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By Daryna Krasnolutska Nov. 16 (Bloomberg) — Ukraine’s economy contracted 15.9 percent last quarter, extending the former Soviet state’s decline, as political wrangling stalled the payment of bailout funds needed to keep the country afloat. The annual contraction compares with a 17.8 percent economic slump in the second quarter, the Kiev-based state statistics committee said today in a statement on its Web site, citing preliminary figures. Ukraine lurched into recession after the global crisis undermined demand for steel, the country’s main export, and left about 20 banks in need of state aid. The former communist nation is now relying on a $16.4 billion International Monetary Fund loan to avoid bankruptcy and to keep up Russian gas payments ahead of winter. The IMF is withholding a $3.4 billion tranche after parliament passed a social spending bill in defiance of the fund’s calls for budget cuts. The hryvnia lost 0.5 percent against the euro to trade at 12.1580 at 10:48 a.m. in Kiev. Against the dollar, the currency was little changed and trading at 8.1187. While a resumption of global trade flows is showing signs of supporting Ukraine’s exporters, recovery prospects are uncertain as credit remains tight, hampering business investment needed for growth. Banks’ asset quality took a hit after last year’s 37 percent hryvnia depreciation against the dollar and the IMF estimates non-performing loans jumped to 30 percent of total lending at the end of June. More than half the banks’ loans are in foreign currency, according to Fitch Ratings. ‘Financial Instability’ “Political dynamics mean policy may not be restored to a sustainable path before there is a further bout of financial instability,” Fitch analyst David Heslam said in a Nov. 12 statement. “A further sharp depreciation in the hryvnia would intensify pressure on Ukraine’s crisis-hit banking system.” The country risks a continued economic decline coupled with faster inflation should policy makers resort to printing money to address their budget needs, Fitch warned on Nov. 12. The rating service “sees an elevated risk that Ukraine could resort more heavily to monetary financing via the National Bank of Ukraine providing liquidity to banks, effectively printing money,” Heslam said. “This would in turn risk undermining fragile confidence in the currency and the banking system, and/or a rapid loss of foreign exchange reserves.” Annual inflation stood at 14.1 percent in October, compared with 15 percent the previous month, the statistics office said on Nov. 9. Presidential Elections The country’s chances of an economic recovery may stall as policy makers, mindful of Jan. 17 presidential elections, fail to agree on budget reform needed to keep bailout funds flowing. Prime Minister Yulia Timoshenko will appeal President Viktor Yushchenko’s Oct. 30 approval of an opposition lawmaker bill that will swell the budget deficit beyond IMF mandated limits. “At the root of the problem is Ukraine’s inconsistent macroeconomic policy framework, as the authorities are aiming to defend the exchange rate while avoiding necessary fiscal tightening in the absence of adequate sources of non-monetary financing,” Fitch’s Heslam said. The failure of the main political groupings to agree on budget cuts and IMF-prompted economic reforms has been generated to a large part by the pending elections, provoking the leading candidates to prioritize popular support over needed fiscal and monetary changes. Orange Revolution Yushchenko will run again in the January poll and will face challenges from his erstwhile ally Timoshenko and the leader of the biggest opposition party Viktor Yanukovych , whose rigged run for the office four years ago triggered the Orange Revolution that brought Yushchenko to power. Even so, there are some signs that parts of the economy are recovering as global trade flows rebound. Industrial production , which makes up more than 25 percent of GDP, increased at an average rate of almost 2 percent monthly in the third quarter, compared with a decline of 0.13 percent in the second quarter, according to statistics office data. The “improved situation is very fragile,” central bank adviser Valeriy Lytvytskyi said on Oct. 28. Natsionalnyi Bank Ukrainy has lowered the discount rate twice since June and cut its overnight rate to 15.5 percent on loans using Treasury bills as collateral. The key discount rate now stands at 10.25 percent. Lytvytskyi said he will advise policy makers to reduce the rates by 0.25 to 0.5 percentage point to support the economy. Economic Outlook The government expects the economy to contract 12 percent this year, while the IMF sees a 14 percent decline. “Although the rate of decline of GDP is slowing, non- performing loans continue to grow,” Moody’s Investors Service said on Oct. 14. “Susceptibility to event risk that would lead to a multi-notch downgrade is assessed as high.” Moody’s rates Ukraine B2, while Fitch ranks the sovereign’s debt B-. Standard & Poor’s rates Ukraine CCC+. The three services’ ratings range between five and seven notches below investment grade. To contact the reporter on this story: Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net