KYIV POPULISM COULD TRIGGER "FISCAL DEVASTATION"

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001835

SENSITIVE
SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 10/20/2019
TAGS: EFIN EREL ETRD PGOV PINR UP XH
SUBJECT: KYIV POPULISM COULD TRIGGER "FISCAL DEVASTATION"

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


1. (SBU) Summary. Ukraine's shaky IMF program took another
direct hit, after the Rada (parliament) enacted legislation
to significantly increase budget spending for pensions and
public sector wages. The IMF said the measure would lead to
"fiscal devastation," while the World Bank estimated an
increased government deficit of "at least a couple"
percentage points of GDP. Tymoshenko, whose BYuT faction
unanimously voted against the law, dubbed the move an "atomic
bomb" for Ukraine's budget. Deputies from the Viktor
Yanukovych-led Party of Regions provided overwhelming support
for the law, together with members from OU-PSD, the Communist
Party, and the Lytvyn Bloc. All eyes are now turned to
President Viktor Yushchenko, whose advisors have given mixed
signals about whether the President intends to veto the law.
End summary.

DETAILS OF THE LAW
--------------


2. (U) The Rada passed legislation on October 20 to increase
public sector wages and pensions. The law provides for an
initial rise in the monthly minimum wage from UAH 669 ($83)
to UAH 744 ($93) on November 1, 2009, with subsequent
quarterly augmentations in 2010. The increases would
continue until the minimum wage reached UAH 922 ($115),a 38%
total rise. According to the law, pensions would increase
47% by the end of 2010. The current minimum monthly pension
is UAH 498 ($62),which would rise in pace with minimum wage
increases until reaching UAH 734 ($92). The social spending
law was unanimously supported by the Party of Regions (172),
Communist party (27),Lytvyn bloc (19),and the
pro-presidential half of Our Ukraine-PSD (33).

IFI REACTION
--------------


3. (SBU) IMF budget expert Igor Shpak told Econoff on
October 21 that the law, if signed, would lead to "fiscal
devastation." Nonetheless, the Kyiv-based official said that
the IMF had concerns President Yushchenko would succumb to
pressure and sign the law. IMF staff and mission team
members were "hoping" Yushchenko's training as an economist
would outweigh short-term political considerations. Shpak
acknowledged that IMF envoy Ceyla Pazarbasioglu, currently in
Kyiv to assess Ukraine's $16.4 billion Stand-By Arrangement,
had been actively engaged on the issue with the Presidential
Secretariat.


4. (SBU) World Bank senior economist Ruslan Piontkivsky
similarly commented that the law's potential impact was "at
least a couple" of percentage points of GDP for 2010. He
expressed concern that such additional budget allocations
would make the 2010 deficit too large to be financed by
non-inflationary means, and he hoped that Yushchenko would
veto the law.

BYUT OPPOSITION
--------------


5. (U) Prime Minister Tymoshenko's bloc (BYuT) and the
pro-coalition wing of OU-PSD refused to vote for what the PM
called an "atomic bomb" for the state budget. BYuT
representatives publicly called on President Yushchenko to
veto the legislation.


6. (SBU) Deputy Prime Minister Turchynov stated the measure
would cost UAH 8 billion (nearly $1 billion) in 2009 alone
and could lead to substantial hryvnia emission and inflation.
Turchynov also noted that the measure had the potential to
"ruin" Ukraine's financial system. Deputy Finance Minister
Voldymyr Matviychuk said that the measure would require UAH 8
billion in additional funding in 2009 and UAH 71 billion
(roughly $8.6 billion) in 2010. In order to find the money
to implement the law, Matviychuk speculated that the
government would need to lay off 45% of public sector
employees (teachers, doctors),an amount equal to 1.6 million
jobs.


7. (SBU) BYuT MPs had told us on October 6 that they had
allowed the measure to go forward beyond a first reading in
exchange for Regions' guarantees to unblock the Rada's
rostrum. BYuT's legislative agenda, particularly related to
the 2010 budget law, had been stymied for weeks by Regions'

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demands for social spending increases.

PROPONENTS MORE SANGUINE
--------------


8. (SBU) Contrary to dire projections by the Cabinet and
Ministry of Finance, Party of Regions' shadow Finance
Minister Azarov downplayed the law's fiscal effect, saying
the measure would cost UAH 5.5 billion (UAH 2 billion to
raise minimum wages and 3.5 billion to raise pensions). The
author of the law, Lytvyn Bloc's Oleh Zarubinskiy, said that
the increase could be funded with cuts to Presidential
Secretariat and Cabinet of Ministers expenditures (by UAH 1
million and 17%, respectively).

PRESIDENT UNDECIDED
--------------


9. (SBU) The President will likely receive pressure from a
variety of sources. His own faction members from OU-PSD
voted in favor of the pre-election spending increases. On
the other hand, the President will have to contend with the
IMF's concerns about the fiscal impact of the law.


10. (C) Deputy Head of the Presidential Secretariat Igor
Popov told Poloff that the Secretariat had held an October 21
meeting on the law and was "split 50/50." Popov, who also
serves as the President's representative to the Rada, said
that Yushchenko had not determined whether to veto the law.
While the President understood the law's "horrible" financial
implications for the budget, Popov implied that the politics
of the presidential campaign could drive Yushchenko's
decision making. Throwing his hands up in the air, Popov
declared "that's populism for you." The Presidential aide
said Yushchenko had determined he would remain "silent" in
the coming days before making a final decision.


11. (C) Roman Zhukovskiy, a senior economic advisor in the
Presidential Secretariat, publicly indicated on October 20
that the Secretariat would propose to veto the bill.
Zhukovskiy noted to us on October 21, however, that the
President was "awaiting a more detailed study" of the law.
He acknowledged that the measure could be considered a "major
threat to state finances," but that it was not the only one
of the sort the President had contended with. Zhukovskiy
admitted that he was personally opposed to the law and that
he would continue to lobby against a Presidential signature.


12. (SBU) If Yushchenko were to veto the law, it is unclear
whether Regions and the other groups in support of the law
could muster support to override. Deputy Speaker Oleksandr
Lavrynovych (Party of Regions) purported he had located
enough Rada MPs to push through an override. Yet, Rada
watchers have noted that Regions and its allies would have to
whip up roughly 50 additional votes, a tough task that would
require significant horse trading.


13. (U) The President also could rely on technical means to
thwart final adoption of the law. Rada procedures require a
bill's drafter to determine sources of financing and estimate
the budget impact of a potential law. No such determinations
were provided with the draft law on social spending.
Furthermore, the Rada's legal committee has noted that
current Ukrainian legislation requires the minimum wage and
pension rate be set in conjunction with the current budget
law, an action that had not been completed prior to passage.

COMMENT
--------------


14. (SBU) It is difficult to fully assess the fiscal impact
of the law, since it remains uncertain whether higher pension
earners would be re-indexed according to the pension minimum.
The World Bank's Piontkivsky's estimation of roughly 2% of
GDP expenditure increases did not account for re-indexed
pensions at all levels. Perhaps a better indicator for the
law's potential effect would be the Ministry of Finance's
projections of general re-indexed pension rate adjustments,
which would add roughly UAH 71 billion (nearly 7% of GDP) in
budget obligations.


15. (C) Given the law's expected popularity among key voting
constituents and the difficulty Tymoshenko's government would
have in fulfilling its terms, Yushchenko may decide to let it
pass. In this case, Tymoshenko would need to come up with
extra cash for pensioners by November 1, putting at greater

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risk the government's ability to pay for other obligations.
Regions appears to be betting that the President and
Tymoshenko will suffer politically in any case.
PETTIT