VZCZCXRO7459
RR RUEHDBU RUEHSL
DE RUEHKV #1984/01 3171341
ZNY CCCCC ZZH
R 131341Z NOV 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 8810
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 001984 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR, EUR/UMB, EEB/OMA 
 
E.O. 12958: DECL: 11/12/2019 
TAGS: EFIN EREL ETRD PGOV PINR UP XH
SUBJECT: WAKING UP TO UKRAINE'S FISCAL NIGHTMARE 
 
REF: A. KYIV 1982 
     ¶B. KYIV 1981 
     ¶C. KYIV 1916 
 
Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and 
(d) 
 
¶1.  (C) Summary.  Payment delays have begun in Ukraine's 
regions and will get much worse in December 2009.  January 
and February 2010 will be even darker, with no near-term 
causes for optimism in sight.  Analysts from the IMF, World 
Bank, and EBRD ominously predict that, while social payments 
will continue (albeit unevenly) and the December 7 gas bill 
will likely be met, Ukraine's voting populace will be in for 
a rude awakening when the state treasury is drained.  Public 
enmity will be concentrated at Prime Minister Tymoshenko, who 
has few apparent options left to avoid fallout from the 
budget crisis.  End summary. 
 
UKRAINE IN SURVIVAL MODE, SAYS IMF 
---------------------------------- 
 
¶2.  (C) The IMF's Kyiv-based budget expert Igor Shpak 
confirmed that Ukraine was essentially broke.  Ministry of 
Finance plans to covert IMF Special Drawing Rights (SDRs) on 
November 13 were a last ditch effort to "survive" through 
November 2009 and make the December 7 gas payment.  Shpak 
indicated that every Cabinet of Ministers meeting now began 
with a visit from the chairwoman of the state treasury, who 
deliberated with Tymoshenko and her ministers on how to 
"manually" distribute the few remaining state resources for 
¶2009. 
 
¶3.  (C) December would be even more difficult, according to 
Shpak.  Absent an unforeseen event, the state treasury will 
be unable to make a portion of its payments.  In the IMF's 
view, there were three ways to avoid barren coffers in 
December: 1) find additional resources from the IMF; 2) beg 
or twist the arm of NBU governor Stelmakh to monetize; or 3) 
run arrears.  The first option was "very unfeasible", while 
the second was unlikely, given the acrimonious relationship 
between the NBU and the GOU. 
 
¶4.  (C) Shpak acknowledged that cutting outstanding 2009 
expenditures would be nearly impossible, since 90% of 
projected December payments were to so-called protected 
articles, such as transfers to localities, pensions, and 
entitlements.  Arrears to regional budgets were "imminent", 
Shpak said.  The IMF had already heard evidence of delayed 
payments of teachers' wages in Kyiv.  There were anecdotes of 
widespread, general arrears throughout Ukraine's regions. 
 
¶5.  (C) Increased VAT refund arrears were also likely.  The 
IMF official indicated that the GOU had been manipulating VAT 
statistics, and that proper accounting for arrears was now 
intentionally non-existent.  Shpak could not say whether the 
GOU figure of UAH 18 billion ($2.2 billion) reflected overdue 
or total VAT refund claims.  Either way, it was a figure that 
was likely to grow in the coming weeks. 
 
¶6.  (C) The IMF foresees a "nightmare" scenario in January 
and February 2010, when the GOU will encounter even worse 
payment problems.  Revenues are due to "collapse" in January, 
Shpak said.  Electoral politics surrounding the budget would 
get "very messy," he projected. 
 
¶7.  (C) In such an environment, it was unlikely the 
"incapacitated" Rada budget committee would pass the 2010 
budget.  The IMF has not ruled out the possibility that a 
last minute deal would be made among Ukraine's authorities, 
similar to the "disastrous" pact made on December 26, 2008, 
that set in motion the unsustainable 2009 fiscal deficit. 
Since target dates for the draft 2010 budget already had been 
breached, Shpak predicted the GOU continue to try to gain 
control over early 2010 expenditures with the so-called 
provisional transition budget, the Ukrainian version of a 
continuing resolution (Ref A). 
 
WORLD BANK: ARREARS INEVITABLE 
------------------------------ 
 
¶8.  (C) Admitting it was difficult to know exactly how 
Tymoshenko would spend the IMF SDRs, World Bank senior 
economist Ruslan Piotkivskiy surmised that Naftohaz would 
likely use up to the equivalent of $600 million in SDRs for 
the December 7 payment to Gazprom.  This would leave the 
 
KYIV 00001984  002 OF 002 
 
 
equivalent of $1 billion in SDRs for outstanding budget 
allocations and/or the January 7 payment (Ref B). 
Piotkivskiy opined that, if pressed, Tymoshenko would choose 
to fund social payments over gas, while working hard to free 
up money from other sources to prevent a shut-off. 
 
¶9.  (C) The World Bank's Piotkivksiy argued that the NBU had 
some room to monetize without violating its IMF-backed net 
reserve floor or significantly adversely affecting inflation. 
 Acknowledging political realities, however, Piotkivksiy said 
the NBU was unlikely to purchase government debt before the 
presidential election.  In the World Bank's view, it was 
certain a future NBU governor (appointed by the newly elected 
president) would face significant pressure to monetize the 
deficit in 2010. 
 
¶10.  (C) Piotkivskiy said Tymoshenko would try to gain 
revenues from the issuance of short-term domestic securities, 
such as those auctioned in October at a punitive interest 
rate of around 30%.  He cautioned that the domestic market 
would remain small and that yields would be driven sky high. 
Ultimately, such an auction could not be a viable substitute 
for other revenue sources. 
 
¶11.  (C) Piotkivskiy concluded that the GOU would be stuck 
with an outstanding (roughly $2 billion) deficit in December, 
after it burned through IMF SDRs and issued small amounts of 
short-term government debt.  Across-the-board arrears would 
inevitably result, likely for subsidies, transfers to local 
budgets, VAT refunds, and government goods and services. 
 
EERIE RESEMBLANCE TO 1998, SAYS EBRD 
------------------------------------ 
 
¶12.  (C) EBRD's London-based senior economist Alexander 
Pivovarskiy suggested that short-term borrowings at 
exorbitant rates could help Ukraine get through fiscal 
difficulties during the election period.  But they would put 
Ukraine in an extremely tight bind in April-June 2010, 
particularly if the IMF program remains off track or if 
international financial markets continued to be closed, 
preventing Ukraine from rolling over short-term debt.  EBRD 
director of policy studies Jeromin Zettelmeyer concurred, 
commenting that such a scenario bore an eerie resemblance to 
Ukraine's 1998 default. 
 
¶13.  (C) If there were a silver lining amidst the country's 
fiscal mess, Zettelmeyer said it was in the NBU's refusal to 
monetize government debt (Ref C).  Done for "perverse" 
reasons of political competition between Yushchenko and 
Tymoshenko, Zettelmeyer noted that blocking deployment of 
NBU's reserves had given Ukraine a heightened chance of 
escaping a devastating currency crisis. 
 
COMMENT 
------- 
 
¶14.  (C) Separate conversations with the IMF, World Bank, and 
EBRD -- institutions whose lending programs in Ukraine are on 
the shoals due to GOU non-compliance -- reveal a startlingly 
clear picture of the country's coming difficulties.  IFIs' 
portentous words of warning, combined with skittish market 
behavior, indicate that analysts are again pondering 
worst-case scenarios. 
 
PETTIT