UKRAINE IMF VISIT HIGHLIGHTS DEEPENING BANK CRISIS

UNCLAS SECTION 01 OF 02 KYIV 002097 SENSITIVE SIPDIS DEPT FOR EUR/UMB, EEB/OMA TREASURY PLEASE PASS TO TTORGERSON E.O. 12958: N/A TAGS: EFIN ECON ETRD PGOV XH UP SUBJECT: UKRAINE IMF VISIT HIGHLIGHTS DEEPENING BANK CRISIS REF: KYIV 2030 AND PREVIOUS SENSITIVE BUT UNCLASSIFIED, NOT FOR INTERNET DISTRIBUTION ¶1. (SBU) Summary. The International Monetary Fund (IMF) is not commenting on the substance of its ongoing discussions with the government of Ukraine (GOU) on a possible support program, but its representatives told us on October 17 that the delegation's stay in Kyiv was open-ended. PM Tymoshenko said the IMF was prepared to loan Ukraine anywhere from $3 to $15 billion and suggested the IMF would expect the country to delay early parliamentary elections. There was no independent confirmation of Tymoshenko's claims, although various analysts speculate that IMF support could total $10 to $15 billion. Although the National Security and Defense Council (NSDC) will continue discussions on an economic emergency package on October 20, the GOU, President Yushchenko, and the National Bank of Ukraine (NBU) have not demonstrated they can form a consensus to tackle the crisis and jointly accept IMF conditions for an assistance package. ¶2. (SBU) Attention of market participants in Kyiv is now focused on how Ukraine will finance $50 to $60 billion in external commitments due in 2009. The NBU's foreign exchange reserves of $37 billion are not sufficient to cover the expected commitments, and international sources of funding, used heavily by Ukraine's private sector in recent years to fuel growth, have all but dried up as a result of the world's financial crisis. There has been speculation, unsupported by any GOU statements, that Ukraine may seek exceptions to its WTO commitments to deal with the deteriorating balance of payments situation. End Summary. IMF Silent on Substance, GOU Plans Unclear -------------- -------------- ¶3. (SBU) The IMF delegation, the first in five years to Ukraine, continued its discussions with the GOU on October 17. The local IMF office would not comment on the substance of the discussions, but told us only that the delegation was planning to remain in Ukraine on an "open-ended" basis. IMF Managing Director Dominique Strauss-Kahn was quoted as saying that the IMF was prepared to help Ukraine, and PM Tymoshenko said that the IMF could loan Ukraine anywhere from $3 to $15 billion. There was no independent confirmation of the figures cited by Tymoshenko. NBU deputy governor Oleksandr Savchenko, leading the negotiations with the IMF, has suggested that an IMF deal may be signed as early as next week. Various analysts have speculated that Ukraine may be seeking a $10-15 billion "stand-by" program. ¶4. (SBU) Parallel to the IMF discussions, the National Security and Defense Council (NSDC) began discussing an emergency package to support Ukraine's banking system and fend off a balance of payments crisis. The NSDC announced that it would meet again on October 20 to approve the package. The NSDC would not comment on the measures being discussed, but various media reports speculated that the package would, among other measures, focus on boosting Ukrainian exports while diminishing imports. There was even speculation that Ukraine would request from the WTO exemptions from its commitments in order to deal with a potential payments crisis. However, Post has not had any GOU confirmation that this might be the case. ¶5. (SBU) Any IMF support will focus on stabilizing Ukraine's banking system and helping the country meet its external debt obligations, particularly in the short term. Discussions among market participants and analysts in Kyiv in recent days have focused on the composition and term structure of Ukraine's external debt, which has grown by about 45 percent in the past two years and currently totals roughly $100 billion, or 60% percent of GDP. Of this debt, about $15 billion is public sector debt, $38 billion is debt owned by banks, and $43 billion is external debt of Ukraine's corporate sector. The rest is inter-company lending. ¶6. (SBU) Most observers have argued that the level of external debt by the public sector, which has remained fairly constant in recent years, is not a source of concern. The GOU is not dependent on external borrowing to finance its modest budget deficit, and it could turn increasingly to internal sources of funding if the international capital markets remain as dormant as they are now. While less is known about the composition of the $43 billion in external debt owned by Ukraine's corporate sector, several analysts have pointed out that it is concentrated in a few hands, primarily the largest and most well-known Ukrainian companies with international exposure. Banking Vulnerabilities the Chief Concern -------------- -------------- KYIV 00002097 002 OF 002 ¶7. (SBU) During an October 16 discussion, Dominique Menu, country head for the Ukrainian subsidiary of the French bank BNP Paribas, said his bank believed that corporate borrowers are typically cash rich and have low debt-to-capital ratios. Separately, Jock Mendoza-Wilson, head of investor relations at System Capital Management (SCM),the holding company of Rinat Akhmetov, Ukraine's wealthiest businessman, told us that SCM had "low gearing" in its balance sheet and sufficient sources of internal funding, even in light of the recent and drastic drop in steel production and prices. The inability to borrow abroad would not harm SCM's current operations, but it would all but destroy SCM's aggressive foreign expansion plans. SCM had hoped to borrow heavily in coming years to finance $6 billion in foreign acquisitions, Mendoza-Wilson told us. ¶8. (SBU) The banking sector, which has grown rapidly in recent years on the back of aggressive foreign borrowing, is the main focus of concern. BNP Paribas' Menu said risks mainly reside in each individual bank's external debt and asset profile. There was little concern about a chain reaction, or domino effect, of bank failures, because banks do very little business with each other. Currently, loans to other banks equal only 2 percent of bank assets, he pointed out. Instead, the main risk was banks' ability to roll-over short term external debt, now around $13 billion, that will come due in the coming months. ¶9. (SBU) Ukrainian banks controlled by foreign banks owe roughly 70 percent of the $38 billion in external bank debt, and another 10 to 15 percent is owed by banks owned by the largest Ukrainian oligarchs, Menu estimated. BNP Paribas is still operating on the assumption that foreign banks would remain interested and able to provide their Ukrainian subsidiaries with the minimum funding they need to stay afloat, and that cash-rich oligarchs would likewise support their banks if necessary. The biggest challenge would lie with the remaining Ukrainian banks that had neither strong foreign or domestic backing, he said. ¶10. (SBU) There is consensus among our interlocutors that Ukraine's external situation, as well as its short-term financing, remain precarious. On October 16, Citibank country director Nadir Shaikh said his bank expects that Ukraine will need to finance about $50-60 billion in external payments in 2009. Of this total, some $15 to $18 billion will be Ukraine's current account deficit, which has more than doubled since last year and could reach 10 percent of GDP, he estimated. (Note: Other analysts expect a current account deficit of up to $24 billion.) Another $20 billion will be needed for servicing the long-term debt -- this includes about $12 billion of long-term debt coming due and $8 billion of interest -- and the remaining $15 billion will be short-term debt coming due. ¶11. (SBU) The NBU's foreign exchange reserves -- currently about $37 billion -- cannot cover the expected financing need, Shaikh pointed out, and the world's capital markets have all but dried up. Citibank viewed Ukraine's position as critical, and said that the next six to nine months would be the most difficult time for the country, but the situation could improve in the second half of 2009 if world markets stabilize. The NBU had already lost about $1.5 in reserves since October 3 to support the hryvnia. Further devaluation of the currency, which has lost 9.2 percent in recent weeks, was inevitable, Shaikh said. ¶12. (SBU) Shaikh and others were skeptical about the GOU's ability and willingness to effectively address the crisis. He pointed out that the IMF would impose conditions in exchange for an assistance package, but it is still unknown whether the Tymoshenko government and President Yushchenko can jointly agree on IMF stipulations. The institutional rivalry and lack of trust between the NBU and the Ministry of Finance could further complicate matters, he said. ¶13. (SBU) Comment. Bad blood between Yushchenko and Tymoshenko has already colored the domestic political discussion on measures needed to address the potential balance of payments crisis. Yushchenko has openly blamed Tymoshenko. Tymoshenko has tried to downplay the significance of the situation, but is now modifying her position as it becomes clearer that action is necessary. She has suggested that the IMF would expect that Ukraine delay the early elections in return for its support. Ministers from Timoshenko's BYUT-led government, including Viktor Pynzenyk and Oleksandr Turchynov, have spoken out in favor of an IMF deal. Analysts suggest that IMF funding might help them drive through difficult structural reforms on privatization and domestic gas price liberalization, measures normally off-limits for the bloc's populist wing. In any case it is still too early to tell how the economic crisis will influence the political situation in the country. End Comment. TAYLOR