UKRAINE: SCENESETTER FOR THE VISIT OF THE

C O N F I D E N T I A L KYIV 000606 SIPDIS SIPDIS E.O. 12958: DECL: 03/19/2018 TAGS: PREL PGOV PHUM OVIP UP SUBJECT: UKRAINE: SCENESETTER FOR THE VISIT OF THE PRESIDENT AND THE SECRETARY TO KYIV Classified By: Ambassador for reasons 1.4(a,b,d). ¶1. (C) Summary. Your visit to Kyiv provides a historic opportunity to acknowledge the democratic transformation that has occurred in Ukraine since the Orange Revolution and to encourage further steps to consolidate reform and bring Ukraine fully into Europe. You will encounter intense interest in the position of the United States and NATO's response regarding the Ukrainian request for a Membership Action Plan (MAP) at the Bucharest Summit. The January 15 publication of a letter to the NATO Secretary General requesting a Membership Action Plan at the April 2007 Bucharest Summit, signed by President Yushchenko, Prime Minister Tymoshenko and Rada Speaker Yatsenyuk, has brought NATO issues to the forefront in Kyiv. If Allies agree to grant Ukraine a MAP at Bucharest, your visit will spark new confidence among Ukraine's elite that Ukraine's westward course is assured; this would be a major personal victory for President Yushchenko who has staked Ukraine's future security on eventual NATO membership. If NATO does not agree at Bucharest to give Ukraine a MAP, your visit will be critical to reassure Ukraine's elite, particularly President Yushchenko, that we will continue to demonstrate our strong support for Ukraine moving closer to NATO and Europe. Although united on NATO, orange allies Yushchenko and Tymoshenko have sparred over everything from Russian gas to personnel appointments leading to strains in the coalition. ¶2. (SBU) Your visit can do much to validate the President and Prime Minister's commitment to ensure that Ukraine is a part of Europe, has a realistic goal in eventual NATO membership, and is ready to pursue further economic and political reforms. You will also be able to encourage former PM Yanukovych to lead a constructive opposition and have a chance to meet one of Ukraine's young political stars -- 33-year old Speaker of the Parliament Arseniy Yatsenyuk. You will see Ukraine's main UNESCO heritage site, St. Sophia's Cathedral, and get a taste of Ukrainian culture before meeting young Ukrainian students working with the Peace Corps to spread the message of the danger of HIV/AIDS. Your visit will also help us reach agreement on a Road Map for our bilateral relationship, an agreement on cooperation in space, approval of a new Trade and Investment Framework Agreement, the return of the Overseas Private Investment Corporation (OPIC) to Ukraine, and the conclusion of two commercial contracts with U.S. firms on nuclear fuel supply and spent fuel storage that will break two long-standing Russian monopolies. We suggest the following main messages for your meetings: -- We applaud Ukraine's democratic development and progress in political and economic reform and support Ukraine's movement toward Europe and NATO. -- There will be a positive outcome for Ukraine at Bucharest, whether or not Allies agree to support Ukraine's request for MAP. -- We want to see the President, Prime Minister, and Rada work together to ensure an effective government. End summary. United on MAP, but Strains in Other Areas -------------- ¶3. (C) Orange Revolution allies President Yushchenko and Prime Minister Tymoshenko united forces following an unexpectedly strong showing by Tymoshenko's political bloc in the September pre-term parliamentary elections. They formed a coalition and established a government with Tymoshenko at the head as Prime Minister, recreating their post-Orange Revolution alliance. All eyes are on whether Prime Minister Tymoshenko and President Yushchenko can work together better than they did in 2005, when Tymoshenko was dismissed after seven months of infighting; thus far, Tymoshenko has been particularly cooperative in responding to presidential initiatives. Ukraine's complicated constitution divides executive power between the President and Prime Minister, with the President taking the lead for foreign and security policy and the Prime Minister having responsibility for the economy and social programs. Although the three main political forces advocate similar approaches to economic reform and a foreign policy that calls for greater integration into Europe, all the players are also keeping their eye on the next presidential election in early 2010. ¶4. (C) President Yushchenko has a reputation as a visionary and is the one Ukrainian leader who has had a solid unwavering commitment to seeing Ukraine in NATO and the European Union. He has been the driving force behind Ukraine's request for a MAP at Bucharest and has been tireless in making the case both at home and abroad. In Yushchenko's view, NATO membership is the only thing that can guarantee Ukrainian sovereignty and territorial integrity for the long run. Nearly recovered from his 2004 dioxin poisoning, Yushchenko's scarred face continues to clear up and his health appears to have improved dramatically. Yushchenko remains the country's best-known symbol and proponent of a democratic future for Ukraine. However, his detached leadership style and willingness to engage in backroom political deals have resulted in low poll ratings and this visionary president is now worried about his chances for reelection. With presidential elections less than two years away, Yushchenko does not trust his populist, ambitious and increasingly popular Prime Minister. This has led to tensions within the coalition and a lack of cooperation on many issues -- although both sides continue to profess publicly that the orange coalition is viable and functioning. ¶5. (C) Firebrand Yuliya Tymoshenko, returning to political center stage after two years in opposition with her trademark braided hairstyle intact, hit the ground running after her December 18 confirmation as Prime Minister in a restored orange coalition. She got a budget passed in eight days, completed her government program for the upcoming year, which was sent to the Parliament for approval, and is making progress in fulfilling campaign promises, such as to return lost savings from the defunct Soviet-era state savings bank. As a result, her popularity in the country continues to grow. Tymoshenko signed the joint letter with the President asking for a MAP, has lobbied European leaders in support of Ukraine's request, and shares Yushchenko's opinion that in the long term, only NATO membership can guarantee Ukraine's sovereignty. However, she has been more cautious about making strong public statements in favor of MAP, arguing privately that President Yushchenko and his team in the Secretariat will use her support for MAP against her if the SIPDIS coalition collapses and she decides to run for president herself. ¶6. (C) Former Prime Minister Yanukovych, Yushchenko's unsuccessful rival in the 2004 fraudulent presidential election that led to the Orange Revolution, remains in the wings, adopting a public anti-NATO stance that plays well to his Russo-centric electoral base in the east while negotiating hard behind the scenes to return to power in alliance with the President. After the MAP letter was disclosed, Yanukovych and his opposition Party of Regions used the NATO issue as a pretext to block the Parliament's work for most of February. In its turn, the coalition criticized Yanukovych for his about-face on the NATO issue, rightly pointing out that in his most recent turn as Prime Minister, his government openly supported closer ties with NATO, although stopped short of requesting a MAP. Yanukovych has argued that he made a deal with Yushchenko to support pre-term elections in exchange for a coalition between his Regions Party and the President's party. However, Tymoshenko's strong showing scuttled those plans, leaving Yanukovych on the political sidelines. ¶7. (C) Rada Speaker Yatsenyuk represents Ukraine's political future. Although only 33 years old, he has been head of Ukraine's National Bank, the Minister of Economy and the Minister of Foreign Affairs. A Yushchenko loyalist, Yatsenyuk was rumored to have been a reluctant candidate to be the Speaker of the Parliament, arguably the third-most important political job in the country after the President and Prime Minister, accepting the job only after the President asked him to do so. Although having little prior parliamentary experience, Yatsenyuk is a quick study and appears to be making progress in forcing a strongly divided legislature to function. With his commitment to western ways of doing business and his flawless English, Yatsenyuk is an example of Ukraine's impressive new generation of political leaders. Some already see him as a future presidential candidate. A Booming Economy with Worrisome Inflation Numbers -------------- -------------- ¶8. (SBU) Despite the political uncertainty of the past three years since the Orange Revolution, the overall economy has been growing strongly. The economy remains buoyant with real GDP growth in 2007 of 7.2%. Growth has been fueled by higher prices for steel (Ukraine's chief export),and strong private consumption spurred by rising pensions and wages. The consumption boom has kept inflation above 10% for the past four years, reaching 16.6% in 2007 and up to 21% in February 2008, and led to a surge in imports. The Tymoshenko government has continued the practice of previous governments in budgeting generous wage and pension increases that far outstrip growth in labor productivity. Ukrainian banks are expanding rapidly, and their aggressive lending policies are fueling a real estate boom of questionable sustainability. A major drop in world steel and chemical prices, possibly abetted by contagion from the worldwide credit crisis that might threaten foreign borrowing by Ukrainian banks and companies, poses the main risk to the economy in the mid-term. ¶9. (SBU) One of our primary goals has been to support Ukraine's integration into the world economic system, and Ukraine is in the final stages of acceding to the World Trade Organization; only formal ratification by the Parliament remains, and is expected to occur within months. Although all major political parties advocate reform, the pace of structural economic reform remains slow and political leaders have resorted to administrative measures, such as restricting exports of grain and sunflower oil and seeds to combat rising bread and edible oil prices. The World Bank recently ranked Ukraine 139th out of 178 countries as a place to do business. The U.S. Overseas Private Investment Corporation (OPIC) suspended business in Ukraine over the GOU's failure to pay compensation for an insurance claim. The GOU has now said it wants to bring OPIC back into Ukraine quickly, yet concrete progress to solve the issue has been slow. State administration of the economy is still heavy-handed, and both the tax system and commercial law are in need of a major overhaul. The failure of the tax authorities to refund value-added-tax to U.S. firms on a timely basis, for example, is causing some companies to rethink their investment strategies in Ukraine. State regulation of the economy is sometimes openly corrupt. Although the overwhelming majority of companies are now in private hands, the privatization of remaining state-owned enterprises is politicized and often corrupt. The main obstacles to accelerated reform are universally understood in Ukraine, however, and looking forward, the ongoing modernization of commercial life and the opening of the economy to the outside world will likely lead to a continuation of gradual, if uneven, economic reform. Russia and Energy Security -------------- ¶10. (SBU) The geopolitics and economics of energy continue to play a central role in Ukraine. Energy consumption per capita remains the highest in the world, and the energy infrastructure is decaying, yet every government to date has struggled to reform the mismanaged, corrupt and non-transparent energy sector. The problems facing the sector are well-understood, however, and the most recent gas deal with Russia, which foresees the removal of a particularly questionable and non-transparent intermediary is a noteworthy accomplishment of the Tymoshenko government. The Ukrainian private sector, particularly the steel industry, has begun to invest in energy efficiency. Ukraine remains heavily dependent on gas and oil imports from Russia and Central Asia, and is the main transit country for Russian gas and oil shipments to central and western Europe. Ukraine has traditionally charged Russia an extremely low rate for gas transit in return for Russian willingness to sell it gas below world prices. Nominal import prices for gas have increased from $50/thousand cubic meters (tcm) in 2005 to $179.50/tcm and beyond in 2008, and Russia has signaled it wants to eventually move to price levels charged to Western European customers. Russia clearly wants to take control of Ukrainian energy infrastructure, and has been putting pressure on Ukraine by proposing new pipelines in the Baltic and Black Seas that could circumvent Ukraine's pipelines. Most Ukrainian policymakers agree that Ukraine must diversify its sources of energy and move towards a market-based energy relationship with Russia, but Kyiv has yet to develop a long term strategy on how to achieve these goals. ¶11. (SBU) We have encouraged Ukraine to open its energy market to more foreign investment. Few Ukrainian energy companies have the technical and financial resources to bring domestic production up to potential, but foreign direct investment levels remain low. There are some bright spots, however: Houston-based Vanco in October 2007 signed Ukraine's first-ever production sharing agreement for oil and gas exploration in the Black Sea, and New Jersey-based Holtec hopes to sign a contract amendment in the near future for certification and deployment of spent fuel management systems to store used fuel from Ukrainian reactors. Within the framework of the USG-supported Nuclear Fuels Qualification Project, Westinghouse is finalizing a contract to supply nuclear fuel to Ukrainian reactors, all of which currently receive their fuel solely from Russia. Forces within the Ukrainian energy establishment, likely acting at the behest of Russian interests, had been trying to torpedo both the Westinghouse and Holtec projects, but Tymoshenko's government is moving to complete these contracts before your visit. These projects' success, or lack thereof, will be important signals whether Ukraine has the will to move towards more energy diversity in the face of Russian geopolitical and economic interests. ¶12. (U) Visit Embassy Kyiv's classified website: www.state.sgov.gov/p/eur/kiev. Taylor