VZCZCXRO8027
PP RUEHDBU RUEHIK RUEHLN RUEHPOD RUEHSK RUEHSL RUEHVK RUEHYG
DE RUEHKV #1602/01 2601339
ZNR UUUUU ZZH
P 171339Z SEP 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 8422
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE

UNCLAS SECTION 01 OF 03 KYIV 001602 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/UMB, EEB/OMA 
 
E.O. 12958: N/A 
TAGS: EFIN EREL ELAB ECON ETRD PGOV PREL XH UP
SUBJECT:  TYMOSHENKO'S CONTROVERSIAL 2010 BUDGET 
 
SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION 
 
¶1.  (SBU) Summary: Ukrainian Prime Minister Yulia Tymoshenko's draft 
2010 budget projects a deficit equivalent to 4% of GDP (exclusive of 
funds for bank recapitalization) and contains moderate increases in 
social spending, as well as provisions for transfers to economic 
sectors hit by the country's current crisis.  The most profound 
change is a technical mechanism that would allow transfers of funds 
directly from central authorities to local, city-level governments, 
bypassing oblast-level governors, who are subordinate to the 
President.  President Yushchenko is unlikely to approve this 
provision.  The current political standoff in the Rada (Ukraine's 
parliament) may preclude final passage of the draft budget before 
the January 1 due date.  Even if it mustered enough support in the 
Rada, the budget likely would be amended after the January 2010 
presidential elections.  End summary. 
 
BUDGETARY PARAMETERS 
-------------------- 
 
¶2.  (SBU) The draft budget provides for revenues of UAH 284.8 
billion and expenditures of UAH 324.3 billion, equaling annual 
increases of 19% and 20.6%, respectively.  The upper limit for the 
deficit is projected by the GOU to be UAH 46.7 billion (roughly $5.6 
billion) or 3.97% of GDP, a figure within the IMF's required target. 
 Nonetheless, this amount could become a source of controversy, as 
President Yushchenko had called on the government to limit the 2010 
budget deficit to 3% of GDP. 
 
¶3.  (SBU) The proposed budget would transfer UAH 17.9 billion to 
cover the Pension Fund's 2010 deficit, an increase over the UAH 13 
billion allocated for this purpose in 2009.  It also foresees that 
Ukraine would repay UAH 31.7 billion in external debt. 
 
¶4.  (SBU) The budget's proposed subsidy for Naftohaz, covering the 
differential between the cost of Russian gas and the price afforded 
to Ukrainian residential consumers, is UAH 6.52 billion.  This 
amount is lower than the UAH 7.7 billion that was ultimately 
approved for Naftohaz in 2009 through a March 11 Cabinet of 
Ministers' resolution, but higher than original 2009 budget figures 
of UAH 1.6 billion. 
 
¶5.  (SBU) In addition to core spending, the GOU has also accounted 
for expected increases in financing needs for bank recapitalization, 
equal to UAH 50.5 billion.  This amount is expected to cover 
recapitalizations for an undisclosed number of top Ukrainian 
domestic banks, as well as provide "top-off" money for previously 
nationalized banks that have suffered further deterioration of their 
loan portfolios.  (Note:  As in 2009, when UAH 18.6 billion was 
transferred from bank recapitalization funds to Naftohaz via 
treasury bills, the GOU considers money set aside for bank 
recapitalization to be fungible.  The IMF did not include bank 
recapitalization funds in its estimate of the GOU's 2009 core budget 
deficit, a position it will likely adopt in 2010.  End note.) 
 
PLUGGING THE GAP 
---------------- 
 
¶6.  (SBU) In order to finance the 2010 budget deficit, the GOU would 
rely on record levels of domestic borrowing -- up to UAH 104 billion 
($12.4 billion), a figure that may prove unrealistic, given the slow 
revival of the domestic bond market.  There are also concerns that 
National Bank of Ukraine (NBU) purchases of domestic treasury bills 
would become the primary source of debt financing, a move that would 
increase inflationary pressures.  The government plans foreign 
borrowings at the comparatively low amount of UAH 15 billion ($1.8 
billion), yet even this may turn out to be wishful thinking, given 
Ukraine's current inability to access external financing.  The GOU's 
revenue target for privatizations is an ambitious UAH 10 billion 
($1.2 billion).  However, the GOU's active efforts to privatize 
Odessa Portside Plant, several regional power distribution companies 
(the so-called "oblenergos"), and Ukrtelecom, may mean these 
revenues could materialize. 
 
OPTIMISTIC MACRO ASSUMPTIONS 
---------------------------- 
 
¶7.  (SBU) The draft budget foresees 2010 GDP growth at 3.76% and 
inflation at 9.7%.  Rada budget committee and Our Ukraine faction 
member Pavlo Zhebrivskiy commented that a 3% growth figure would be 
more realistic, with prospects dim for an uptick in the critical 
chemical production sector.  Zhebrivskiy also said that inflation 
would likely reach 12-13%, as the GOU plans to impose higher 
residential gas rates, per the IMF agreement. 
 
¶8.  (SBU) Local analystQhave focused on the GOU's "overly 
optimistic" exchange rate assumptions of UAH 7.5/$1.  The hryvnia 
 
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has faced nothing but downward pressure of late and currently is 
being traded at around UAH/USD 8.4-8.5.  Furthermore, most corporate 
foreign debt due in 2009 was rolled over to 2010, suggesting that 
demand for dollars will remain high and depreciation pressures for 
the hryvnia will continue.  Using a more realistic exchange rate 
translates into increased government expenditures, especially for 
gas and foreign debt payments, perhaps pushing the 2010 budget 
deficit well above 4%. The average price for imported Russian gas 
projected in the budget is $260 per thousand cubic meters (tcm). 
(Comment:  Oil prices would need to fall in 2010 for this figure to 
be a realistic forecast.  The 2009 average price will be 
approximately $230/tcm, though Ukraine received 20% off the base gas 
price in 2009, per the January 2009 gas contracts.  Without that 
discount, the average price in 2009 would have been roughly 
$288/tcm.  End comment.) 
 
SOCIAL SPENDING 
--------------- 
 
¶9.  (SBU) The draft budget contains a 16% increase in the minimum 
wage and a 7% increase in the minimum pension, both of which would 
be implemented gradually during the course of the year.  It also 
provides 20% wage increases for education and public healthcare 
workers.  Still, these increases have been criticized by Viktor 
Yanukovich-led Party of Regions (PoR) as too little.  PoR has been 
pushing its plan to significantly increase social spending (between 
UAH 8-40 billion), a move blocked by Tymoshenko's BYuT and others. 
 
 
ECONOMIC DEVELOPMENT 
-------------------- 
 
¶10.  (SBU) The draft budget would expand Ukraine's economic 
development fund, known as the stabilization fund, raising it from 
UAH 19.9 billion in 2009 to UAH 27 billion for 2010, though this 
line item has long been criticized as non-transparent and a tool for 
"manual management" of budgetary resources.  Analysts tell us that 
revenue sources for the stabilization fund are also questionable, as 
UAH 19.6 billion or 1.7% of GDP would be transferred via borrowing 
and privatization. 
 
¶11.  (SBU) Stabilization fund expenditures would be allocated to 
Euro 2012 infrastructure projects (UAH 6.69 billion), public housing 
(UAH 1.15 billion), agriculture support (UAH 3.38 billion), and 
military equipment purchases (UAH 3.38 billion).   In addition to 
funding economic development programs via the stabilization fund, 
the GOU would also use budget resources to support the coal industry 
to the tune of UAH 21.6 billion ($2.6 billion), a figure that is 
nearly twice the value of the annual output of all state-owned 
mines.  This proposal has been roundly criticized for heightening 
structural imbalances in Ukraine's coal sector. 
 
LOCALITIES AFFECTED 
------------------- 
 
¶12.  (SBU) The proposed budget would alter the way in which the 
central government would transfer funds to local budgets.  According 
to the draft budget, the central government and localities would 
bypass the 26 oblast-level governors, who are subordinated to the 
President, in favor of direct communication between localities and 
the Cabinet of Ministers, who would be the ultimate arbiters of all 
budgetary transfers.  This proposal has raised eyebrows in Kyiv, 
particularly regarding the technical capacity of over 12,000 cities, 
towns, and villages to manage increased accounting responsibilities. 
 Moreover, President Yushchenko will likely be adamantly opposed to 
the change, as it would strip his appointed governors' ability to 
allocate and distribute resources.  Reportedly, the IMF also views 
this proposed reform with skepticism, considering that it has been 
hastily and improperly prepared by the government. 
 
RADA (AND BUDGET) BLOCKED 
------------------------- 
 
¶13.  (SBU) Yanukovich has announced that the PoR will continue to 
block the Rada from voting on the 2010 budget until the 2009 budget 
is amended to increase social spending.  Taking the PoR's indefinite 
blockage together with controversial elements of the proposed 2010 
budget, most observers believe Tymoshenko's fiscal program has 
little chance of approval.  Deputy Head of the Presidential 
Secretariat Oleksandr Shlapak described the budget as being full of 
"pseudo reforms" and consisting of "election promises, trickery, and 
cowardice."  Furthermore, analysts project that even if the proposed 
budget were adopted, Ukraine's new president would likely be forced 
by fiscal imbalances to initiate significant amendments. 
 
¶14.  (SBU) If the 2010 budget is not adopted by December 31, monthly 
budget allocations will be funded at one-twelfth of 2009 
 
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allocations.  This would provide the GOU significant discretion to 
manage expenditures, since the monthly allocations would be 
distributed to the state treasury in bulk.  Nonetheless, Tymoshenko 
has announced that the Cabinet of Ministers will draft a separate 
resolution on the implementation of an interim 2010 budget if the 
proposed budget is not passed.  Observers have expressed concern 
that Tymoshenko would use a Cabinet resolution to ram through the 
new rules on direct transfers to localities, even if President 
Yushchenko ultimately vetoed the 2010 budget based on his opposition 
to that provision. 
 
COMMENT 
------- 
 
¶15.  (SBU) The IMF appears to have been supportive of Tymoshenko's 
draft 2010 budget, perhaps because the GOU continues to promise an 
increase in gas prices for residential customers, which the IMF has 
said could provide an extra 1% of GDP in revenue in 2010.  Whether 
Tymoshenko will fulfill her pledge to the IMF to raise household gas 
prices just prior to the formal launch of her presidential campaign 
and at the beginning of winter heating season is yet to be seen. 
 
¶16.  (SBU) Possible increases in domestic gas prices 
notwithstanding, the IMF will still need to push for pension and 
other social spending reform, given the limited availability of 
domestic and external financing and the possibility that 
privatization revenue may not be forthcoming.  Yet, with the 
election season fast approaching and little success to date on these 
goals, we are not optimistic about the prospects for serious pension 
reform this year, even with IMF insistence. 
 
PETTIT