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INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RHEHAAA/NSC WASHDC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 000071 
 
SIPDIS 
 
STATE FOR EUR/UMB AND EEB/OMA 
 
E.O. 12958: DECL: 01/14/2030 
TAGS: EFIN ECON ENRG EREL PGOV UP
SUBJECT: UKRAINE'S NATIONAL BANK WILL HELP WITH GAS PAYMENTS 
 
Classified By: Ambassador John F. Tefft for Reasons 1.4 (b) and (d) 
 
¶1.  (C) Summary.  Despite the lack of political unity, the 
National Bank of Ukraine was obliged to help the government 
make its gas payments to Russia in a timely manner, National 
Bank Governor Stelmakh told the Ambassador on January 14. 
During the meeting, Stelmakh also noted that the exchange 
rate had been under pressure of depreciation recently as a 
result of political uncertainty and banks engaging in 
speculation.  Nonetheless, he expressed confidence in the 
National Bank of Ukraine's monetary policy, particularly its 
success in holding down inflation over the past year.  Nadra 
Bank would be brought back to life quickly if creditors would 
only agree to a stiff financial haircut.    End Summary 
 
Stelmakh Complains of Lack of Political Unity 
--------------------------------------------- --- 
 
¶2.  (C) Disharmony between Ukraine's President and Prime 
Minister had a negative impact on Ukraine's economy, National 
Bank Governor Volodymyr Stelmakh told the Ambassador on 
January 14.  Conducting monetary policy was difficult. 
Stelmakh complained that as a result of political infighting, 
the National Bank of Ukraine (NBU) lacked access to basic 
statistics, including budget deficit and GDP figures. 
Business was difficult.  The government, for example, owed 
businessmen UAH 17 - 22 billion ($2.1-$2.75 billion) in VAT 
arrears, according to Stelmakh.  And the economy continued to 
suffer generally from the government's inability to address 
the economic crisis in a unified manner. 
 
Gas Payments Continue to be Problematic but Will Be Made 
--------------------------------------------- ----------- 
 
¶3.  (C) Gas payments were also a problem. Stelmakh confirmed 
that the National Bank made the decision in December to 
"provide for these problems" although doing so violated the 
Bank's standard operating procedures.  Expressing a sense of 
responsibility for facilitating gas payments, Stelmakh noted 
that the NBU was obligated to be involved since the IMF loan 
was intended to support Ukraine's balance of payments and gas 
payments constitute an important balance of payments line 
item. 
 
¶4. (C) Stelmakh confirmed that the NBU monetized $900 million 
in early January from reserves to help the government make 
the January 11 gas payment.  The NBU ensured, however, that 
it used accounts within the National Bank itself to enact the 
payment.  Stelmakh wanted to guarantee that neither Naftohaz 
nor the GOU could touch the money before it was transferred 
to Gazprom out of concern that the funds would be used for 
domestic obligations instead.  The transaction was finalized 
on January 6, according to Stelmakh.  Stelmakh criticized 
Russia for trying to use Ukraine's difficulties making the 
payments to discredit Ukraine at every turn.  He also stated 
that, although Ukraine was in discussions with Russia about 
schemes for making the February and March gas payments, he 
doubted that the Russians would come through in any way. 
Ukraine hoped that Russia would allow Ukraine's gas payment 
to be offset by advance gas transit fees or provide loans. 
Stelmakh stated categorically, however, that gas payments, 
which would be lower in February and March, would be made. 
He did not state specifically how they would be made but said 
that the NBU was obliged to be involved. 
 
¶5. (C) Clearly unhappy that the NBU had not been the 
recipient of all IMF program money to Ukraine, Stelmakh 
asserted that the IMF program was actually operating in 
violation of Ukrainian law.  He stated that of the $10.6 
billion the Ukraine already received from the IMF, $4.9 
billion had gone directly to the Government of Ukraine to pay 
domestic obligations. Stelmakh claimed that any debt burden 
taken on by the government should first have the approval of 
the Ukrainian parliament.  However, Tymoshenko's government 
had not sought parliamentary approval.  Stelmakh also 
maintained that the money the government had earned from 
selling Kyoto carbon credits had gone directly to the budget, 
rather than into "green" programs as intended. 
 
NBU Successfully Held Inflation Low 
----------------------------------- 
 
¶6.  (C) With pride, Stelmakh reported that the NBU was able 
to lower inflation from 22% to 12% in 2009, despite severe 
GDP contraction, which he estimated at 18%, a drop in 
 
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exports, and a large government deficit.  Stelmakh believed 
that the low inflation rate showed that the NBU's monetary 
policy was "correct." 
 
Exchange Rate Intervention but Banks Pushing Rate Lower 
--------------------------------------------- ---------- 
 
¶7.  (C) The National Bank continued to intervene in the 
currency markets to support the national currency (the 
hryvnia).  However, Stelmakh complained that the NBU's 
ability to intervene was limited because half of the IMF loan 
had gone directly to the GOU for budgetary support instead of 
to the NBU for balance of payments support.  In recent days, 
Stelmakh thought currency depreciation was being driven by 
psychological factors in advance of the elections.  He 
lamented the ability of the media to whip up panic and drive 
down the exchange rate.  Stelmakh also said that the NBU was 
seeking to consult with banks that were coming in with low 
bids for currency.  Stelmakh said, for example, that Citibank 
had bid for currency at 8.25 when the official exchange rate 
was hovering closer to 8.0.  These bids had reportedly caught 
the NBU off guard as it had spent $725 million in December 
and another $25 million during the first week in January in 
support of the hryvnia. Stelmakh hypothesized that banks were 
looking to make some money on currency speculation since 
lending was still basically frozen.  The NBU was considering 
suggesting new regulations that would require banks found to 
be speculating on the exchange rate to repay any NBU 
recapitalization funds they may have received.  (Note: 
Citibank told Econoff on 1/15 that it and other banks had 
received a harsh letter from the NBU threatening to hold CEOs 
of banks personally liable for foreign exchange transactions 
and any impact of a devaluation on the economy.  For its 
part, Citibank believes the downward pressure on the hryvnia 
is primarily a function of high demand from the population 
for foreign currency given the politically unstable period. 
End note.) 
 
Nadra Bank 
---------- 
 
¶8. (C) Expressing concern about the health of the banking 
system, the Ambassador noted that U.S. export credit agencies 
had interests as creditors in Nadra Bank and asked about 
efforts to address the problems at Nadra and in the sector. 
In response, Stelmakh said that Nadra was among the first 
group of banks to be recapitalized; however, a conflict of 
interests between its owners and the Prime Minister had 
stalled a full workout.  He was aware that foreign firms 
(including Cargill) and foreign export credit agencies were 
interested in restructuring their loans to Nadra.  The talks 
with creditors were ongoing and not easy, according to 
Stelmakh.  Creditors were now being offered a package which 
would require a 60% write-off, restructuring of 30% over the 
next 3-7 years, and a 10% cash payment.  But Stelmakh thought 
that Nadra couldn't even come up with the 10% cash payment. 
If the creditors agreed, Stelmakh thought the bank would come 
back to life within 2-3 months, and he expressed willingness 
to continue negotiations with the creditors.  In general, 
Stelmakh thought that the banking system was in better shape 
than in was a year ago as banks had been required to increase 
their reserves. 
 
Ukraine Shifting out of G-7 Currencies 
-------------------------------------- 
 
¶9. (C) Prior to the IMF program, Ukraine had its reserves 
invested in a broad range of stable but relatively high 
yielding currencies and short-term bonds, according to 
Stelmakh.  However, the IMF has recommended that Ukraine hold 
its reserves in G-7 country instruments only.  As a result, 
Stelmakh said the NBU was buying more U.S. T-bills and 
selling off Norwegian and Danish currency-denominated 
instruments, among others.  Stelmakh complained that this 
would mean lower returns on NBU reserves but said the IMF 
required such a move. 
 
COMMENT: NBU Chief in Precarious Position 
----------------------------------------- 
 
¶10.  (C) Although NBU Governor Stelmakh said at the beginning 
of the meeting that the National Bank was not a political 
organization and that he tried to pay little attention to the 
issues surrounding Ukraine's election, he is at the center of 
one of Ukraine's most heated political conflicts between 
 
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Prime Minister Tymoshenko and President Yushchenko.  So far, 
he has remained a strong Yushchenko supporter and resisted 
monetizing much of the government's domestic debt.  However, 
realizing the necessity of meeting Ukraine's international 
obligations, he (with the President's acquiescence) has made 
it clear that as a last resort the NBU will do what it takes 
to help the government with gas payments over the next few 
months.  End Comment. 
 
TEFFT