VZCZCXRO8842
RR RUEHDBU RUEHSL
DE RUEHKV #1910/01 3081418
ZNY CCCCC ZZH
R 041418Z NOV 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 8727
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RHEHAAA/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001910 
 
SIPDIS 
 
STATE FOR EUR/UMB AND EEB/OMA 
 
E.O. 12958: DECL: 11/03/2029 
TAGS: EFIN EREL ECON PREL UP
SUBJECT: GOU BROKE, NATIONAL BANK KEY TO UPCOMING GAS 
PAYMENTS 
 
REF: A. KYIV 421 
     ¶B. KYIV 955 
     ¶C. KYIV 1472 
     ¶D. KYIV 1487 
     ¶E. KYIV 1835 
     ¶F. KYIV 1888 
 
Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and 
(d) 
 
 ¶1.  (C) Summary.  Ukrainian government coffers are all but 
empty and Naftohaz is unlikely to be able to meet upcoming 
gas payment obligations without support from the National 
Bank of Ukraine (NBU).  Analysts forecast that the government 
needs to find $2.5 - $3.75 billion to cover expenses for the 
rest of the year.  This figure does not include gas payments, 
which will require $1 -$1.5 billion.  To cover the gap, with 
the IMF program in question, analysts believe the NBU will 
eventually release funds for gas payments, and possibly for 
wages to teachers and doctors.  NBU financing and government 
tightening would allow the GOU to muddle along for the next 
few months.  However, Ukraine's grim budgetary situation only 
gets worse in 2010, and the economic and political 
consequences of just "muddling through" will be painful.  End 
summary. 
 
Glaring Budget Gap 
----------------- 
 
¶2.  (C) The Ukrainian government needs $2.5 - $3.75 billion 
in the final months of 2009 to meet its budgetary 
obligations, according to Ildar Gazizullin, an economist at 
the local think tank International Center for Policy Studies. 
 In addition, the newly signed social spending law (refs E 
and F) that would increase pensions and wages if implemented 
could add another $337 million to the government deficit in 
¶2009.  Ukraine's efforts to combat the flu outbreak have also 
lead the Rada (Ukraine's parliament) to amend the 2009 budget 
and direct $125 million to the Ministry of Health, despite 
the fact that the government's emergency reserve fund is 
broke.   Taking into consideration all of these needs, Senior 
World Bank economist Pablo Saavedra estimates that Ukraine's 
requirements for the rest of the year amount to 2.5 - 3% of 
GDP, or approximately $3 billion. 
 
Gas Payments, External Obligations 
---------------------------------- 
 
¶3.  (C) Separately, Ukraine must make gas payments totaling 
between $1-$1.5 billion for the rest of the year to Russia. 
President Yushchenko's Envoy for Energy Security Bogdan 
Sokolovsky confirmed on November 4 that the November 7 gas 
payment (for gas received in October) would be $470 million 
and that Naftohaz has approximately one-third, or $150 
million, of the required payment in working capital. 
According to Sokolovsky, the Presidential Secretariat, the 
Cabinet of Ministers (CabMin), and Naftohaz were working 
together to find a solution to the payment problem.  While 
Ukraine had asked Russia for some concessions, Sokolovsky 
said Russia seemed unwilling to be flexible on the terms of 
the payment.  Sokolovsky also said that while Naftohaz still 
has on its books a portion of the UAH 18.6 billion  ($2.3 
billion) in treasury bonds that the CabMin had provided over 
the summer to increase Naftohaz's statutory capital, there 
were few buyers for the bonds.  In the end, the bonds would 
have to be sold to the NBU, but Sokolovsky predicted that the 
NBU would be reluctant to purchase the bonds.  He commented 
that the NBU is already near its reserve limits as set by the 
IMF.  Ukraine will need to pay Gazprom approximately $500 
million in December and a similar sum again in January (for 
December gas deliveries).  Naftohaz,s ability to pay will 
not improve by then, said Sokolovsky. 
 
¶4. (C) Sokolovsky also lamented that if the IFIs had given 
Ukraine the $1.7 billion in financing promised over the 
summer (ref C), Ukraine would not be having the current 
difficulties in making its gas payment.  He added that the 
IFIs had been too firm on their conditions, including calling 
for a gas price increase, and would find themselves being 
pressured into giving Ukraine financing this winter when the 
situation worsens and gas transit to Europe is threatened. 
 
¶5.  (SBU) Ukraine reportedly has few other external debt 
payments due in the remainder of the year.  Economists put 
the number at no more than $300 million for interest and 
other payments for November and December combined.  In 
addition, the recent Naftohaz Eurobond and bilateral debt 
 
KYIV 00001910  002 OF 003 
 
 
restructurings (ref D) removed the need to cover any of these 
quasi-sovereign obligations for the rest of 2009. 
 
IMF Program Off Track 
--------------------- 
 
¶5.  (C) President Yushchenko's recent signing of the social 
spending law and Prime Minister Tymoshenko's proposed 2010 
budget have both pushed Ukraine's negotiations with the IMF 
futher off track.  The 2010 budget as submitted already 
implied an 8% deficit, according to Saavedra at the World 
Bank, and needed to be revised to be more in line with the 4% 
the IMF and other IFIs could accept.  In addition the World 
Bank estimates show that the social spending bill would add 
between 2.5% to 7.5% of GDP to the budget deficit in 2010, 
depending upon how the increases are indexed. 
 
¶6. (C) Commenting on the political implications of the law, 
Independent Rada member Taras Chornovil told PolOff on 
November 3 that in his opinion Yushchenko gave Yanukovych an 
"amazing gift" when he signed the social welfare legislation 
into law.  Overcoming the economic affects of the law, 
including the pressure it puts on the IMF program, would be 
detrimental for Tymoshenko.  Deputy Head of the Presidential 
Secretariat Ihor Popov explained that he believes that the 
only reason Yushchenko signed the social welfare legislation 
was to damage Tymoshenko's presidential campaign.  He said 
Tymoshenko would bear the brunt of public disaffection if the 
economy or exchange rate worsened in response to a delay in 
the IMF's fourth tranche.  Party of Regions Rada Memember 
Yuriy Miroshnochenko commented that the end of the IMF 
program would be the end of the Tymoshenko candidacy for 
president. 
 
¶7. (C)  IMF resident representative, Max Alier, said on 
October 3 that the IMF and the GOU are still negotiating a 
Letter of Intent (LOI), which would be the basis for the 
release of the next tranche of money.  From the IMF 
representative's perspective, there are three essential 
elements for a LOI, as follows: 
 
¶A. Resubmission of the draft 2010 budget, bringing down the 
fiscal deficit to 4% of GDP.  However, the PM has declined to 
do this, instead promising to use administrative measures to 
bring spending into line with a 4% target. 
 
¶B. Commitments regarding "incomes policy", meaning the GOU 
would oppose and the President would veto any legislation 
(like the recent pension/minimum wage law, plus whatever else 
the Rada might think up) that provides wage/ pension 
increases greater than inflation. 
 
¶C. Signatures, demonstrating political commitment to the IMF 
program, preferably by all who originally bought into the 
program (President, Prime Minister, NBU, and Finance 
Ministry), but at least the NBU (central bank) and Finance 
Ministry, which the IMF has found minimally sufficient in 
some other countries. 
 
Can Ukraine Make Its Gas Payments without the IMF? 
--------------------------------------------- ----- 
 
¶8.  (SBU) If IMF money does not come through in the near 
term, the NBU could participate in schemes that would allow 
its reserves to be used to make gas payments, as it has done 
in the past (refs A and B).  However, the Bank, allied with 
President Yushchenko, has resisted monetizing government 
debts, including gas payments, in recent months as political 
tension between the President and the Prime Minister has 
mounted.  Yushchenko's Deputy Chief of Staff Oleksandr 
Shlapak told the press that the president would not allow the 
'&QAb"zQg~I9GS-8QQ?QQ[\VgQgoods and services to continue to 
accrue if they chose to use the money for gas payments. 
However, since Naftohaz is able to collect only about $100 - 
$150 million in revenue each month from consumers, December's 
payment would be no easier to finance.  Both the IMF and the 
World Bank believed that the government would not fund gas 
payments if it meant arrears to pensioners, teachers, or 
doctors. 
 
Will the NBU Step In to Rescue the Government? 
--------------------------------------------- - 
 
KYIV 00001910  003 OF 003 
 
 
 
¶9.  (C) Local analysts believe there is enough pressure on 
President Yushchenko such that he will approve NBU financing 
of the gas payments for the rest of the year.  The president 
would risk handing Tymoshenko the right to blame him and the 
NBU for a gas crisis if gas payment obligations are not met. 
Saavedra at the World Bank also expected the NBU to cover 
wage and pension payments as needed.  He argued that 
Yushchenko understood that voters were unlikely to cast votes 
in his favor if they believed Yushchenko and the NBU were 
between them and their paychecks/ pensions. 
 
Comment: Continued Economic Hardship 
------------------------------------ 
 
¶10.  (C) Given the political nature of the decision, it is 
difficult to predict with any certainty whether and how much 
the National Bank will intervene to keep Ukraine's economy 
afloat.   The timing of any such intervention could clearly 
have political implications for the presidential elections as 
well.  Even with NBU intervention, Ukraine is facing 
continued economic hardship.  The 2010 budget as submitted 
makes the economic situation even more unsustainable next 
year.  One can expect that the biggest challenge for the next 
president will be how to deal with economic issues, including 
the continuing need to make gas payments, which are expected 
to increase, and an ever wider budget deficit in 2010.  A new 
government might be able to approve some upward adjustments 
in gas prices for consumers relatively soon after coming into 
office; however, reform that arguably would have a more 
significant impact on the budget, such as pension reform, 
will be much more difficult and take longer to address. 
IFI lending could get the country through the elections, but 
the economic problems will remain.  End Comment. 
PETTIT