IMF SIGNALS UKRAINE PROGRAM OFF TRACK

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001519 SENSITIVE SIPDIS DEPT FOR EUR, EUR/UMB, EEB/OMA E.O. 12958: DECL: 09/03/2019 TAGS: EFIN EREL ETRD PGOV PREL UP XH SUBJECT: IMF SIGNALS UKRAINE PROGRAM OFF TRACK REF: KYIV 1487 Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and (d) ¶1. (C) Summary. The IMF mission team concluded its visit in Kyiv on September 4 without a major public announcement, but close observers have acknowledged to us that the Fund's program may have gone off track. The visit was originally envisioned as a visit to provide technical assistance and oversight for the Ministry of Finance's 2010 draft budget, a source of unease for the IMF in the run-up to Ukraine's January 2010 presidential elections. Nonetheless, growing concerns about Ukraine's lack of fiscal discipline, its non-transparent financial sector activities, and unfulfilled promises on gas pricing reforms (reftel) caused the IMF to dispatch mission director Ceyla Pazarbasioglu. Talks with Ukraine's authorities have been characterized to us as "difficult" and a way for the Fund to begin "saving face." End summary. IMF PULLING BACK? -------------- ¶2. (SBU) Over the course of this week's negotiations, the IMF has made no formal statements to the public. However, on August 31, IMF resident representative Max Alier sharply criticized Ukraine's authorities for deviating from agreed upon actions, alluding to the possibility that the Fund would postpone additional disbursements or pull the plug on its program altogether. Analysts have speculated that Alier's statements were an opening salvo, intended to set the stage for a tougher stance by Pazarbasioglu. ¶3. (C) IMF banking advisor Jochen Andritzky told Econoff on September 4 that Pazarbasioglu had come to Ukraine to monitor the Ministry of Finance's progress on the 2010 budget. When pressed, however, Andritzky quickly acknowledged that Pazarbasioglu, in fact, had been concerned about the whole IMF program and was dispatched to assess progress on broader conditionalities. The Kyiv-based Andritzky could not say whether Pazarbasioglu had taken a strong line on the lack of gas price increases, or how the IMF would deal with the monetization of the country's fiscal deficit. But he did agree that there was a "growing consensus" that Prime Minister Tymoshenko had extracted money from the IMF while offering very little in return. Recognizing the GOU may have the ability to weather its financial storms in the months �00A;before the presidential election without another loan tranche, Andritzky did not discount the possibility that a lack of action by the GOU would force the Fund to suspend its lending. He pointed to IMF shareholders as the source of political pressure to be "soft" on Ukraine, especially those with significant banking exposure. ¶4. (C) Other embassy sources close to the IMF negotiations indicated that Pazarbasioglu had expressed her dismay about the "lies" of the government. Pazarbasioglu reportedly told former Finance Minister Viktor Pynzenyk that Prime Minister Tymoshenko had "misled" the IMF mission in July regarding her government's willingness to hold down the budget deficit and enact gas price reforms. ¶5. (C) EBRD's principal economist (and former IMF senior economist) Alex Pivovarsky told us on September 4 that Pazarbasioglu had characterized Ukraine's actions as having "crossed a boundary." Pazarbasioglu apparently said that she had "put her trust" in the Prime Minister but had been "taken advantage of." Pivovarsky further commented that the talks with the National Bank of Ukraine (NBU) and the GOU had been described to him as "difficult -- just short of yelling sessions." According to the EBRD's conversations with colleagues in Washington, Pazarbasioglu's tougher stance reflected the belief among senior IMF officials that this mission trip was a way for the Fund to begin "saving face." ¶6. (C) London-based Pivovarsky said that the EBRD had already calculated that the IMF program would go off track. He said that despite the "significant carrot" of $3.8 billion (2.5 billion SDR) that had been slated for November disbursement, there was little chance of a fourth tranche before the presidential January election. The Fund simply was "paying the price for the political consequences of its decisions," he said, alluding to the "flexibility" the Fund has shown to date with Ukraine. In the EBRD's view, the IMF had no other choice than to walk away before the elections. KYIV 00001519 002 OF 003 It would be a "disservice to the country" to refrain from pushing Ukrainian authorities to adopt policies necessary to stabilize the country. NBU ACTIONS PARTICULARLY EGREGIOUS -------------- ¶7. (C) In two meetings this week with Acting NBU Governor Shapovalov, Pazarbasioglu apparently raised concerns about NBU interventions in the forex market, which IMF banking advisor Andritzky said had been implemented in a "confidence destroying" manner. The IMF reiterated its call for all banks to have equal access to NBU refinancing at market rates. In recent weeks, Shapovalov had publicly acknowledged that the NBU continued to sell foreign exchange below UAH 8/$1 dollar to undisclosed recipients, who presumably then would have pocketed the arbitrage. Andritzky told us he had informally floated the idea of adding a new IMF conditionality on refinancing disclosures, which he said had been well-received in the banking community. He also said that the IMF was toying with the idea of monitoring the banking system at the "micro" level to better root out NBU-fostered theft. Equating these two actions to what the Fund would require of a country like Afghanistan, Andritzky commented that the level of corruption in Ukraine could "hardly be worse." ¶8. (C) Even after receiving entreaties to clean up its forex interventions, NBU Vice Governor Krotyuk apparently urged Pazarbasioglu to go public with commentary about the state of the IMF's Ukraine program. Andritzky told us that the NBU perceives that it is doing a "splendid" job fighting the crisis, especially compared to the "botched" handling of the budget by the Tymoshenko government. Krotyuk had expected that the IMF would publicly compliment the NBU. Pazarbasioglu apparently declined to offer comment. PRESSURES ON BUDGET, CURRENCY EVEN WORSE -------------- ¶9. (C) On September 3, Pynzenyk told our source, BNP Paribas head of office Dominique Menu, that the GOU's budget figures had become more and more unrealistic, and that there had developed an imperative to cut spending, increase public debt, and push privatizations. The former Finance Minister called the GOU's current efforts of monetizing the budget deficit, estimated to be at least 3% of GDP thus far in 2009, to be extraordinarily dangerous, particularly in an environment where GDP declines in the first half of 2009 may mean that the GOU has over UAH 27 billion (roughly $3.1 billion) less revenue than expected. Analysts project Ukraine's deficit will grow to between 6-8% of GDP (not counting bank recapitalizations and Naftohaz debt) by the end of 2009. ¶10. (C) Menu said that he and other foreign bankers were especially concerned about a rapid depreciation of the hryvnia, which is already the world's worst performing currency of late. Pivovarsky expected that the hryvnia would overshoot due to market concerns about the IMF program and Ukraine's budget and banks, though he expected the currency would recover in early 2010 if investor confidence rallied. The overshooting would be painful for banks that had extended sizable foreign currency-denominated credits. Pivovarsky predicted balance sheets would worsen and more recapitalization of banks would be necessary. He questioned the will of foreign-owned banks to ante up another round of cash, if the NBU did not demonstrate it would enforce the same capital adequacy requirements for Ukraine's domestically-owned banks. ¶11. (C) The IMF expects the hryvnia exchange rate to hit UAH 9/$1 dollar, which Andritzky characterized as the equilibrium rate that "we have all been expecting -- though perhaps not this soon." However, Andritzky did not discount that the exchange rate would overshoot, in part as a result of the NBU's non-transparent measures and its inability to rein in the "lack of trust" in the market. He said some traders had held off selling dollars all week, but some had begun to come back into the market on September 4 as the inter-bank rate approached UAH 9/$1 dollar. YUSHCHENKO WEIGHS IN -------------- ¶12. (SBU) President Yushchenko told journalists on September KYIV 00001519 003 OF 003 3 that Tymoshenko's government had "seriously undermined" cooperation with the IMF, suggesting that Ukraine had failed to meet five of six conditionalities that were necessary for disbursing the Fund's fourth loan tranche. Without specifically naming any preconditions, he insinuated that Tymoshenko's government had been unable to "rationalize" its budget goals. Alluding to Russia, Yushchenko also warned of "foreign markets" that would offer "non-transparent" loan conditions, suggesting that Tymoshenko and Putin had come closer to a finalizing a bilateral financing deal that would include the GOU "trading" what he called "national assets." The President said he would attempt to stop any privatizations of chemical or power generation plants and would oppose the sale of Odesa Portside Plant, rumored to be of interest to Russian industrial concerns. GOU DEFENDS ITS RECORD -------------- ¶13. (U) On September 3, Deputy Prime Minister Hryhoriy Nemyria denied reports that the IMF had expressed formal concerns about the implementation of its lending program. He commented that the IMF had not sent a letter to Ukraine expressing dissatisfaction with Ukraine's failure to raise domestic gas prices. Nemyria told reporters that Pazarbasioglu had noted to him personally that she did not wish to give interviews in Ukraine or send official letters to the authorities. Nemyria said that the IMF mission visit was related to consultations on the 2010 budget and was not a program review, which would remain slated for late October or early November. G-7 MEETING WITH IMF -------------- ¶14. (SBU) The IMF's Pazarbasioglu and Alier have scheduled a brief with G-7 and E.C. ambassadors on September 5 in Kyiv. Embassy Kyiv will attend and report septel. COMMENT -------------- ¶15. (C) The IMF may have had no other choice than to send a hard-hitting message to the Ukrainian authorities. The bulk of the Fund's conditionalities have been left undone, and Ukrainian officials have given no impression they will take on any tough decisions before the January 2010 presidential election. The Fund may have concluded that it would be better for both Ukraine and the IMF's long-term interests if the program temporarily goes off track than for more liabilities to migrate to the public balance sheet without the necessary, concomitant reforms to spur growth. PETTIT