchynov signed a decree backed by lawmakers last month to reinstate a military draft, his office said on its website.

“The government doesn’t control the situation in Donetsk as well as part of the Donetsk region,” Turchynov said yesterday in Kiev. “Because there is a real threat of Russia starting a continental war, our army is on full combat alert.”

The IMF, which approved a $17 billion bailout for Ukraine early today, said “a significant recalibration of the program” might be required if the situation worsens. The U.S. and the European Union accuse Russia of stoking the turmoil, which has worsened even after they ratcheted up sanctions on Russian interests in the worst confrontation since the Cold War.

Russia says Ukraine’s rulers must listen to complaints in the east and cede powers to the regions. German Chancellor Angela Merkel urged Russian President Vladimir Putin today to help free the detained observers.

International Aid

With the crisis straining Ukraine’s shrinking economy, the government will get an immediate $3.2 billion disbursement under the IMF program to help it meet the $9 billion in debt payments it’s facing this year. The loan approval unlocks a total of $27 billion in international aid.

Gross domestic product fell 1.1 percent from a year earlier in the first quarter as industrial production and the hryvnia slumped amid deadly protests and Russia’s annexation of the Crimean peninsula. With the currency down 29 percent this year, the government has pledged to stabilize the nation’s accounts.

“The authorities have developed a bold economic program to secure macroeconomic and financial stability and address long- standing imbalances and structural weaknesses to lay a firm foundation for high and sustainable growth,” IMF Managing Director Christine Lagarde said in an e-mailed statement.

Even so, the yield on Ukraine’s dollar-denominated bonds due 2023 rose 26 basis points to 10.65 percent, a six-week high, amid the continuing tensions on the ground.

‘Long-Lasting Disruption’

The Washington-based lender’s staff said in an e-mailed report that more financing would be needed if there was “a long-lasting disruption of relations with Russia that depresses exports, investment, and growth or loss of economic control over the east that reduces budget revenue.” Ukraine’s three eastern regions accounted for 30 percent of industrial output last year, according to the IMF.

As many as 1,000 gunmen have seized buildings in more than 10 cities in eastern Ukraine, according to the Interior Ministry, while Gennady Kernes, mayor of the city of Kharkiv, is in a hospital in Israel after being shot.

Rebels in Slovyansk released two hostages, though they still have 50 more, including eight observers from the Organization for Security and Cooperation in Europe. Vyacheslav Ponomarev, the city’s self-appointed mayor, said he’s in discussions with the government in Kiev to swap the OSCE monitors for his captured allies, according to Interfax.

Putin Call

While Merkel urged Putin to intervene when they spoke by phone today, according to a German government statement, the Kremlin cited the Russian president as telling the chancellor the “most important” thing now is for Ukraine to remove its troops from the east.

Russia is also suffering from the crisis. Its economy is in a recession and may only expand 0.2 percent this year, Antonio Spilimbergo, the IMF’s mission chief for Russia, said yesterday. The ruble is down 7.6 percent against the dollar this year, the second-worst among 24 emerging-market currencies tracked by Bloomberg.

The U.S. and Europe are threatening industries such banking and energy if Putin doesn’t calm the crisis.

“We will escalate the costs to Russia as Russia, if it does, escalates its provocative behavior,” White House Press Secretary Jay Carney told reporters yesterday in Washington.

Putin has warned the U.S. and the EU that further sanctions may trigger a response against foreign companies in Russia’s energy and other industries.

Russian forces, estimated by NATO to number about 40,000, continue to mass on Ukraine’s border, Turchynov said.

Meanwhile, in Moscow, Putin celebrated May 1 with a return to Soviet-era traditions in the shape of a parade by unions and medals for “heroes of labor” awarded in the Kremlin.

In the first Labor Day march across Red Square since the Soviet Union collapsed, workers carried banners saying “I’m proud of my country,” “In Putin we trust,” and “We’re going to vacation in Crimea.”

--With assistance from Volodymyr Verbyany in Kiev, Sandrine Rastello in Washington, Dalia Fahmy in Berlin and Ilya Khrennikov in Moscow.