VZCZCXRO0935
PP RUEHDBU
DE RUEHKV #0360/01 0551237
ZNY CCCCC ZZH
P 241237Z FEB 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7366
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 000360 
 
SIPDIS 
 
DEPT FOR EUR, EUR/UMB, EEB/OMA 
 
E.O. 12958: DECL: 02/24/2019 
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: IMF COMPROMISE WOULD LEAVE SEVERE UKRAINE BUDGET 
GAP 
 
REF: A. KYIV 288 
     ¶B. KYIV 265 
     ¶C. KYIV 349 
 
Classified By: AMBASSADOR WILLIAM B. TAYLOR, REASONS 1.4 (B) AND (D) 
 
¶1.  (C) Summary. Ukraine faces a glaring budget gap this 
year, even if it meets all IMF conditionalities and 
introduces severe budget discipline.  The GOU has thus far 
failed to complete "prior actions" articulated by the IMF, 
necessary before the Fund can pay out the next tranche of its 
$16.4 billion Stand-By Arrangement (SBA).  Unfulfilled 
measures for cutting the budget deficit may be the largest 
impediment to the return of the IMF mission team, though the 
local IMF representative remains confident that the GOU will 
eventually move to enact minimal reforms. 
¶2.  (C) The IMF estimates that Ukraine will need $2.6 billion 
in external budget support in 2009, funds that can only come 
from international donors as long as the world's capital 
markets remain frozen.  We continue to weigh in with the GOU 
leadership on the need to meet IMF conditionalities, and we 
encourage Washington to be prepared to work with EU partners, 
the IMF, and the World Bank to give Ukraine financial 
support, but only if Ukraine fulfills IMF prior actions and 
World Bank structural reforms.  Ukraine's political 
leadership must demonstrate unity and a greater willingness 
to do everything in its power to tackle the crisis, which is 
growing more serious by the day.   End summary. 
 
IMF Sanctions a "Compromise" on Budget 
-------------------------------------- 
 
¶3.  (SBU) In order to return to Ukraine to complete the first 
review of its $16.4 billion SBA, the IMF has stipulated GOU 
action on reducing the budget deficit, ensuring central bank 
independence, improving crisis coordination, and devising a 
mechanism for bank restructuring.  It has also sought a joint 
declaration by PM Tymoshenko, President Yushchenko, and 
Speaker Lytvyn on their readiness to implement tough economic 
reforms. 
 
¶4.  (SBU) Among these IMF "prior actions," budget politics 
are proving the most complex.  According to the IMF, the 2009 
budget passed by the GOU faces a UAH 50 billion deficit 
($6.49 billion or 5 percent of GDP).  While Lytvyn has 
referred to IMF figures as authoritative, PM Tymoshenko told 
the Ambassador on February 17 that the budget deficit will be 
much smaller than the IMF has estimated, equivalent to only 3 
percent of GDP.  (Note: She suggested the cost of bank 
recapitalization would add another 3 percent of GDP to 
overall GOU expenditures in 2009, equaling a total fiscal gap 
of 6 percent or $7.8 billion.  End note.) 
 
¶5.  (SBU) Ukraine's economic circumstances have worsened 
considerably since the SBA was signed, causing the Fund to 
relax its original balanced budget conditionality and 
introduce a "compromise" budget plan.  In this plan, IMF 
officials tell us they expect the GOU to cut spending and/or 
increase revenues to generate an expected savings equal to at 
least UAH 20 billion ($2.6 billion or 2 percent of GDP). 
That would still leave a gap of UAH 30 billion, or 3 percent 
of GDP.  Of this gap, the IMF hopes that Ukraine would 
receive roughly $2.6 billion of external financing, equal to 
2 percent of GDP.  This entire compromise package would then 
leave a residual financing need equivalent to one percent of 
2009 GDP (roughly UAH 10 billion or $1.3 billion), a figure 
the IMF expects Ukraine can finance domestically, even under 
the current circumstances.  With credit markets closed to 
Ukraine, the IMF concludes that any external financing would 
take the form of lending from sovereign and multilateral 
donors. 
 
Measures for the Deficit 
------------------------ 
 
¶6.  (SBU) According to the IMF's Kyiv-based resident 
representative Max Alier and the World Bank's Kyiv-based 
senior economist Pablo Saavedra, the GOU has been given a 
wide ranging "menu" of potential measures to cut the budget 
deficit.  From this menu (including value-added tax reforms, 
pension targeting, and reductions in energy subsidies), the 
GOU has told the IMF it will make limited amendments to the 
state pension scheme, while also imposing higher excise taxes 
on tobacco and alcohol.  The IMF concedes the GOU's proposal 
would only implement a portion of the IMF and World Bank's 
total menu, as the GOU appears ready to resist any further 
 
KYIV 00000360  002 OF 003 
 
 
measures that it feels are politically unfeasible in the 
run-up to 2010 presidential elections. 
 
¶7.  (SBU) Of the two measures selected by the GOU to cut the 
budget deficit, a proposal to increase excise taxes on 
alcohol and cigarettes has not yet been tabled in the Rada by 
the GOU.  The pension bill is further along in parliament. 
Rada MPs are currently deliberating over legislation (bill 
number 3556) that would reduce expenditures by pegging 
pensions to 2007 wage levels, instead of to 2008 levels, 
which would reduce pension outlays significantly, since 
nominal wages have increased substantially in recent years. 
MPs have also debated technical tweaks to the pension bill 
that would increase payroll taxes and bolster the overall 
Pension Fund, 30 percent of which is to be financed by the 
2009 budget (Ref A). 
 
External Financing 
------------------ 
 
¶8.  (SBU) To date, only $500 million, via a World Bank 
Development Policy Loan (DPL), has been offered by 
international donors to help Ukraine finance its budget 
deficit this year.  No other donors or bilateral lenders have 
come forth to cover the remaining $2.1 billion the IMF says 
Ukraine will need.  The World Bank DPL is scheduled for 
disbursement in summer 2009, and it comes with strings (known 
as "structural measures") attached:  The GOU must a) pass a 
public procurement law, b) increase support for the poorest 
of Ukraine's citizens through a World Bank-approved pension 
targeting mechanism, c) place a floor on infrastructure 
funding, and d) pass legislation to improve Ukraine's 
business environment. 
 
¶9.  (SBU) PM Tymoshenko has appealed to the World Bank to 
move up the disbursement date of the DPL.  However, according 
to Saavedra, World Bank President Robert Zoellick told 
Tymoshenko on February 20 that the $500 million DPL would 
only be disbursed in mid-2009, and only if the GOU adhered to 
IMF conditionalities and implemented World Bank-proposed 
measures.  Tymoshenko reportedly requested additional budget 
support beyond the World Bank's current pledge.  Zoellick 
responded by saying that needed structural measures are still 
unmet by the GOU, so it is too early to talk about any 
further loan program.  World Bank officials have stated that 
they welcome using the DPL as a "platform" for other donors. 
 
¶10.  (C) Even the Russian bilateral loan (Ref B) now looks to 
be in trouble.  The IMF's Alier commented to us that the 
Russians will not lend money to Ukraine, because they have 
huge problems at home and Ukraine will not accept Russian 
political conditionalities.  At the rate Russia is burning 
foreign exchange to prop up the ruble, it will be out of 
reserves in less than a year, Alier said. 
 
¶11.  (C) Separately, Ukrainian Ministry of Foreign Affairs 
official Andriy Nadzhos told Econoff that although the "zero 
option" (on Soviet-era assets and liabilities -- see below) 
was the only conditionality formally on the table from 
Moscow, he suspected Russia would gain significant political 
leverage and "greater access to economic assets" if a deal 
were to go through.  Nadzhos had learned from contacts at 
Ukraine's Justice Ministry that the bilateral loan deal was 
being held up on the Russian side.  Apparently, Ukraine's 
Justice Ministry has requested from Moscow records of total 
Soviet-era assets abroad before it agrees to revert control 
of these assets to Russia in exchange for Moscow paying 
vestigial Soviet-era debts.  Ukraine seeks to verify whether 
its share of Soviet-era external property exceeds Ukraine's 
proportion of Soviet-era debt.  Moscow has thus far refused 
to provide the requested information. 
 
¶12.  (C) In lieu of a bolstered World Bank program or Russian 
bilateral support, the IMF has increasingly weighed in with 
Kyiv-based G7 ambassadors to help Ukraine cope with its 2009 
budget deficit.  IMF chief envoy Ceyla Pazarbasioglu has told 
the Ambassador and his G-7 colleagues on numerous occasions 
that Ukraine cannot cover its budget deficit without external 
financing.  She has also given her blessing for PM Tymoshenko 
and President Yushchenko to reach out to foreign countries 
for additional support. 
 
¶13.  (C) If the remaining $2.1 billion is not forthcoming 
from bilateral or multilateral donors, the IMF will expect 
Ukraine to take further difficult fiscal measures to rein in 
the budget deficit.  Besides the IMF and World Bank-proposed 
 
KYIV 00000360  003 OF 003 
 
 
menu options for cutting spending and/or increasing revenues, 
Alier told us that "monetizing debt is the most unacceptable 
option, given that inflation would immediately take off." 
 
On the IMF Coming Back 
---------------------- 
 
¶14.  (C) Alier said he expects that the IMF mission, 
previously slated to return this week, will eventually come 
back, but he cautioned that Ukraine still needs to take 
concrete steps before that will happen.  He pointed out that 
the pension bill had not been voted upon, the excise bill had 
not been forwarded by the GOU, bank recapitalization and 
restructuring measures remained in draft form at the National 
Bank, and a mandatory joint declaration (by PM Tymoshenko, 
President Yushchenko, and Speaker Lytvyn) was mired in 
acrimonious politics.  (Note: On February 20, Yushchenko 
signed a 13 percent import tariff into law, in what appears 
to be a violation of WTO rules and IMF continuing performance 
criteria (Ref C).  As of February 24, Alier told us he still 
had not received official comment from IMF headquarters on 
the tariff law, which may further complicate Ukraine's IMF 
program.  End note.) 
 
Comment 
------- 
 
¶15.  (C) Although it appears Ukraine's IMF program will 
remain stuck in the coming days, we continue to expect 
Ukraine's leaders to take joint actions that have been 
expressed as mandatory preconditions for further 
international donor engagement.  In the event Ukraine shows 
it will move to implement IMF prior actions and World Bank 
structural reforms, the USG should team up with the EU, IMF, 
and the World Bank to establish an emergency loan facility 
for Eastern Europe that will allow Ukraine and other 
threatened countries to meet external financing and budget 
obligations.  We encourage continued outreach with European 
partners to develop a joint response to Ukraine's economic 
crisis, recognizing that failing banks, falling currencies, 
and possible large-scale defaults in Eastern Europe are an 
imminent threat to the European banking and business 
communities.  EBRD President Thomas Mirow told the Ambassador 
on February 16 that the issue of a regional response may be 
raised at the next ECOFIN meeting on March 10.  USG views on 
a regional plan will be useful prior to that meeting.  End 
comment. 
TAYLOR