HISTORICAL IMF PACKAGE IMMINENT, MAY NOT BE ENOUGH

C O N F I D E N T I A L KYIV 002142

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA
TREASURY PASS TO TTORGERSON

E.O. 12958: DECL: 10/25/2018
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: HISTORICAL IMF PACKAGE IMMINENT, MAY NOT BE ENOUGH

REF: KYIV 2138

Classified By: AMBASSADOR WILLIAM B. TAYLOR, REASONS 1.4(B) AND (D)


1. (C) Summary. IMF chief envoy Ceyla Pazarbasioglu told
the Ambassador on October 25 that Ukraine,s IMF package may
amount to the second largest ever in IMF history and would be
likely finalized soon, possibly as early as this weekend.
She stated that implementation of the assistance package
would be conditioned on Ukraine,s fractious government
coming to terms on anti-crisis legislation. She predicted
her mission would wrap up by October 29, and that the IMF,s
Executive Board could vote for approval as soon as the week
of November 3. She emphasized that the IMF package alone
will not equip the GOU for needed reforms, restore investor
confidence, or loosen capital flows. Her team requested U.S.
assistance in reaching out to other governments, foreign and
domestic banks, private corporations, and the World Bank as a
necessary supplement to the IMF deal. End Summary.


Funding Scope and Timeline
--------------


2. (C) Pazarbasioglu was unable to comment on an exact
figure, but she said Ukraine,s assistance package would be
the IMF,s second largest and the &quickest8 fund in
history. The IMF,s Executive Board is prepared to take an
immediate vote and, according to Pazarbasioglu, would
undoubtedly be satisfied that the deal is within the IMF
delegation,s pre-approved mandate. The size of the package,
Pazarbasioglu pointed out, would not &shock the markets8 or
restore investor confidence on its own. Any deal needed to
be coupled with a unified message from Ukraine,s politicians
and have concomitant support from the private sector,
domestic and foreign banks, and foreign governments.


3. (C) The IMF team was prepared to conclude its negotiations
on October 25, pending an agreement on terms with President
Yushchenko, PM Tymoshenko, Minister of Finance Pynzenyk, and
National Bank of Ukraine (NBU) Governor Stelmakh. Just as in
previous IMF negotiations with Brazil and Turkey, the
delegation will also request a separate letter from
opposition leader Viktor Yanukovych, pledging the support of
his Party of Regions in the event of a change in government.


4. (C) Pazarbasioglu will remain in Kyiv until October 29 or
30, long enough to ensure that the Rada will pass anti-crisis
legislation consistent with the IMF package. The IMF
Executive Board,s decision could come as soon as the week of
November 3, according to Pazarbasioglu, though she was
uncertain whether the Board had yet set a firm date for its
meeting.


Conditionalities and Political Risk
--------------


5. (C) Pazarbasioglu stressed that implementation and
disbursement of an IMF package hinges on anti-crisis
legislation that has been proposed in the Rada but is still
seemingly far from approval (reftel). Pazarbasioglu
described IMF assistance as &useless8 unless attached to
measures propping up the banking sector and ensuring a
balanced budget. After the IMF reaches agreement with
Ukraine's five signatories (see paragraph 3),and after the
IMF Executive Board approves the agreement and the Rada
passes anti-crisis legislation, an initial disbursement ) up
to one-third of the total package ) could be made almost
immediately. A second tranche would be linked to a balanced
budget, and a third would be released at a later unspecified
date.


6. (C) A prudent fiscal stance and a balanced budget are both
vital, Pazarbasioglu stated, since Ukraine,s government has
to take &measures to give confidence8 to the markets. The
IMF package will not attach specific conditions on fiscal
policy beyond a "balanced budget" (see paragraph 7),except
to ask the government for a two-year suspension on a policy
that links the minimum wage with a subsistence minimum.


7. (C) Pazarbasioglu stated that Rada legislation should
treat the banking crisis in three important ways: it should
have a mechanism for thorough diagnosis and rating of
individual banks; a bank recapitalization program for
troubled but solvent institutions; and a bolstered deposit
insurance fund for clients of the weakest banks that may
inevitably fail. Technical adjustments to the NBU,s
authority would also be needed, so that the NBU would be
certain to make good use of the available monies. She said
that bank recapitalization funding could cause up to a 1.5
percent budget deficit, though this program would be seen by
the IMF as a permissible exception to its conditions for a
balanced budget.


8. (C) IMF conditionalities will require a flexible exchange
rate to partially offset the huge terms-of-trade shock
befalling Ukraine, caused by a collapse in steel prices and
anticipated cost increases for imported Russian gas in 2009.
Pazarbasioglu expects the NBU to move to a flexible rate
policy, though she believes the NBU needs &hand holding8 on
exchange rate liberalization, as it lacks both technical
expertise and political backing.


9. (C) PM Tymoshenko was characterized by Pazarbasioglu as
being "on board," while President Yushchenko &almost
understands8 the gravity of the situation but is being
"pulled the other way by confidants.8 She admitted candidly
that Ukraine,s internal party deliberations and constraints
were &tough (for the delegation) because the IMF is not a
political entity."


10. (C) The Ambassador gave a readout from meetings with
Yanukovych deputies who have been unreceptive to IMF
intervention. Without specifically naming Yanukovych Chief
of Staff Serhiy Liovochkin, with whom the Ambassador met on
October 24, Regions, leaders were described as being opposed
to fiscal belt tightening and a free floating exchange rate.
The Ambassador mentioned that the Yanukovych,s camp believed
Ukraine,s economic troubles could be managed with the NBU,s
$34 billion remaining reserves, and that the IMF package
should not be counted on for disbursement until May. In
fact, according to Liovochkin, the IMF, the U.S., and all the
major financial institutions were at fault for Ukraine,s
economic woes. Pazarbasioglu and the Ambassador agreed that
Liovochkin,s point of view was not reflective of the urgent
need to assist banks and restore confidence in Ukraine,s
markets. Rather, it was indicative of Regions, political
stance prior to possible Rada elections.


IMF,s Interlocutors and Assistance Requests
--------------


11. (C) Pazarbasioglu told the Ambassador that their meeting
on October 25 was her first discussion outside a tight group
of Ukrainian interlocutors. She had held talks with
President Yushchenko (3 times) and PM Tymoshenko (2 times)
and interacted daily with National Bank of Ukraine Governor
Stelmakh and Minister of Finance Pynzenyk. She also has met
with Minister of Economy Danylyshyn, Minister of Energy
Prodan, and top executives at Naftohaz, the state energy
company. Her deputies have had full access to the National
Bank's records, and she characterized Naftohaz,s
transparency as &day and night8 compared to early IMF,s
fears about possible veils of information secrecy. The NBU
was described as "very cooperative, very worried,8 though
Pazarbasioglu added that she herself is also &very worried8
about the central bank whose top layer is solid but
underneath is weak technically.


12. (C) Pazarbasioglu requested the Embassy,s assistance in
cultivating private sector support for Ukraine,s economy,
since the Fund,s program will not contain investor fear or
capital flight on its own. The IMF plans to convene two
separate roundtables early next week: one with bankers,
foreign and domestic; the other with business and industrial
leaders. The goal is for the IMF to brief banking and
industry leaders on the assistance package, as well as
solicit a general message of support from the two groups.
Pazarbasioglu mentioned the possibility of a road show with
major rating agencies and investment banks, likely to be held
in London and New York in November. (Note: IMF resident
representative in Kyiv informed Embassy late on October 25
that Rada Speaker Yatsenyuk will sponsor similar roundtables
for IMF briefings on either October 26 or 27. If the IMF
determines Yatsenyuk,s attendees are satisfactory, it may
cancel plans to hold its own roundtables. End Note.)


13. (C) Separately, the Ambassador gathered G-7 plus EU
ambassadors in Kyiv on October 24. They pledged to
coordinate a G-7 plus EU meeting with the President, followed
by meetings with the Prime Minister and opposition leader
Yanukovych, calling on Ukraine,s leaders to jointly come to
a resolution to the dual economic and political crises.


14. (C) The IMF envoy also expressed a keen interest to meet
with U.S. Treasury officials in Kyiv, in order to discuss
ways to bolster technical assistance in the banking and
financial sector. She felt that the NBU urgently needed
resources and technical collaboration.


15. (C) Pazarbasioglu asked for USG intervention with World
Bank (WB) headquarters to approve a Development Policy Loan
(DPL3). The WB,s funding, presently contingent on a public
procurement law still pending in the Rada, would greatly help
relieve pressures on the supply side in Ukraine,s economy,
as well as complement the IMF,s demand side actions.


16. (C) The Ambassador met later on October 25 with WB
resident representative Martin Raiser, who indicated that the
WB was prepared to approve a $500 million DBL3 loan by the
end of 2008. The WB was standing firm on principle, he said,
and saw the public procurement law as a necessary
anti-corruption measure. Raiser suggested a draft law in the
Rada was ready for approval but opposed by vested interests,
particularly deputies in Tymoshenko's BYuT faction.

Comment
--------------


17. (C) Pazarbasioglu,s clear message was that the IMF
package, while precedent setting, will nonetheless fall short
of achieving the Fund,s ultimate goal of propping up
Ukraine,s faltering economy. Only a concerted effort by all
parties with a stake in the country,s stability will stave
off a further unraveling. Pazarbasioglu believes the IMF
should convene key private sector actors while still on the
ground in Ukraine, but it has turned to the U.S. to help
generate sufficient World Bank support and provide needed
technical expertise. End Comment.


TAYLOR
TAYLOR