Ukraine cbank warns government on economy, urges IMF talks

KIEV (Reuters) - Ukraine's government has damaged its credibility among investors by setting unrealistic growth targets and needs to resume talks with the IMF, the central bank said in a memo that exposed deep divisions between policymakers.

The memo also dismissed this year's inflation target, warned the country's credit rating was at risk of being cut and said interest rates would have to rise if price pressures persisted.

It was published by several Ukrainian media outlets and its existence was confirmed by the central bank late on Thursday.

The International Monetary Fund stopped disbursing payments to Ukraine earlier this year after the government delayed implementing a range of unpopular fiscal reforms, including raising the retirement age.

The central bank's salvo comes amid signs that Kiev, mindful of a worsening backdrop for growth that includes the threat of economic meltdown in neighboring Belarus, is now preparing to bite the bullet on the conditions needed for a resumption of the loan program, which was launched last July.

A failure to meet those requirements "would lead to (Ukraine) not receiving $7.7 billion this year alone," the central bank said.

This week the government submitted a redrafted pension reform bill to parliament. [ID:nLDE75023E]

"Positive newsflow on Ukraine and IMF cooperation ... suggests that the decision to continue the current IMF program was made at the highest level," VTB Capital said in a note on Friday.

"This is a marked change from the spring's 'no need for the IMF' rhetoric from various officials."

TRUST 'UNDERMINED'

The central bank said in the memo, dated May 19 and addressed to Prime Minister Mykola Azarov, that it would raise rates and allow the hryvnia currency to appreciate if inflationary pressure persists.

The hryvnia has been trading at around 7.9-8.0 per dollar in the last few months as the central bank intervened to prevent both excessive appreciation and weakening.

Capping inflation at 8.9 percent this year in line with the government's forecast was hardly possible, the bank said. Annual inflation could reach 12-13 percent in the summer months

"The unrealistic inflation forecast casts doubt on all macroeconomic projections both for the current and next year," the bank said. "Thus, they undermine trust in Ukraine's economic policy as a whole."

Ukraine wants to boost its gross domestic product by 4.5-5.0 percent this year, up from 4.2 percent in 2010.

A key driver for its economy is steel exports, while energy is largely imported, making the economy vulnerable to external price shocks.

The country is rated "B" by Fitch, "B2" by Moody's and "B+" by Standard and Poor's. All three agencies upgraded the country or improved their outlooks following the deal with the IMF.

Commenting on the leaked memo, central bank chairman Serhiy Arbuzov said late on Thursday that "such correspondence is normal practice around the world."

"...In such discussions the government and the central bank find common solutions to economic problems," he said in a video address posted on the bank's website.

The government has not commented on the leak.

(Reporting by Natalya Zinets; Writing by Olzhas Auyezov; Editing by John Stonestreet)