Identifier
Created
Classification
Origin
09KYIV1910
2009-11-04 14:18:00
CONFIDENTIAL
Embassy Kyiv
Cable title:  

GOU BROKE, NATIONAL BANK KEY TO UPCOMING GAS

Tags:  EFIN EREL ECON PREL UP 
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ZNY CCCCC ZZH
R 041418Z NOV 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 8727
INFO RUCNCIS/CIS COLLECTIVE
RUEHZG/NATO EU COLLECTIVE
RHEHAAA/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001910 

SIPDIS

STATE FOR EUR/UMB AND EEB/OMA

E.O. 12958: DECL: 11/03/2029
TAGS: EFIN EREL ECON PREL UP
SUBJECT: GOU BROKE, NATIONAL BANK KEY TO UPCOMING GAS
PAYMENTS

REF: A. KYIV 421

B. KYIV 955

C. KYIV 1472

D. KYIV 1487

E. KYIV 1835

F. KYIV 1888

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

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001910

SIPDIS

STATE FOR EUR/UMB AND EEB/OMA

E.O. 12958: DECL: 11/03/2029
TAGS: EFIN EREL ECON PREL UP
SUBJECT: GOU BROKE, NATIONAL BANK KEY TO UPCOMING GAS
PAYMENTS

REF: A. KYIV 421

B. KYIV 955

C. KYIV 1472

D. KYIV 1487

E. KYIV 1835

F. KYIV 1888

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


1. (C) Summary. Ukrainian government coffers are all but
empty and Naftohaz is unlikely to be able to meet upcoming
gas payment obligations without support from the National
Bank of Ukraine (NBU). Analysts forecast that the government
needs to find $2.5 - $3.75 billion to cover expenses for the
rest of the year. This figure does not include gas payments,
which will require $1 -$1.5 billion. To cover the gap, with
the IMF program in question, analysts believe the NBU will
eventually release funds for gas payments, and possibly for
wages to teachers and doctors. NBU financing and government
tightening would allow the GOU to muddle along for the next
few months. However, Ukraine's grim budgetary situation only
gets worse in 2010, and the economic and political
consequences of just "muddling through" will be painful. End
summary.

Glaring Budget Gap
--------------


2. (C) The Ukrainian government needs $2.5 - $3.75 billion
in the final months of 2009 to meet its budgetary
obligations, according to Ildar Gazizullin, an economist at
the local think tank International Center for Policy Studies.
In addition, the newly signed social spending law (refs E
and F) that would increase pensions and wages if implemented
could add another $337 million to the government deficit in

2009. Ukraine's efforts to combat the flu outbreak have also
lead the Rada (Ukraine's parliament) to amend the 2009 budget
and direct $125 million to the Ministry of Health, despite
the fact that the government's emergency reserve fund is
broke. Taking into consideration all of these needs, Senior
World Bank economist Pablo Saavedra estimates that Ukraine's
requirements for the rest of the year amount to 2.5 - 3% of
GDP, or approximately $3 billion.

Gas Payments, External Obligations
--------------


3. (C) Separately, Ukraine must make gas payments totaling
between $1-$1.5 billion for the rest of the year to Russia.

President Yushchenko's Envoy for Energy Security Bogdan
Sokolovsky confirmed on November 4 that the November 7 gas
payment (for gas received in October) would be $470 million
and that Naftohaz has approximately one-third, or $150
million, of the required payment in working capital.
According to Sokolovsky, the Presidential Secretariat, the
Cabinet of Ministers (CabMin),and Naftohaz were working
together to find a solution to the payment problem. While
Ukraine had asked Russia for some concessions, Sokolovsky
said Russia seemed unwilling to be flexible on the terms of
the payment. Sokolovsky also said that while Naftohaz still
has on its books a portion of the UAH 18.6 billion ($2.3
billion) in treasury bonds that the CabMin had provided over
the summer to increase Naftohaz's statutory capital, there
were few buyers for the bonds. In the end, the bonds would
have to be sold to the NBU, but Sokolovsky predicted that the
NBU would be reluctant to purchase the bonds. He commented
that the NBU is already near its reserve limits as set by the
IMF. Ukraine will need to pay Gazprom approximately $500
million in December and a similar sum again in January (for
December gas deliveries). Naftohaz,s ability to pay will
not improve by then, said Sokolovsky.


4. (C) Sokolovsky also lamented that if the IFIs had given
Ukraine the $1.7 billion in financing promised over the
summer (ref C),Ukraine would not be having the current
difficulties in making its gas payment. He added that the
IFIs had been too firm on their conditions, including calling
for a gas price increase, and would find themselves being
pressured into giving Ukraine financing this winter when the
situation worsens and gas transit to Europe is threatened.


5. (SBU) Ukraine reportedly has few other external debt
payments due in the remainder of the year. Economists put
the number at no more than $300 million for interest and
other payments for November and December combined. In
addition, the recent Naftohaz Eurobond and bilateral debt

KYIV 00001910 002 OF 003


restructurings (ref D) removed the need to cover any of these
quasi-sovereign obligations for the rest of 2009.

IMF Program Off Track
--------------


5. (C) President Yushchenko's recent signing of the social
spending law and Prime Minister Tymoshenko's proposed 2010
budget have both pushed Ukraine's negotiations with the IMF
futher off track. The 2010 budget as submitted already
implied an 8% deficit, according to Saavedra at the World
Bank, and needed to be revised to be more in line with the 4%
the IMF and other IFIs could accept. In addition the World
Bank estimates show that the social spending bill would add
between 2.5% to 7.5% of GDP to the budget deficit in 2010,
depending upon how the increases are indexed.


6. (C) Commenting on the political implications of the law,
Independent Rada member Taras Chornovil told PolOff on
November 3 that in his opinion Yushchenko gave Yanukovych an
"amazing gift" when he signed the social welfare legislation
into law. Overcoming the economic affects of the law,
including the pressure it puts on the IMF program, would be
detrimental for Tymoshenko. Deputy Head of the Presidential
Secretariat Ihor Popov explained that he believes that the
only reason Yushchenko signed the social welfare legislation
was to damage Tymoshenko's presidential campaign. He said
Tymoshenko would bear the brunt of public disaffection if the
economy or exchange rate worsened in response to a delay in
the IMF's fourth tranche. Party of Regions Rada Memember
Yuriy Miroshnochenko commented that the end of the IMF
program would be the end of the Tymoshenko candidacy for
president.


7. (C) IMF resident representative, Max Alier, said on
October 3 that the IMF and the GOU are still negotiating a
Letter of Intent (LOI),which would be the basis for the
release of the next tranche of money. From the IMF
representative's perspective, there are three essential
elements for a LOI, as follows:


A. Resubmission of the draft 2010 budget, bringing down the
fiscal deficit to 4% of GDP. However, the PM has declined to
do this, instead promising to use administrative measures to
bring spending into line with a 4% target.


B. Commitments regarding "incomes policy", meaning the GOU
would oppose and the President would veto any legislation
(like the recent pension/minimum wage law, plus whatever else
the Rada might think up) that provides wage/ pension
increases greater than inflation.


C. Signatures, demonstrating political commitment to the IMF
program, preferably by all who originally bought into the
program (President, Prime Minister, NBU, and Finance
Ministry),but at least the NBU (central bank) and Finance
Ministry, which the IMF has found minimally sufficient in
some other countries.

Can Ukraine Make Its Gas Payments without the IMF?
-------------- --------------


8. (SBU) If IMF money does not come through in the near
term, the NBU could participate in schemes that would allow
its reserves to be used to make gas payments, as it has done
in the past (refs A and B). However, the Bank, allied with
President Yushchenko, has resisted monetizing government
debts, including gas payments, in recent months as political
tension between the President and the Prime Minister has
mounted. Yushchenko's Deputy Chief of Staff Oleksandr
Shlapak told the press that the president would not allow the
'&QAb"zQg~I9GS-8QQ?QQ[\VgQgoods and services to continue to
accrue if they chose to use the money for gas payments.
However, since Naftohaz is able to collect only about $100 -
$150 million in revenue each month from consumers, December's
payment would be no easier to finance. Both the IMF and the
World Bank believed that the government would not fund gas
payments if it meant arrears to pensioners, teachers, or
doctors.

Will the NBU Step In to Rescue the Government?
-------------- -

KYIV 00001910 003 OF 003




9. (C) Local analysts believe there is enough pressure on
President Yushchenko such that he will approve NBU financing
of the gas payments for the rest of the year. The president
would risk handing Tymoshenko the right to blame him and the
NBU for a gas crisis if gas payment obligations are not met.
Saavedra at the World Bank also expected the NBU to cover
wage and pension payments as needed. He argued that
Yushchenko understood that voters were unlikely to cast votes
in his favor if they believed Yushchenko and the NBU were
between them and their paychecks/ pensions.

Comment: Continued Economic Hardship
--------------


10. (C) Given the political nature of the decision, it is
difficult to predict with any certainty whether and how much
the National Bank will intervene to keep Ukraine's economy
afloat. The timing of any such intervention could clearly
have political implications for the presidential elections as
well. Even with NBU intervention, Ukraine is facing
continued economic hardship. The 2010 budget as submitted
makes the economic situation even more unsustainable next
year. One can expect that the biggest challenge for the next
president will be how to deal with economic issues, including
the continuing need to make gas payments, which are expected
to increase, and an ever wider budget deficit in 2010. A new
government might be able to approve some upward adjustments
in gas prices for consumers relatively soon after coming into
office; however, reform that arguably would have a more
significant impact on the budget, such as pension reform,
will be much more difficult and take longer to address.
IFI lending could get the country through the elections, but
the economic problems will remain. End Comment.
PETTIT