Kiev - The International Monetary Fund (IMF) tightened screws on Ukraine's government on Friday, saying the former Soviet republic could receive critically-needed emergency loans only if it adopted a "realistic budget."

"We are willing to agree to a change in the (planned) size of the (Ukrainian) deficit," said Max Alier, director of the IMF mission to Ukraine.

But Ukraine's divided government must develop a budget "not based on inflation-generating measures," he added.

The Fund in November gave Kiev an initial 4 billion dollar tranche of a 16.5 billion dollar "standby credit" aimed primarily at stabilizing Ukraine's tottering banking sector. A balanced Ukrainian state budget and non-inflationary fiscal policy were key loan conditions.

Ukraine's government led by Prime Minister Yulia Tymoshenko - a populist politician frequently critical of IMF-favoured free market policies - in December passed a budget planning a substantial deficit, and in the first two months of 2009 began a dramatic expansion of the money supply, sparking double-digit inflation.

The IMF was scheduled to issue the second tranche of the low- interest loan, 4 billion dollars on February 17, but Fund officials have dragged feet on forking over the cash, citing Ukraine's failure to live up to loan terms.

Alier's declaration that the IMF might accept a deficit Ukrainian budget to allow the credit programme to continue, was contingent on the Tymoshenko government's confirmation to the IMF of a national budget based on "real non-inflationary sources," the Interfax news agency reported.

The IMF pre-condition of a Ukrainian national budget with a minimal deficit carries the potential of throwing the entire loan programme into jeopardy, as Tymoshenko has been locked in a political battle with President Viktor Yushchenko over responsibility for the country's failing economy, and indeed whether or not there will be a deficit at all.

The two Ukrainian politicians are sharply divided on Ukraine's 2009 growth potential, monetary policy, government revenues predictions - all issues requiring agreement for the passage of a new budget bill.

Possible emergency financing from Russia is a key disconnect between Yushchenko and Tymoshenko, with Tymoshenko saying cash from Moscow might well be a viable alternative to IMF funds, and Yushchenko calling any loan from the Kremlin "a direct threat to our (Ukrainian) national security."

"The (Tymoshenko) government must act responsibly and take realistic steps to deal with this crisis," Yushchenko said in an interview.

Excise policy is another major bone of contention, with Yushchenko supporting minimal changes and continued adherence to free market principles, and Tymoshenko already having rammed through parliament an across-the-board 13 per cent tax on most imports, in probable violation with World Trade Organization terms.

Tymoshenko in recent weeks has stuck to her guns, and the government's rosy 4 per cent predicted GDP growth for 2009, saying in remarks to Channel 5 television "Ukraine will come out of the crisis... and the worst is already behind us."

Economic turmoil stemming from Tymoshenko and Yushchenko's failure to agree on economic policy, and the effects of the world financial crisis on Ukraine, have halved the value of Ukraine's national currency the hryvna since August, and brought foreign investment in Ukraine to an almost total halt.

Ukraine's government is according to independent media already close to broke, with a current account deficit of some 5.5 billion dollars and worse to come in March as new international debt comes due, and Ukraine face a half-billion dollar bill for Russian natural gas.

"Ukraine's economy is one of the most vulnerable worldwide to economic shocks," editorialised the English-language Kyiv Post newspaper. "The nation is starved for revenue."

But Alier in Friday comments left little hope the IMF would come to Ukraine's rescue any time soon.

"Inflationary policies (as proposed by the Tymoshenko government) could only have a negative effect," he said. "We cannot support that." (dpa)