IMF STOCKTAKING

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 001531

SIPDIS

DEPT FOR EUR/UMB, EEB/OMA

E.O. 12958: DECL: 09/07/2034
TAGS: ECON EFIN PGOV PREL UP XH
SUBJECT: IMF STOCKTAKING

REF: KYIV 01519

Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b)
and (d)


1. (SBU) Summary. IMF's Resident Representative in Ukraine,
briefing on mission director Ceyla Pazarbasioglu's
"stocktaking" visit to Kyiv, commented that he has doubts
about Ukraine's intention to live up to its commitments and
expressed concern over Ukraine's ability meet its budget
obligations past September. He observed that bank
recapitalizations were proceeding relatively well and that
tax and pension reform committees had been formed and were
meeting. However, the independence of the central bank and
its ability to withstand pressure to monetize budget
shortfalls remained uncertain. As a result of unmet
commitments, the IMF is considering where to draw the line as
it approaches negotiations for the fourth tranche. End
Summary.


2. (SBU) Max Alier, the IMF's Resident Representative in
Ukraine, briefed the US, UK, French, German, Canadian, and
European Commission diplomatic missions in Kyiv on Saturday
afternoon. Alier reported on the September 1 - 4 visit of an
IMF team to Kyiv to assess the state of the IMF's standby
program in Ukraine. The IMF visiting team was led by Ceyla
Pazarbasioglu who has headed the previous IMF Mission visits
to Ukraine.


3. (SBU) Alier stressed that the staff visit was not a
negotiation but what he called a "stocktaking" of the IMF
program and preparations for a late October visit to Kyiv,
when a formal IMF review mission and negotiations concerning
a fourth IMF tranche will occur. Alier stated that the past
week of meetings between the IMF and GOU (from the "PM on
down") had been intense and had not gotten off to a good
start when a Ukrainian paper on August 31 published an
interview Alier had given to it earlier on August 7. Alier
in his interview comments had noted that the IMF would not be
a party to an irresponsible GOU budget.


4. (SBU) Gas prices: The first "bad news" from the visit
was the GOU's failure to implement a commitment to raise gas
prices for households by 20% on September 1. The GOU claimed
a failure to win trade union approval of the increase as
required by "law" and a court injunction against the NERC
prevented the increase. GOU officials said they planned to
implement a promised 20% increase on energy producers on
October 1 which does not face the same legal hurdles. Alier
could not reconcile what GOU officials had told him this past
week about gas prices and PM Tymoshenko's earlier statement
in western Ukraine that there would not be a gas price
increase before January 2010 elections. Alier volunteered
that if the GOU really wanted to do something that it seemed
always to find a way to do it, but he could envision a
situation where the barriers to a price increase on household
gas could drag on "forever".


5. (SBU) Fiscal Situation: Alier noted the GOU fiscal
situation is "very tight" and "they cannot make it on their
own," and as such the GOU must get a fourth IMF tranche or
find another funding source. The recent payment for August
gas had come from a VAT refund due Naftohaz, which in turn
used it to pay Gazprom. Alier said September will be "tight"
and "we'll see what they do in October". He expects Ukraine
will "close the tap" and import little Russian gas in
September, and that October will be a very difficult month
for the GOU, as a fourth tranche of $3.8 billion, if
approved, can only be disbursed in mid-November. Alier noted
that negotiations over a fourth tranche, which the GOU wants
to be used solely for budget support, will be difficult.
Alier speculated that Tymoshenko has been negotiating with
Putin to win Russian financial aid, and that she would "care
less" about the IMF program if she could find bilateral funds
to fund the budget.


6. (SBU) 2010 Budget: Alier indicated it is too soon to
review the GOU's 2010 budget. The IMF wants the GOU to
produce a 2010 budget with no more than a 3.0% budget deficit
(4% with Naftohaz subsidies included),but the GOU has been
indicating a 3.75% (before Naftohaz subsidies) deficit is in
order. Alier added that the GOU's revenue projection for
2010 was "quite large" and that the numbers would get closer
scrutiny from an IMF budget team that will visit Ukraine this
week. The Cabinet of Ministers faces a September 15 deadline
to submit a budget to the Rada (parliament).


7. (SBU) Bank Recapitalization: Alier expects that bank

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recapitalization will be completed by the end of 2009 and
that the 2010 budget will not have to take account of funds
for bank recapitalization. He expects the resolution process
at UkrpromBank would be completed first, which is a less
complicated situation than that at Nadra Bank. Alier added
the NBU will handle small problem banks and that these were
not really recapitalizations, as the banks will be merged or
liquidated.


8. (SBU) NBU Independence: Alier noted the NBU, which falls
under President Yushchenko's purview, thus far was "not
cooperating fully with monetizations." The NBU had not
implemented a recently passed law requiring it to provide UAH
10 billion to fund the hosting of the Euro 2012 soccer
tournament, and the NBU had not delivered on an alleged deal
between PM Tymoshenko and NBU Head Stehlmakh to monetize the
repayment of Naftohaz bonds. Alier believes that NBU
monetization of the budget gap is "not a high possibility,"
but whether the NBU can ultimately resist pressure to
monetize the budget gap remains to be seen. Alier stated it
will be a matter of public relations, claiming that if the
GOU could not pay wages in the autumn it would blame the NBU,
thus placing the NBU in the position of defending its
policies. Alier noted the Rada had failed to pass
legislation ensuring the NBU's independence, a condition of
the IMF program, and that GOU-NBU tensions were "running
high." He also observed Stehlmakh was "on vacation" again
and apparently not involved in day to day NBU operations.


9. (SBU) Exchange Rate: Alier said "liquidity injections"
and "panic in the population" were driving recent hryvnia
depreciation. Repetition by television stations (which Alier
characterized as owned by oligarchs with export oriented
businesses that would welcome further depreciation) of
stories about an autumnal decline of the hryvnia could become
a self fulfilling prophecy. Alier noted the NBU's official
exchange rate "makes no sense" and does not comply with the
IMF condition that it be kept within 2% of the market rate,
and the NBU was facing the issue of "how much do you let it
go" in terms of UAH depreciation.


10. (SBU) Budget Code: The GOU, according to Alier, is
trying to "sneak by" again a new budget code that would allow
more funds to be sent to the regions. The IMF is not opposed
to decentralization, but the proposal is not the way to do
it. Tymoshenko was meeting with 12,000 local government
officials this week.


11. (SBU) Bright Spots: Alier said that committees to work
on pension reform and tax reform are formed and were meeting.
However, he did not expect any substance out of the reform
committees before the January 2010 elections. He also
indicated that the GOU had agreed to a "monitoring committee"
where the IMF meets all with all parts of the government
affected by an issue (the committee membership changes with
the issue) and that in fact the commission had met with the
IMF team during their visit. Alier expressed the hope that
the monitoring committee would begin regular biweekly
meetings with the IMF team.


12. (SBU) Istanbul Meetings: Alier sees no serious
negotiations between GOU and IMF in Istanbul, as relevant
staff (including Pazarbasioglu and Alier) will not be there.


13. (SBU) The Executive Board: Pazarbasioglu will consult
with IMF management in Washington, and several Executive
Directors already have requested meetings with her. Alier
believes a "decision" regarding the direction of the IMF
program in Ukraine cannot wait until November and he expects
IMF management will "be reaching out to capitals" and that
the IMF Mission to Ukraine will soon "get some parameters"
from Washington. Alier noted that a decision regarding
"where you draw the red line" is needed from Washington, and
then added that when the IMF leaves a country it does not
formally announce that it is walking out.


14. (C) Comment: In the run-up to Ukraine's January
presidential election, it is difficult to envision PM
Tymoshenko making the hard, necessary reforms to which she
has previously committed, even if the IMF threatens to walk
away from future disbursements. As Alier alluded, if
negotiations for the IMF's fourth tranche prove to be
difficult, PM Tymoshenko will attempt to secure other funding
sources -- including bilateral support from Russia -- as well
as pressure the NBU to monetize any budget shortfall. Such
actions by Tymoshenko would be a significant setback for the
reform process in Ukraine. End Comment.
PETTIT