VZCZCXRO5926
PP RUEHDBU RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #0692/01 1121322
ZNR UUUUU ZZH
P 221322Z APR 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7687
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY

UNCLAS SECTION 01 OF 04 KYIV 000692 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: OVIP PGOV ECON PREL UP
SUBJECT: SCENESETTER FOR THE VISIT OF DEPUTY SECRETARY 
STEINBERG AND SENIOR DIRECTOR LIPTON 
 
Summary 
-------- 
 
¶1. (SBU)  Your April 26-28 visit to Kyiv comes in the midst 
of Ukraine's unfolding economic and financial crisis.  The 
IMF has recently concluded its mission review, recommending 
disbursement of a second loan tranche that had been delayed 
for two months.  The agreement with the IMF is a major 
accomplishment for Ukraine's authorities, the Prime Minister 
in particular, who managed to pass legislation and issue 
resolutions to cut the fiscal deficit.  Nevertheless, there 
remains significant work on bank recapitalization and 
resolution, each necessary to prevent a deeper than nine 
percent GDP economic downturn that is now foreseen by the 
World Bank. 
 
¶2.  (SBU)  Complicating resolution of economic issues, 
political relations between the president and prime minister 
have remained dysfunctional.  Some effort has been made 
recently to appear more coordinated - the March 23 gas 
conference hosted by the European Commission seems to have 
ushered in a new era of trying to keep up appearances, and 
the mood seems to have been extended by the need to meet IMF 
conditionalities on delivery of further tranches. 
Nevertheless, the political situation remains the driver of 
daily Ukrainian policy making, as the leading political 
blocks and their leaders jockey for position in upcoming 
presidential elections. Further complicating the political 
situation, the Prime Minister and leader of the opposition 
are negotiating to form a new, broad coalition that would 
push through major constitutional changes. 
 
¶3.  (SBU) Ukraine's relationship with Russia has remained 
tense and complicated.  Since the August 2008 Georgia-Russia 
conflict, Ukrainian perceptions of the potential security 
threat presented by Russia have come into greater focus, 
particularly against the backdrop of continuing opposition by 
some NATO members to MAP status for Ukraine.  Changing U.S. 
policy toward Moscow has led to speculation that the U.S. has 
softened its support of Ukraine as the price of improving 
U.S.-Russia relations. End Summary. 
 
Major Themes 
------------- 
 
¶4. (SBU) We see the opportunity with your visit to convey the 
following themes to Ukrainian interlocutors: 
 
-  Economic: The agreement with the IMF is a major 
accomplishment, but you cannot rest on these laurels.  In 
particular, a great deal of work remains to be done to get 
the banking sector out of the deep hole you are still in. 
 
-  Political:  The political squabble between the President 
and Prime Minister was affordable when the economy was 
growing at seven percent annually.  It is totally 
unaffordable when facing a severe economic decline.  Yes, 
your constitution needs to be amended.  But the international 
community can only support you if the amendment process 
follows your constitution, is democratic, and is broadly 
accepted by Ukrainians. 
 
-  Political/Security: The Obama Administration strongly 
supports Ukraine.  Our desire to reinvigorate our 
relationship with Russia does not require a change in our 
orientation toward Ukraine.  We reject zero-sum arguments 
that we can pursue positive relations with one, but not both. 
 Decisions regarding the pursuit of membership in NATO are up 
to Ukraine.  The U.S. has supported and will support your 
decision.  NATO's door remains open to Ukraine, but NATO does 
not drag countries into the Alliance against their own will. 
 
-  Energy/EU:  You need to follow through on reforms agreed 
on with the EU on March 23 in the energy sector. 
 
 
IMF Relations and Economic Challenges 
---------------------------------------- 
 
¶5. (SBU) The IMF mission team recently concluded its review 
of Ukraine's progress under the Fund's October 2008 Stand-By 
Arrangement.  Disbursement of the IMF's second loan tranche 
had been delayed since mid-February, due to an unfinanced 
budget deficit of roughly 5 percent of GDP (roughly $6.25 
billion) and a lack of progress on bank recapitalization.  In 
recent weeks, the Rada has taken measures to raise excise 
taxes on tobacco and alcohol, but when it failed to pass 
legislation on April 14 that would have made modest cuts to 
pensions and reduced Natohaz's budget deficit, the Cabinet of 
Ministers stepped in with 19 resolutions that aim to provide 
 
KYIV 00000692  002 OF 004 
 
 
the fiscal discipline called for by the IMF.  The action was 
clearly prepared long before the Rada vote, and appears to 
have had the full support of the IMF, which has indicated 
that it will accept the resolutions in lieu of laws.  The IMF 
looks set to disburse its second tranche after the Fund's 
board meets in mid-May, and it has indicated it would 
increase the tranche from $1.87 to $2.8 billion, with $1.4 
billion devoted to the budget gap. 
 
¶6. (SBU) The IMF's decision to provide budget support -- 
taken together with Rada-backed excise taxes, CabMin 
resolutions, and expected funds from a $500 million World 
Bank DPL loan -- do not fully cover Ukraine's expected 2009 
budget deficit.  With the blessing of the IMF and the World 
Bank, Ukraine continues to request budget support from the 
United States, the European Union and other key states, 
Russia, Japan, China, and Saudi Arabia.  Thus far, no 
bilateral budget support has been forthcoming.  Deputy Prime 
Minister Hryhoriy Nemyria is expected to actively follow-up 
on this request during his trip to the United States for the 
IMF and World Bank spring meetings on April 22-27. 
Immediately following your visit to Ukraine, Prime Minister 
Yulia Tymoshenko will travel to Moscow to call for Russian 
bilateral budget assistance.  She is also expected to raise 
the matter with German Chancellor Angela Merkel on April 30, 
when the two reportedly will meet in Warsaw on the margins of 
European People's Party Congress. 
 
¶7. (SBU) As analysts project that Ukraine's GDP will decline 
at least 9 percent in 2009, stresses on the banking sector 
have mounted, causing the IMF and World Bank to call for 
urgent reforms.  A bank recapitalization unit has been 
recently established in the Ministry of Finance, and initial 
plans have been made for a problem bank unit at the NBU to 
oversee bank resolution.  Although only a nascent regulatory 
framework has been developed for either, the GOU has proposed 
seven domestic banks to receive initial recapitalization 
funds by May 1.  The GOU will likely move to write down 
existing shareholders with current regulatory power, but the 
basis to do so is weak and could be challenged in court.  The 
GOU plans to effectively nationalize the banks it 
recapitalizes by taking majority stakes.  Foreign bankers 
have told us that they expect shareholders of parent banks in 
Europe, Russia, and the United States to fully finance their 
recapitalization costs.  Despite concerns of deleveraging, we 
have not heard that any foreign-owned banks are seriously 
contemplating pulling up stakes. 
 
 
Renewed Orange Coalition Falters Again 
-------------------------------------- 
 
¶8.  (SBU) Orange Revolution allies Viktor Yushchenko and 
Yuliya Tymoshenko united forces following an unexpectedly 
strong showing by Tymoshenko's political bloc (BYuT) in the 
September 2007 pre-term parliamentary elections.  They formed 
a coalition and established a government in late 2007 with 
Tymoshenko as Prime Minister.  Many hoped that they would 
work together better than they had in 2005, when Yushchenko 
dismissed Tymoshenko after seven months of infighting.  In 
early September 2008, following a string of mutual 
recriminations, Yushchenko's Our Ukraine-People's Self 
Defense bloc (OU-PSD) pulled out of its coalition with 
Tymoshenko's parliamentary faction. 
 
¶9. (SBU) The split between Yushchenko and Tymoshenko was 
finalized on October 8, when the President dissolved the Rada 
and called pre-term elections. PM Tymoshenko opposed the 
decision to call pre-term elections, citing the unfolding 
domestic economic crisis as requiring political continuity 
and stability.  Tymoshenko successfully delayed preparations 
for early elections, which required the passage of laws in 
parliament both on administering and funding the vote, while 
cobbling together a new coalition. The new coalition 
announced on December 9, thereby avoiding early elections, is 
comprised of the PM's bloc, Rada speaker Volodomyr Lytvyn's 
bloc and a majority of the now fractured former 
pro-presidential OU-PSD bloc.  The new coalition, on paper a 
majority of MPs, has struggled to pass legislation in the 
Rada and has often had to turn to the non-coalition 
Communists to successfully push forward its agenda. 
 
Moving Toward Elections - and a new constitution? 
-------------------------------------------- 
 
¶10. (SBU) In the latest salvo in the ongoing feud between 
Tymoshenko and Yushchenko, the PM's coalition joined with the 
opposition Party of Regions and the Communists to set October 
25 as the date for the next presidential election, rather 
than a date in December or January as expected.  Yushchenko 
 
KYIV 00000692  003 OF 004 
 
 
has challenged the Rada's decision in the Constitutional 
Court, calling the Rada's legal justification for October 25 
deeply flawed.  However, the President has said that he would 
agree to the earlier date if simultaneous early Rada 
elections were also held.  There is no obvious legal 
justification for pre-term parliamentary elections. 
Tymoshenko and the coalition are against simultaneous 
elections.  BYuT and Regions are attempting to negotiate an 
entirely new coalition that would seek broad Constitutional 
changes in the near term that would have the president 
elected in the parliament, and establish a full parliamentary 
republic. 
 
¶11. (SBU) Tymoshenko, Yushchenko, and opposition head and 
former PM Yanukovych are all likely candidates for the 
presidential election.  Recent polls show that Tymoshenko and 
Yanukovych are the likely contenders in a presidential 
runoff.  Arseniy Yatsenyuk, the young liberal former Rada 
speaker and foreign minister, is considered a credible 
challenger to Yanukovych and Tymoshenko, and has announced 
that he intends to run for president.  Yushchenko, whose 
popularity polls in the low single digits, is not expected to 
be a serious contender and some observers speculate that he 
may not even run.  Polls also show that voters are 
disillusioned with the political process, which could lead to 
low voter turnout, or an increase in protest voters. 
 
Ukraine's Security Concerns 
--------------------------- 
 
¶12. (SBU) Ukrainian perceptions of potential security threats 
have sharpened since the August 2008 Georgia-Russia conflict. 
 These sensitivities are set against doubts about whether 
NATO will ever allow Ukraine Membership Action Plan (MAP) 
status. For the most part Ukrainian officials remain 
committed to pursuing Euro-Atlantic integration.  How long 
they will continue to do so in the face of the continuing 
lack of Ukrainian public support (at only about 25%) for NATO 
membership is not clear.  Many of our interlocutors have 
questioned whether "the reset button" signals a departure 
from our policy of strong support for Ukraine's western 
orientation, including its Euro-Atlantic integration. 
 
¶13. (SBU)  The August conflict and Russian occupation of 
Georgian territory, and Russia's subsequent recognition of 
Georgia's breakaway regions, has raised specific worries 
about Russian intentions toward Crimea, and whether Russia 
intends to pursue a "South Ossetia strategy" in this 
autonomous Ukrainian region.  A lack of progress in regular 
negotiations regarding the Black Sea Fleet has exacerbated 
these suspicions.  Rumors continue to circulate that Russia 
is issuing passports in Crimea; however, facts do not seem to 
bear this out.  President Yushchenko has taken a strong 
position rejecting Russian actions in Georgia. Ukraine will 
not recognize the independence of either breakaway region. 
Ukraine does not intend to change its policy allowing arms 
sales to Georgia, and intends also to continue Ukrainian 
participation in the UN Observer Mission in Georgia (UNOMIG). 
Despite the officially strong solidarity with Georgia from 
Yushchenko, officials occasionally lament that Saakashvili's 
actions in August have caused discord in Ukraine-Russia 
relations. 
 
¶14. (SBU) The non-extension of the Strategic Arms Reduction 
Treaty (to which Ukraine is a party) has become a concern in 
the context of aggressive Russian rhetoric. Speaker Lytvyn 
and MFA officials have raised with us the need for a new 
security guarantee for Ukraine. To this end, Prime Minister 
Tymoshenko called for greater Ukrainian participation in the 
European Security and Defense Policy (ESDP) at this year's 
security conference in Munich.  Russian foot-dragging on 
border demarcation and Russian unwillingness to engage in a 
meaningful way through normal bilateral commissions or 
working groups have also served to increase the level of 
general concern in the GoU regarding the extent of Ukraine's 
strategic exposure. Ukrainian officials view Russia's 
parallel "one plus two" process on Transnistria settlement 
discussions as detrimental to the internationalized 5 2 
process, and also to Ukraine's interests. 
 
¶15. (SBU) Some prominent political figures seem already to 
have decided that the prudent course lies closer to Moscow in 
today's strategic environment.  For example, Rada Speaker 
Lytvyn, who has in the past favored neutrality over NATO 
membership, recently asserted that the answer to Ukraine's 
problems of funding and building a reliable navy is to 
request that the Russian Black Sea Fleet protect Ukrainian 
naval interests. 
 
¶16. (SBU) Prime Minister Tymoshenko has maintained an 
 
KYIV 00000692  004 OF 004 
 
 
understated approach on NATO membership, and has focused her 
public commentary instead on increasing Ukraine's ties to the 
EU, including her statement at the Munich Security 
Conference. 
 
Energy 
------ 
 
¶17. (SBU) In January 2009, PM Tymoshenko and Russian PM Putin 
signed controversial supply and transit contracts ending the 
crisis that saw gas shutoffs to EU Member States, and taking, 
in some ways, a step toward transparency.  The contracts 
remove controversial gas intermediary RosUkrEnergo (co-owned 
by Russian's Gazprom and Ukrainian oligarch Dymtro Firtash), 
and established a fixed formula for determining the price of 
imported gas.  However, the transit price charged to Russia 
remains below market levels, and, while Ukraine is subject to 
take or pay provisions in the supply contract, Russia is not 
subject to similar provisions in the transit contract.  The 
price for Russian gas sold to Ukraine will be $270 per 
thousand cubic meters (tcm) beginning in second quarter 2009. 
 Prime Minister Tymoshenko will travel to Moscow for talks 
with Putin on April 29 at which she is expected to offer to 
negotiate an intergovernmental agreement with Moscow to 
govern the Russia-Ukraine gas relationship. 
 
¶18. (SBU) Ukraine continues to have severe domestic problems 
in its energy sector, which both undercut state oil and gas 
company Naftohaz's financial viability and prevent 
development of domestic oil and gas resources. Domestic 
natural gas prices for the general population and municipal 
heating companies are well under the import price.  State 
budget subsidies to Naftohaz aim to bridge the gap between 
the import price and the domestic consumer price, but many 
domestic consumers still fail to pay on time and in full. 
Ukraine's complicated legal procedures for exploration and 
development of oil and gas deposits dissuade foreign 
investment into the sector. 
 
¶19. (SBU) The March 23 Brussels conference aimed to bring PM 
Tymoshenko and President Yushchenko together to commit to 
reforms that would bring Ukraine's gas sector in line with 
the EU energy community treaty.  Based on the Ukrainian 
commitment to these reforms, the World Bank, the European 
Bank for Reconstruction and Development, and the European 
Investment Bank, pledged they would provide financing for the 
modernization of Ukraine's gas transit system (GTS). Ukraine 
is to provide a detailed timetable for sector reforms by the 
end of 2009 and implement the reforms by 2011, including the 
phase out of domestic price subsidies. 
 
¶20. (SBU) Ukraine's commitment to reform in the energy sector 
is yet to be seen.  While Tymoshenko and Yushchenko provided 
a unified voice in Brussels, their cooperation has flagged 
since returning to Kyiv.  Moreover, the steps Ukraine will 
have to take to implement the reforms required by the EU and 
the IFIs will be hard for Ukraine to swallow, especially in 
the midst of its economic crisis. 
 
TAYLOR