VZCZCXRO9248
PP RUEHDBU RUEHIK RUEHLN RUEHPOD RUEHSK RUEHSL RUEHVK RUEHYG
DE RUEHKV #1611/01 2611538
ZNR UUUUU ZZH
P 181538Z SEP 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 8436
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 001611 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/UMB, EEB/OMA 
 
E.O. 12958: N/A 
TAGS: EFIN EREL ELAB ECON ETRD PGOV PREL XH UP
SUBJECT: CONCERNS ON UKRAINE'S 2009 BUDGET DEFICIT 
 
REF: KYIV 1557 
 
SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION 
 
¶1. (SBU) Summary.  Extensive government manipulation of the budget 
and coerced advance payment of corporate taxes have kept Ukraine in 
the black so far this year, but revenue from these measures is 
exhausted and the Government of Ukraine (GOU) has numerous outlays 
in the balance of the year.  Analysts project that if current 
revenue and expenditure projections remain, the GOU will face a 9.2% 
of GDP deficit, without any clear source of financing beyond (still 
uncertain) IFI loans.  In the absence of external financial support, 
analysts speculate that Kyiv authorities will rely particularly on 
monetization by the National Bank of Ukraine (NBU), since the 
ability to generate revenue in other ways is limited.  While the 
economic crisis has made local budgets more dependent on transfers 
from the central budget, oblast and municipal leaders complain that 
the Ministry of Finance is squeezing the localities by delaying 
payments.  End summary. 
 
GOU REPORTS REVEAL FALSE PARITY 
------------------------------- 
 
¶2.  (SBU) Tax and non-tax revenues for the first seven months of 
2009, according to recently released data by the GOU, totaled UAH 
115.8 billion (roughly $14.5 billion).  This figure was 6.2% lower 
than over the same period last year, a relatively small drop given 
GDP declines of 20.3% and 18%, respectively, in the first and second 
quarters of this year.  The GOU achieved these revenue figures by 
forcing pre-payment of taxes and by extensively manipulating non-tax 
revenues.  Such tactics have left Ukraine's budget in a dire 
situation for the balance of 2009, with the government now unable to 
cover the gaps that are emerging. 
 
¶3.  (SBU) Reports of near parity between expenditures and revenues 
for the first seven months of 2009 do not reflect the projected 
annual deficit.  The IMF and other local budget analysts continue to 
foresee a deficit of 6.5% of GDP, excluding financing necessary for 
Naftohaz and bank recapitalization, which reaches UAH 55 billion ($7 
billion) and in large part must be financed over the balance of 
¶2009.  Budget estimates that include financing needs for Naftohaz 
and bank recapitalization raise the projected deficit to 9.2% of 
GDP. 
 
¶4.  (SBU) The IMF has already provided Ukraine with $4.8 billion in 
budget support from its second and third loan tranches.  Absent 
another IMF loan tranche dedicated to the budget or World Bank DPL 
fiscal support (both of which could be held up by GOU noncompliance 
with required prior actions), Ukrainian authorities find themselves 
with few financing options.  This has raised fears in the business 
community that the government will continue to use coercive means to 
extract payments.  It has also raised alarms about the possibility 
of monetization of the outstanding deficit. 
 
MANIPULATION AND EXTORTION OF TAXES 
----------------------------------- 
 
¶5.  (SBU) The decline of tax revenues in the first half of 2009 
would have been more severe had the GOU not required companies to 
pay enterprise profits taxes in advance.  We have heard reports that 
most major companies were forced to pay their annual enterprise 
profits taxes in the spring and summer months of 2009, more than 
half a year before such taxes would have been due under more normal 
circumstances. 
 
¶6.  (SBU) A senior partner in a Kyiv-based law firm told us that 
many of his business clients had been tacitly threatened with visits 
from the tax inspector or had been hit with trumped up fines for 
various code violations.  He indicated that most businesses had 
complied with GOU requests for advanced tax payments rather than 
face ongoing legal hassles. 
 
¶7.  (SBU) The American managing director of a major manufacturing 
plant told us on September 18 that his firm had been visited 
repeatedly by tax authorities in recent weeks.  He said the tax 
inspector had told him each business in Ukraine was assigned a "fine 
quota" and that authorities were expected to deliver this amount 
before the end of the year.  The American apparently was told that 
he could hand over a UAH 150,000 fine on the spot for non-existing 
violations, or else he had go to court to protest UAH 2 million 
taxes supposedly evaded, but "either way he would have to pay."  The 
American manager said the entire story had been made up by the 
inspector and could not be justified by the company's financial 
paperwork.  Ukrainian colleagues were fearful of non-compliance, he 
commented, and had no trust in the legal system to resolve the 
case. 
 
 
KYIV 00001611  002 OF 003 
 
 
¶8.  (SBU) State-owned companies have also been affected.  Forced to 
cover much of the GOU's revenue shortfall, energy monopoly Naftohaz 
transferred UAH 19.2 billion (roughly $1.95 billion) in taxes to the 
budget in the first half of 2009.  This amounted to a 45.8% increase 
over the same period last year, constituting roughly 20% of 
Ukraine's budget revenue for the first half of 2009.  In previous 
years, Naftohaz's tax payments had corresponded to about 10% of the 
state budget revenue.  Given Naftohaz's receipt of subsidies and 
recapitalization funds, however, most analysts suspect its tax 
payments amounted to a financial shell game. 
 
2009 TAX REVENUE STRUCTURE 
-------------------------- 
 
¶9. (U) Ukraine relies on various tax sources for nearly 75% of 
budget revenues.  Major taxes include VAT (40% of the budget 
revenue), enterprise profits tax (20%), import duties (6%), and 
excise duties on tobacco, alcohol, petroleum products, and 
transportation (6%). 
 
¶10.  (U) The country's sharp economic downturn has resulted in a 
13.4% decline in tax revenue in the first seven months of 2009, 
year-on-year.  Import duties fell the most dramatically (down 54%), 
followed by a 19% decline in revenue from the enterprise profits 
tax, and 14% decline in revenues from the value added tax (VAT). 
 
¶11.  (U) The only sources of increased tax revenue in 2009 resulted 
from IMF-supported legislation on excise duties on alcohol and 
cigarettes, which grew for both imported and domestic goods by 39% 
and 54%, respectively, though the total net effect of these revenues 
was a fairly negligible UAH 3.5 billion ($430 million). 
 
GOU COOKS (NON-TAX) REVENUE BOOKS 
--------------------------------- 
 
¶12.  (U) Non-tax revenues sources are estimated to be roughly 25% of 
total state budget revenues in 2009.  The most important of these 
are rent fees and profits from government business activities, 
equaling 40% of non-tax revenues and 10% of total revenues.  Within 
this category, the most important sources are profits from the 
National Bank of Ukraine (NBU) and fees levied on oil and gas 
producers.  Ukraine receives other non-tax revenues from 
administrative fees (such as the issuance of passports), land sales, 
and special energy-related surcharges. 
 
¶13.  (SBU) Declining tax proceeds have been offset by increasing 
non-tax revenues, which grew 20% in first half of 2009, y-o-y. 
These increases were almost entirely the result of creative 
accounting.  For example, the Ministry of Finance included a UAH 4 
billion ($90 million) sovereign-guaranteed loan for state 
transportation monopoly Ukravtodor in its 2009 revenue indicators. 
 
 
¶14.  (SBU) The GOU also forced the NBU to transfer UAH 4 billion of 
its future profits, calculating that the central bank would earn at 
least this amount from its financing operations.  Instead, NBU 
Governor Stelmakh recently reported that the central bank will only 
earn UAH 600 million in profits, entitling it to roughly UAH 3.4 
billion in refunds.  Stelmakh made his statement in light of a Rada 
(Ukraine's parliament) plan to force the NBU to pay another UAH 9.8 
billion for Euro 2012 infrastructure projects, money that was to 
have been debited against further 2009 profits (reftel). 
 
LOCAL DEPENDENCY INCREASES 
-------------------------- 
 
¶15.  (SBU) Local revenue sources also have been burdened this year. 
Localities typically rely on transfers from the central government 
for 40% of their revenues.  Failure by state treasury authorities to 
provide transfers has left local budgets facing unfunded mandates, 
creating a relationship of even greater dependence on the central 
government.  Localities have very limited spending discretion, as 
over 80% of expenditures fund so-called protected articles, 
including social payments and public sector wages, as well as 
funding for hospitals and schools. 
 
GOU MASSAGES TREASURY ACCOUNT 
----------------------------- 
 
¶16.  (SBU) The single treasury account, which services central and 
local government revenues, has dipped to historic lows in 2009, 
falling to levels around UAH 1.5 billion prior to the May and August 
IMF loan disbursements.  The paucity of cash is linked to falling 
2009 revenues (which, in turn, resulted from a collapse in GDP and 
industrial output), as well as to the GOU's allocation of roughly $1 
billion for Pension Fund and Naftohaz deficits. 
 
 
KYIV 00001611  003 OF 003 
 
 
¶17.  (SBU) Regional officials, such as Sumy Governor Mykola Lavryk, 
have blamed the state treasury account's low cash balance for delays 
in transfers from the central government to localities.  In a formal 
press statement, the Cherkasy mayor likewise maintained that the 
state treasury had "frozen" payments to municipalities, in order to 
accommodate cash imbalances in the state budget. 
 
HRYVNIA EMISSION INEVITABLE 
--------------------------- 
 
¶18.  (SBU) There is little appetite, either internationally or 
domestically, for GOU debt, depriving the government of the option 
of issuing bonds to cover its deficit.  As a result, to cover the 
budget shortfall, the GOU has returned to its practice of 
monetization.  Via the issuance of treasury bills that are purchased 
by the NBU, the government has monetized roughly UAH 25 billion ($3 
billion) in 2009.  The NBU now holds about 48% of all domestic 
treasury bills, equaling UAH 33.8 billion ($4 billion).  Its total 
holdings constitute a four-fold increase over 2008. 
 
COMMENT 
------- 
 
¶19.  (SBU) Despite its dire budget situation, the GOU has not made 
any spending cuts in 2009.  Rather, with the aid of the IMF's loans, 
it has increased budget expenditures by 6.4% in the first seven 
months of 2009, y-o-y.  Even with another loan tranche that would be 
dedicated to the budget, a policy position not normally adopted by 
the IMF, the GOU would still have trouble meeting its growing fiscal 
obligations, let alone face the external commitments that will come 
due in 2010 after massive corporate roll-overs this year. 
 
PETTIT