VZCZCXRO6672
OO RUEHIK RUEHLN RUEHPOD RUEHVK RUEHYG
DE RUEHKV #1959/01 2760453
ZNR UUUUU ZZH
O 020453Z OCT 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6433
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 02 KYIV 001959 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/UMB, EB/OMA 
TREASURY PLEASE PASS TO TTORGERSON 
 
E.O. 12958: N/A 
TAGS: EFIN ECON XH UP
 
SUBJECT:  UKRAINE SNEEZES, HAVING CAUGHT THE GLOBAL ECONOMIC COLD 
 
SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION 
 
¶1.  (SBU)  Summary.  Despite Ukraine's expansion in trade and 
industry over the past several years, the global financial crisis 
has generated knock-on effects, potentially harming the country's 
economic prospects.  In contrast to the first quarter of 2008, when 
analysts pointed to risks of rampant credit growth and an overheated 
economy, senior government officials, national bankers, and private 
financiers are now seeking to mitigate Ukraine's susceptibility to 
external shocks.  Negative trends show that Ukraine may not be 
impervious to contagion after all.  End Summary. 
 
Immune Altogether... 
-------------------------- 
 
¶2.  (SBU)  Ukraine has had a strong run, with bullish consumption, 
credit availability doubling annually over the past five years, and 
strong profits from export commodities.  The National Bank of 
Ukraine (NBU) amassed foreign currency reserves of $38 billion, and 
sustained real GDP growth and investment profits made Ukraine an 
attractive capital destination, prompting some to assert that the 
economy, together with other emerging markets, was "decoupled" from 
its neighbors' more volatile business cycles. 
 
...Or Suffering from Contagion? 
--------------------------------------- 
 
¶3.  (SBU)  Macroeconomic trends are now rapidly reversing.  Ukraine 
received $5.5 billion in FDI during the first half of 2008, but a 
slowdown in financial inflows is expected to affect both banks and 
the diminutive stock market.  Over 80 percent of investors on the 
illiquid and insider-controlled Kyiv stock exchange (known as the 
PFTS) are foreign funds that have sold shares to cover losses in 
other markets.  The sell-off caused the PFTS index to fall a record 
14.1 percent on September 16, 2008; it is down more than 68 percent 
for the year after gaining 130 percent in 2007.  The precipitous 
rise and fall of the PFTS highlight risks in a CIS-region market, 
where investors are vulnerable to low volumes and chronic valuation 
swings. 
 
¶4.  (SBU)  Aggressive borrowing and lending practices that had 
fueled higher imports, corporate investment, and household spending 
-- on everything from apartments to automobiles to apparel -- are 
now seen as hazardous.  Banks are hustling to roll over maturing 
external debt (no precise data is available, but in the range of 
$25-30 billion), as well as curtail the financial effects of a 
projected $22 billion current account shortfall in 2009 (an 
estimated 9.8% of 2009 GDP, according to the IMF).  A September 
29-30 bailout of Prominvest Bank may be a harbinger of things to 
come.  The Kyiv-based institution received an NBU injection of $200 
million and a credit line of up to $1 billion, after 30 percent of 
its deposits were wiped out in a run.  Ukraine's foreign banks and 
corporate investors are scrutinizing their risk exposure, as roughly 
70 percent of the country's external banking debt (i.e. $9-10 
billion) is owed to parent financial institutions, mostly located in 
Europe.  One banking analyst told EconOff that liquidity shortages 
may lead to a collapse in the equity and asset markets, with high 
default rates in the urban housing sector to result.   Even the 
Association of Ukrainian Banks, an industry lobbyist, expressed 
concern to its members about recent data on credit quality and the 
potential for a sharp reduction in foreign capital. 
 
Currency, Ratings, and Terms of Trade 
--------------------------------------------- -- 
 
¶5.  (SBU)  The NBU has not intervened in the recent sell-off of the 
hryvnia (UAH), which has fallen significantly in recent weeks.  At 
currency booths in Kyiv, the exchange rate reached 5.04-5.11 UAH to 
the dollar, exceeding the NBU's established corridor (4.85 UAH to 
the dollar, +/- 4 percent).  If declines worsen, the NBU might still 
aggressively defend its band, but ICPS -- a respected Kyiv think 
tank -- has concluded that to be an unlikely scenario. 
 
¶6.  (SBU)  Standard and Poor's rating agency has reported that the 
dissolution of the Ukrainian parliamentary coalition will not affect 
the country's sovereign rating.  But Fitch recently adjusted 
Ukraine's outlook to negative, and local experts believe domestic 
and regional instability will decrease confidence in the Ukrainian 
economy, tightening credit and further threatening the country's 
economic health.  Ukraine's sovereign spreads, according to J.P. 
Morgan, recently reached as high as 868 basis points, relative to 
the Emerging Markets Bond Index. 
 
¶7.  (SBU)  Analysts unanimously agree that the Ukrainian current 
account deficit will increase in 2009, with higher energy and lower 
 
KYIV 00001959  002 OF 002 
 
 
commodity prices affecting industries that comprise roughly 50 
percent of exports.  A leading private equity firm estimates that 
Russian imported gas prices will rise in 2009 from $180 to roughly 
$360 per 1,000 cubic meters, adding about $8 billion to the current 
account deficit.  Relying on Russian fuel imports for 
energy-intensive manufacturing, Ukraine's terms of trade will also 
be adversely affected by lower global prices for metals and 
chemicals. 
 
¶8.  (SBU)  A dismantled Tymoshenko-Yushchenko coalition in 
parliament (Verhovna Rada) has made matters worse.  Public sector 
wages, increasing beyond productivity and inflation growth, have 
contributed to a decline in the real exchange rate and may 
contribute to a wage-price spiral.  Necessary fiscal discipline 
requires consensus in the Rada, as well as political will on budget 
matters from top echelons in the government.  Neither appears 
forthcoming in the midst of general political paralysis.  Continuing 
uncertainty about the likelihood of a third set of snap 
parliamentary elections in as many years and the seeming inability 
of Tymoshenko and Yushchenko to put national interests before 
political gaming only increases the growing mood of cynicism. 
 
¶9.  (SBU)  Comment:  Bankers and think tankers, having observed 
trends in Ukraine since the 1990s, are reluctant to use the term 
"crisis" to define Ukraine's current macroeconomic climate.  But, by 
every standard, the country's markets have entered into a period of 
instability, likely caused by the global financial slowdown and 
domestic political troubles.  External vulnerabilities and sagging 
investor confidence could be a double blow to the economy, as 
Ukraine needs foreign direct investment to sustain growth and shore 
up the current account deficit.  It is wishful thinking to assume 
that today's Ukraine is immune from the doleful effects of 
contagion.  End Comment.