Increasingly sour rhetoric with Russia is not deterring investors in Ukraine, who are betting that Western powers will guarantee enough financial aid to shield the troubled economy from investment risk, according to Reuters.

Western powers are aware of a delicate strategic balance in Ukraine, and although they may not be willing to allow Ukraine into NATO or the European Union any time soon, neither do they want total financial failure or default in a country that lies astride key energy routes and dominates the Black Sea.

They also don`t want to see the country financially dependent on Moscow.

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So they have watched closely over the last month as Ukraine and Russia blamed each other for irritating ties, with diplomats expelled, confrontations around Russia`s Ukraine-based Black Sea Fleet and angry exchanges between political leaders.

Russia said on Monday Ukrainian troops and volunteers had fought for Georgia in last summer`s war, something Ukraine has always denied. [ID:nLO588076]

But where worsening relations between the two countries in the aftermath of the Georgia war unnerved markets and hit Ukrainian assets, this year investors say the situation is entirely different.

"The worse relations get, the more likely the West is to make sure they get the aid they need," said emerging markets strategist Nigel Rendell at Royal Bank of Canada.

"Ukraine is definitely a very different case compared to other countries in the region when it comes to their IMF deals."

Ukraine`s economy and currency slumped drastically late last year, reeling from the impact of the global financial crisis and leaving the country dependent on a $16.4 billion rescue package from the IMF (International Monetary Fund).

That has left the confidence of the handful of foreign investors remaining in Ukraine almost entirely dependent on the progress of that deal, with the IMF holding up delivery of a tranche earlier this year blaming political failure to pass essential reforms.



Investors had worried political turmoil ahead of presidential elections in January and a power struggle between Ukrainian President Viktor Yushchenko and one-time ally Prime Minister Yulia Tymoshenko might further delay and imperil the programme.

But the cost of insuring Ukraine`s sovereign debt in the credit default swaps market, which soared earlier in the year as fear of sovereign default made it virtually uninsurable, has fallen back in recent months -- although it remains amongst the highest in emerging markets.

The price move is almost entirely down to the growing market assumption that the IMF would back Ukraine regardless -- unlike other countries such as Latvia or Hungary that are also dependent on international financial aid to survive financially but on whom the lender is seen as being less lenient.

Indeed, the IMF has shown an unusual degree of flexibility, for example by allowing a budget deficit of 6 percent of gross domestic product after initially demanding a balanced budget.

The agreement of another $3.3 billion tranche last month was seen by many as a sign that the IMF would not walk away from Ukraine. The European Union has provided additional support to help Ukraine purchase Russian gas.

"The IMF is taking a softer line on Ukraine the other countries and the reason is simply down to geopolitics," said Commerzbank head of emerging market research Michael Ganske.

Investors are also hoping tensions with Russia will diminish after elections in January, with both front-runners in the polls seen more friendly towards Russia than current President Viktor Yushchenko, who stands little chance of being reelected.

Moscow is seen reluctant to take serious action against Ukraine -- such as closing gas taps as it did earlier this year in a row over payment -- for fear of undermining support for the candidates seen as more Russia-friendly.

By Peter Apps, Political Risk Correspondent, Reuters