UNCLAS SECTION 01 OF 02 KYIV 001790

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR ALIKONIS
DEPT PLS PASS USTR FOR CKLEIN/LMOLNAR/ROWEN
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK
USDA/FAS/OCRA FOR JFLEMINGS/ATHOMAS
USDA/FAS/OGA FOR JLABOR/JTAYLOR
USDA/FAS/PECAD FOR MLINDEMAN

E.O. 12958: N/A
TAGS: EAGR ETRD PGOV UP
SUBJECT: UKRAINE: POLITICS AND MONEY BEHIND GRAIN EXPORT
RESTRICTIONS

REF: A) KYIV 1522, B) KYIV 1422

Treat as Sensitive but Unclassified. Not for Internet.


1. (SBU) Summary: Fear of rising bread prices was the driving force
behind the GOU's decision to reintroduce grain export restrictions
as of July 1. Bread prices are very politically sensitive in
Ukraine, and a number of government officials also have a financial
stake in the quotas through business interests that rely on cheap
grains. The GOU is therefore unlikely to significantly revise the
export restrictions before the September elections. Farmers will
suffer more than the grain trading companies in this incarnation of
export restrictions, as advance warning allowed grain traders to
delay their purchasing, yet Ukrainian farmers have not managed a
vigorous or effective protest. With high world prices for grain
expected to persist, Ukraine needs to develop a more market-friendly
policy in its quest to keep bread prices low. The GOU has some
options: it could move towards direct price subsidies and develop a
grain futures market; a special intervention fund could also be
helpful. End Summary.


2. (U) As reported reftel A, Cabinet of Ministers Resolution No. 844
reinstated limitations on grain exports as of July 1, after a
drought in southern Ukraine reduced the 2007 grain harvest. The GOU
has authorized an export quota of only 3,000 tons, a mere token
amount, for each of the following types of grain: wheat (and a
wheat/rye mix), barley, corn, and rye.

The Politics of Bread
--------------


3. (U) The GOU cited concerns for rising bread prices in defending
the reintroduction of export restrictions, although bread prices had
remained rather stable (see ref A). Yet because domestic wheat
prices were significantly lower than world prices -- in June wheat
sold for approximately $170/ton in Ukraine compared to $300/ton for
wheat futures in the United States -- wheat prices, and eventually

bread prices, were destined to rise in the absence of a government
intervention. Analysts from the Ukrainian Grain Association and the
Ukrainian Agrarian Confederation said they lacked firm data but
estimated that in the absence of export quotas, prices would rise
anywhere from 8% to 40%


4. (U) Rising bread prices have become a kind of bogeyman in
Ukrainian politics. In 2003 former Deputy Prime Minister Leonid
Kozachenko was put under criminal investigation for lifting grain
export quotas after a low harvest. Current Deputy Prime Minister
Viktor Slauta and Minister of Agriculture Yuriy Melnyk found
themselves in a similar position when, on June 6, Prime Minister
Yanukovich publicly threatened their dismissal should bread prices
rise (see also reftel A). The GOU is clearly keeping a close eye on
bread prices in the run-up to parliamentary elections, scheduled for
September 30.

Political Connections
--------------


5. (SBU) Many government officials also have a financial interest in
keeping bread prices low. According to Korrespondent, a Ukrainian
weekly newspaper, 26 MPs from the Party of Regions alone own a stake
in Ukrainian bakeries. For example, MPs Volodymyr Ivanov and Vasil
Khmelnitsky, both recent converts to the Party of Regions, control
Khleb Kieva, one of the larger regional bakeries. Deputy Prime
Minister Slauta has long had ties to Khlib Ukrainy, the state-owned
bread giant; he ran their office in Donetsk during the mid-1990s.
Minister of Agriculture Melnyk, meanwhile, is a member of the board
of the Poultry Union of Ukraine, which benefits from low feed grain
prices. Grain producers, exporters, and other businesses that would
benefit from higher grain prices, meanwhile, lack these significant
political connections. Representatives from both the Ukrainian
Grain Association and Agrarian Confederation told Econoff on July 4
that the political connections of the bakery industry had played a
key role in grain policy, although they declined to name specific
government officials benefiting financially from the quotas.

Farmers to be Hit Hard
--------------


6. (U) Analysts agree that this time the restrictions will hit
farmers harder than the grain traders, since the traders were given
adequate lead-time and adjusted purchasing accordingly. Cargill,

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for example, told Econoff that they had purchased next-to-nothing,
and would play a game of wait and see. At an American Chamber of
Commerce meeting July 16, other traders said their firms would
largely follow similar strategies. Deputy Agricultural Minister
Yuriy Luzan said on July 11 that farmers had only half the funds
necessary to carry out harvesting and sowing campaigns, which
generally occur in August. Additionally, price uncertainty makes it
difficult for farmers to plan in advance or invest in improvements
that would increase their yield. Exporters have said they expect
most farmers to hold onto their stocks until August or September.


7. (SBU) Despite this gloomy state of affairs, farmers have not
voiced strong opposition to the export restrictions. Although they
are well below international levels, domestic prices are actually
higher than they were a few years back, and many farmers are
therefore still in the black. Traders told us this means many
farmers are satisfied to make a profit, even if it is less than they
might earn if they could have exported. Farmers are also hesitant
to rock the boat for fear of upsetting their relationship with the
government, including subsidies in some cases. German Embassy
Agricultural Attache Stefan Kresse commented that some of the larger
agricultural producers, anxious to swallow up some smaller
enterprises, actually appeared to be supportive of the quotas in
that they may serve to bankrupt smaller producers.

Long Term Solutions Needed
--------------


8. (U) At the July 16 American Chamber meeting, all agreed that the
GOU was unlikely to eliminate the export restrictions prior to
September elections and with the development of biofuels, Ukraine
would likely face high world grain prices for some time to come.
Several grain trader reps argued that pressuring the GOU in the near
term would be counterproductive, although there might be some chance
of getting the GOU to back off its export bans on feed grains, which
have no impact on bread prices. (Note: Minister of Agrarian Policy
Melnyk told the press July 20 he expected the export ban would be
lifted October 1, without specifying whether this would be a full or
partial lifting of the ban.)


9. (U) Bunge and Cargill reps suggested a mechanism whereby
exporters could sell 1 million tons of grain to a reserve or
intervention fund at a fixed price for every 4-5 million tons they
were allowed to export. Dmitriy Gorshunov, country manager at Bunge
Ukraine, noted that for example that Russia uses direct subsidies
and already has an intervention fund of 1.5 million tons in place.
Econ Counselor suggested to the group we needed to develop
alternative policy mechanisms to suggest to the GOU for the longer
term, such as futures markets or direct payments to the needy, that
would be more market-friendly and cheaper than export controls. The
group agreed to draft policy proposals.


10. (SBU) Comment: Ukraine has reflexively used export restrictions
as its "go-to" method for restraining rising grain prices. While
this policy works in the short term, it places high costs on the
economy. The differential between domestic prices and world prices
will be hard to sustain in the long run, so the GOU needs to develop
a more market-friendly and less trade-distorting mechanism to
achieve its goals.

TAYLOR