VZCZCXRO2710
RR RUEHDBU RUEHSL
DE RUEHKV #2124/01 3441408
ZNY CCCCC ZZH
R 101408Z DEC 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 8947
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RUCPDOC/USDOC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 04 KYIV 002124 
 
SIPDIS 
 
STATE FOR EUR/UMB AND EEB/OMA 
 
E.O. 12958: DECL: 12/09/2029 
TAGS: ECON PGOV ENGR PREL EFIN UP
SUBJECT: YANUKOVYCH ACOLYTES PREACH ECONOMIC ORTHODOXY 
 
REF: A. KYIV 1920 
     ¶B. KYIV 2110 
 
Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and 
(d) 
 
¶1.  (C) Summary.  Viktor Yanukovych's top economic advisors 
are counseling liberal market reforms, despite the Party of 
Regions' pre-election populist appeals.  Shadow Minister of 
Finance Mykola Azarov and shadow Minister of Economy Iryna 
Akimova separately told embassy officers that Yanukovych as 
president would seek to renegotiate Ukraine's gas contracts 
with Russia, tighten government spending, support EU 
integration, and implement tax and other reforms to improve 
the business climate. 
 
¶2.  (C) Whereas Azarov, considered to be Regions' power 
behind the candidate, railed against the IMF for undue 
flexibility toward the Tymoshenko government, Akimova was 
more conciliatory, choosing to directly blame the Prime 
Minister for her misuse of IMF loan funds.  Azarov and 
Akimova touted the recent Regions-backed social standards law 
as necessary for the most vulnerable populations, though both 
clarified this by stating Yanukovych would limit the law's 
fiscal impact.  End summary. 
 
¶3.  (U) This is the second in a series of cables on the 
economic platforms of Ukraine's presidential candidates. 
 
YANUKOVYCH'S ECONOMIC PLAN 
-------------------------- 
 
¶4.  (C) According to Party of Region's shadow Minister of 
Economy Iryna Akimova, Yanukovych's core pledges on the 
economy were to: 
 
-- increase economic growth and social standards 
-- improve the investment climate and secure property rights 
-- reform tax administration, lower taxes, and reduce red 
tape 
-- reverse recent increases of state debt 
-- heighten fiscal discipline 
-- bolster the bank recapitalization scheme 
-- ensure the independence and accountability of the National 
Bank of Ukraine (NBU) 
-- promote coordination between the NBU and the Ministry of 
Finance 
 
REGIONS ON TYMOSHENKO'S LEGACY 
------------------------------ 
 
¶5.  (C) Akimova told Econoffs that Yanukovych would 
capitalize on Tymoshenko's mishandling of Ukraine's economic 
crisis.  Akimova explained that Regions' key concern was 
increased GOU debt.  She warned that short-term borrowing 
could lead to macroeconomic instability and cause exchange 
rate pressure, further bank failures, and a "second wave" 
shock to the real sector and households. 
 
¶6.  (C) Shadow Minister of Finance Mykola Azarov separately 
told Emboffs that Ukraine's economy and financial system had 
been "totally ruined".  Ukraine was entering 2010 with no IMF 
program, a depleted borrowing limit, a huge budget deficit, 
and had extensive corporate debt that would need to be rolled 
over in 2010.  Roughly 30% of the loans in the banking sector 
were high risk or non-performing, according to Azarov's 
calculations. 
 
FISCAL POLICY 
------------- 
 
¶7.  (C) Azarov complained Tymoshenko had not only wasted IMF 
Stand-By Arrangement (SBA) loan monies over the last year; 
she had also burned through $2 billion in IMF Special Drawing 
Rights (SDRs) for budget and gas payments.  Tymoshenko's 
"incomprehensible" economic policy-making had left a depleted 
treasury in December and "nothing" for the January 7 gas 
payment. 
 
¶8.  (C) Ukraine would have to endure strict fiscal discipline 
in 2010.  A Party of Regions government would have "no 
option" but to cut expenditures by 20%, even though it would 
be "difficult" and "unpopular", said Azarov.  Regions would 
impose trict control over spending.  According to Azarov, 
this was an "elementary" step to rein in the corruption of 
Tymoshenko's government. 
 
¶9.  (C) Akimova separately explained that Ukraine's UAH 40 
 
KYIV 00002124  002 OF 004 
 
 
billion (roughly $5 billion) unfinanced core budget deficit 
had caused Tymoshenko to issue short-term securities (with 
3-6 month maturities) at interest rates around 30%.  This 
"desperate" plan resembled Ponzi schemes in late 1990s 
Russia, especially since there were no clear sources of 
financing for the rollovers of this debt that would be needed 
in April.  Nonetheless, commercial banks were buying 
Tymoshenko's risky but profitable debt rather than lending, 
further drying up remaining liquidity. 
 
¶10.  (C) Sovereign external debt payments due in 2010 were 
$2.3 billion, an amount Akimova believed was manageable if 
the GOU did not accrue more short-term obligations.  However, 
the size and speed of state debt accumulation was "scary" and 
"enormous" -- 36% of GDP by the end 2009 (total sovereign 
plus sovereign-guaranteed borrowing), 44-46% in 2010, and up 
to 60% of GDP (the Maastrict red line) in a couple of years, 
according to Regions' projections from current trends. 
 
¶11.  (C) On the Regions-backed social standards law 
criticized by the IMF (ref A), Akimova explained that 
Yanukovych supported a "reasonable" approach.  It was 
important to raise minimum wage and pension payments for 
Ukraine's poorest citizens, especially if gas and utility 
prices increased.  However, Akimova insinuated that Regions 
would not favor re-indexing all public sector wages and 
pensions based on the new subsistence minimum.  Re-indexing 
of social payments is the prerogative of the Cabinet of 
Ministers, she noted.  An increase in minimum wages and 
pensions does not necessarily trigger increases across the 
board, according to Akimova, contrary to what the Tymoshenko 
government had publicly implied. 
 
¶12.  (C) Azarov noted that the international community had 
been "misled" by Tymoshenko's "unreliable calculations" on 
the cost of wage and pension increases.  Tymoshenko was 
"bluffing" to gain an electoral advantage.  Her suggestion 
that increases in social standards would cost UAH 70 billion 
was nowhere near the real cost of the law, which Regions 
calculated would be closer to UAH 6 billion ($750 million) in 
¶2010.  Azarov said the recipients of the increases in minimum 
wages and pensions would likely spend their additional 
payments on domestic products (butter, eggs, bread) and 
stimulate the domestic economy. 
 
TAX POLICY 
---------- 
 
¶13.  (C) Akimova vowed to put order into the State Tax 
Administration (STA), whose inefficiencies were among highest 
in the world.  She promised that Yanukovych would lower 
enterprise profits taxes (EPTs) from 25% to 19% by 2011 to 
stimulate investment, arguing that "if government can't fund 
investment, then the private sector has to be incentivized." 
Akimova supported a five-year moratorium on EPTs for small 
and medium-sized enterprises, and she said a 3-4 year 
moratorium on changes to tax legislation was necessary to 
provide greater stability and transparency for investors. 
 
¶14.  (C) Azarov, who once headed the State Tax Administration 
and the Rada budget committee, commented that VAT refund 
arrears would be a "huge" burden for a successor government, 
especially since the STA had already collected advanced 
enterprise profit taxes into 2010.  The Party of Regions 
would support tax and pension reform after the economy 
returned to 2-3% growth, according to Azarov. 
 
BUSINESS CLIMATE 
---------------- 
 
¶15.  (C) Akimova separately confirmed that Tymoshenko had 
demanded advance payment of enterprise profit taxes through 
the first quarter of 2010.  Companies with wage arrears had 
received threats from tax and labor authorities.  Tymoshenko 
had claimed she would take over privatized firms if they 
failed to make payroll.  In an environment where savings 
rates and investment had plummeted, Tymoshenko was scaring 
off both domestic and foreign investors, according to 
Akimova.  Yanukovych would campaign on the slogan that 
Regions could be trusted to respect business contracts and 
privatizations. 
 
A "NAIVE" IMF 
------------ 
 
¶16.  (C) The IMF had lost an opportunity to use its "colossal 
leverage" over the GOU, suggested Azarov.  The Party of 
Regions wanted to fulfill the IMF action plan, but it could 
 
KYIV 00002124  003 OF 004 
 
 
not be "tougher than the cop".  The IMF was "naive" to 
believe Tymoshenko's promise to raise rates for gas 
consumers.  A lack of IMF prodding for real reform had been a 
"disservice" to Ukraine and had caused Regions to determine 
the international community was providing political support 
for Tymoshenko, whose government had been kept afloat with 
IMF financing.  Ukraine needed at least $20 billion to 
survive in 2010.  Pointedly Azarov asked, "Are you 
(Americans) ready to provide this?  If not, why did you 
maintain this stance with the IMF?" 
 
¶17.  (C) Akimova's criticisms of the Fund were more nuanced. 
Accumulating debt could be necessary in a crisis; IMF money 
should have been targeted to stabilize the financial and real 
sectors.  Instead IMF monies were spent on gas payments, 
leaving systemic problems untouched, said the Regions' 
representative.  The IMF program had hardly addressed 
Ukraine's underlying macroeconomic instability.  Recent signs 
of growth were only due to the base effect (a dramatic drop 
in H2 2008 GDP). 
 
¶18.  (C) Most concerning to Akimova was the IMF's allowance 
for dramatic increases of internal borrowing.  The budgeted 
limit in 2009 domestic borrowing was UAH 37 billion, but the 
GOU had already taken on UAH 62 billion in new liabilities, 
using Cabinet of Ministers' decrees to get around borrowing 
restrictions. 
 
TYMOSHENKO'S ENERGY POLICY: A BETRAYAL 
-------------------------------------- 
 
¶19.  (C) Azarov told us that Ukraine had misplayed the "aces 
in its hand" with Russia.  "Putin had won and Ukraine had 
lost" from Tymoshenko's negotiation of gas contracts that 
"betrayed her country", according to Azarov. 
 
¶20.  (C) If Yanukovych won the presidential election, he 
would push to renegotiate all gas deals with Russia.  Current 
prices for gas imports will lead to an "impossible" situation 
in the chemicals industry, which requires heavy gas inputs 
and is not profitable when import prices are above $250 per 
thousand cubic meters.  According to Azarov, the gas price 
for domestic consumers should rise 20% to recover import 
costs. 
 
¶21.  (C) Azarov reasoned that the coziness between Tymoshenko 
and Putin at the November Yalta talks did not undermine the 
Party of Regions' claim that it is the faction to best 
restore "friendly, neighborly" relations with Russia. 
Regardless of who is in power, according to Azarov, it is 
"vital" for Ukraine to have a constructive policy towards 
Russia. 
 
¶22.  (C) For her part, Akimova expressed concern that the 
Yalta announcement by Putin and Tymoshenko had not led to a 
written deal waiving fines for lower gas intake.  Akimova 
worried that per the original terms of the January 19, 2009 
gas supply contract, Ukraine could be penalized between $8-9 
billion for the under-purchase of gas in 2009.  Akimova 
called Putin's promise "an instrument of political and 
economic pressure" and said the Russians were willing to 
"actualize" their leverage any time.  (Note: Both Gazprom and 
Naftohaz leadership have stated that they have signed 
agreements revising volumes and waiving penalties for 2009. 
Akimova is the only person from whom we have heard concern 
over the lack of a written agreement since the 
Gazprom/Naftohaz statements were released.  End note.) 
 
¶23.  (C) Akimova thought it would be difficult to get Russia 
to reconsider terms of the gas contracts.  Coming to a 
successful negotiated outcome would be a purely political 
question.  Akimova advocated for gas contract talks "with all 
three partners" (EU, Russia, Ukraine), which would be the 
"only way" to gain greater transparency and efficiency. 
 
¶24.  (C) Akimova said price increases for household gas 
consumers were inevitable.  Tymoshenko had avoided raising 
household prices in 2009, but the GOU had implicitly 
acknowledged in its declared 2010 revenue expectations that 
it was anticipating increases, according to Akimova. 
 
¶25.  (C) Regions' experts had calculated that gas price 
increases would lead to inflation rates of 15-20%.  Targeted 
subsidies for most vulnerable population were therefore 
needed, as were efforts to show Ukrainian citizens that the 
government was doing its utmost to reform utilities and 
increase energy efficiency.  Akimova quipped that people 
would not pay more if they continued to see gushers of hot 
 
KYIV 00002124  004 OF 004 
 
 
water leaking on the streets, alluding to the inefficiencies 
of municipal heating companies. 
 
EU INTEGRATION 
-------------- 
 
¶26.  (C) "EU integration was the direction Ukraine had 
chosen," stated Akimova.  Yanukovych "more than supports" EU 
integration and would continue reforms to bring Ukraine in 
line with EU standards.  There was "no other way", Akimova 
said unequivocally.  "Efforts at harmonization were difficult 
but a necessary step to allow Ukraine to use its economic 
advantages." 
 
¶27.  (C) Azarov commented that the Western media had unfairly 
stereotyped Yanukovych as solely pro-Russian.  Yanukovych was 
the "most pro-Ukrainian candidate", and he recognized that 
Ukraine was increasingly "more European in its essence". 
Azarov speculated that EU integration would happen 
automatically as a factor of Ukraine's development, and 
reforms would occur because they were of "systemic" 
importance. 
 
BANKING SECTOR 
-------------- 
 
¶28.  (C) Financial stability was still missing, said Azarov. 
Bank recapitalization had been conducted via "administrative 
resources".  Although it had had the effect of increasing 
government debt, bank recapitalization was not stimulating 
new lending for the real economy. 
 
¶29.  (C) Akimova had been closely observing trends in the 
exchange rate, as any upward movement would be a "disaster" 
for banks and could lead to another banking crisis.  The NBU 
and Ministry of Finance needed to stabilize the exchange rate 
through collaborative monetary and fiscal policy-making.  A 
Yanukovych presidency would support NBU reforms to enhance 
both its independence and accountability, Akimova noted.  The 
NBU Council should not contain any Rada MPs, due to inherent 
conflicts of interest.  (Not%Hy;Qpragmatic, pro-business wing. 
Despite their differences in style and background, each made 
notably orthodox arguments promoting economic reform, while 
tamping down concerns over populist social spending 
legislation.  Most evident was their separate but 
consistently pragmatic approach to Russia on energy, their 
willingness to make fiscal sacrifices, and their diagnoses of 
what had driven away (or could re-entice) investment.  If 
elected President, Yanukovych could be expected to continue 
to draw advice from his top two economic policy advisors on 
how to escape what Azarov called the most difficult moment in 
Ukraine's post-independence history.  With their 
business-friendly policies, it is clear why many of Ukraine's 
oligarchs support Yanukovych, and why a growing numbers of 
foreigners doing business in Ukraine are comfortable with a 
Yanukovych presidency. 
TEFFT