KIEV, May 10 - The International Monetary Fund on Friday approved disbursement of a $2.8 billion loan installment to Ukraine, easing fears that the country may default on its foreign debt obligations this year.

The IMF also signaled Ukraine may qualify for an additional $3 billion after June 15 if the government sticks to “prudent” fiscal policies and makes progress on bank restructuring and recapitalization.

“A key priority of the authorities is to restore confidence in the banking system,” John Lipsky, First Deputy Managing Director at the IMF, said. “The authorities are committed to proceed with the state capitalization of the systemic problem banks and have taken measures to safeguard bank assets in the interim.”

The latest approval of the second installment brings to $7.3 billion the overall financing released to Ukraine within $16.4 billion two-year stand-by rescue package approved in November 2008. Ukraine already received $4.5 billion in November.

The IMF has been postponing the second installment since January after running into disagreement with the government of Prime Minister Yulia Tymoshenko over size of the budget deficit and other issues.

But eventually the IMF has agreed to allow the government to run the budget deficit of 4% of the GDP in 2009, scrapping its earlier demand of running a balanced budget, taking into account steep economic downturn.

“Given the sharp decline in growth and fiscal revenues, a balanced budget is neither feasible nor economically justifiable at this time,” Ceyla Pazarbasioglu, who led an IMF team for discussions with the government, said. “So, it makes sense to revise the program’s initial target.”

Concerning other disagreements with the government, such as amendments to the budget and lifting of temporary restrictions imposed on imports, the IMF has agreed to give the government more time to implement them.

“The Board also granted waivers of nonobservance of performance criteria pertaining to the cash deficit of the central government, the passage of the budget, exchange rate restrictions, multiple currency practices, and the imposition of import restrictions,” the IMF said. “The authorities have agreed to remove fully in the near future.”

“From this perspective, the authorities’ intention to implement important structural reforms, including pension and tax reforms, by end- 2009 is welcome,” Lipsky said.

“The National Bank of Ukraine has reaffirmed its commitment to implementing a flexible exchange rate policy. Adherence to this commitment is key to helping the economy adjust to external shocks, discouraging dollarization and excessive risk taking by unhedged borrowers, and allowing monetary policy to focus on inflation objectives,” Lipsky said.

Given the potential negative balance sheet effects, the National Bank of Ukraine is prepared to tighten monetary policy if needed, to avoid excessive exchange rate depreciation, according to the IMF.

“The authorities should phase out administrative measures, import surcharges, and restrictions limiting exchange rate flexibility without further delays,” Lipsky said.

Ukraine depends on the IMF lending for avoiding default on foreign debts this year and next, analysts said. Ukrainian government officials have been denying speculations that the country was on the verge of default.

The IMF believes the Ukrainian economy would shrink by 8% on the year in 2009, and “further downward revisions may be needed if regional and global conditions deteriorate further,” Pazarbasioglu said.

“However, there are a number of encouraging signs that the economy has started to adjust to the large economic shocks,” she said. “The exchange rate has undergone a sizable adjustment, the current account deficit has declined significantly, and inflation has fallen more than expected.” (tl/ez)