UKRAINE MINFIN ECONOMIST WANTS REFORM

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 001943

SIPDIS

STATE FOR EUR/UMB AND EEB/OMA

E.O. 12958: DECL: 11/08/2029
TAGS: EFIN EREL ECON PREL UP
SUBJECT: UKRAINE MINFIN ECONOMIST WANTS REFORM

REF: KYIV 1920

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


1. (C) Summary. The new social spending law, which increases
wages and pensions, would be disastrous for Ukraine's
economic recovery, according to Volodymyr Parnyyuk, a leading
Ministry of Finance economist. Even without the social
spending increases, the GOU is facing a $3.75 billion or
larger deficit that would require it to halt expenditures to
all but "protected" items in the budget. Nonetheless,
Parnyuk agreed with recent National Bank of Ukraine (NBU)
resistance to monetizing the deficit. He also argued that it
would be best if the bloated 2010 budget stalled in the
parliament until after the presidential elections in January.
End Summary.

Social Spending Law Disastrous For Economic Recovery
-------------- --------------


2. (C) The recently signed social spending law (reftel)
would result in wage and pension increases for a broad
percentage of the population, according to Ministry of
Finance Director for Macroeconomic Forecasting Department,
Volodymyr Parnyuk. During a meeting with Econoff on November
5, Parnyuk noted that the wage increases would be disastrous
for Ukraine's economic recovery, not to mention that the
government had no money to implement the increases. Parnyuk
repeatedly emphasized that the law had systemic economic
consequences beyond its simple budgetary impact.


3. (C) Although President Yushchenko had argued that only
minimum-level pensions and assistance payments would be
increased by the social spending law, Parnyuk argued that all
social payments would need to be adjusted upward. Without
changes to other laws and regulations that link such payments
to formulas based on the statutory subsistence minimum, the
government would legally be required to implement a broad
indexing of wage and pension hikes. Parnyuk said he
understood the President's desire to guarantee a minimum
standard of living for the people of Ukraine, but argued that
wages had already increased significantly over the past few
years.

Wages Growing Since 2003
--------------


4. (U) Ukraine has made progress since 2003 to reduce the
number of Ukrainians earning less than minimum wage and to
bring Ukraine's minimum wage up to its minimum subsistence
level. In 2003, 18.5% of employees earned less than the UAH
180 monthly minimum wage; 61.4% earned less than the
subsistence level of UAH 342. By September 2008, only 4.8% of
wage earners received less than minimum wage, which had
increased to UAH 522 per month; and 13% were receiving less
than UAH 607, the subsistence level. These changes conform
to a 2005 law that required elimination of the gap between
the minimum wage and the subsistence level. The new social
spending law, passed in October, provides for an initial rise
in the monthly minimum wage to UAH 744 on November 1, with
subsequent quarterly augmentations in 2010. The increases
would continue until the minimum wage reached UAH 922
(roughly $112).


5. (C) Parnyuk argued that continuation of the policy of
increasing minimum wages made little sense given the onset of
the global economic crisis and Ukraine's GDP contraction of
roughly 15% in 2009. The share of wages and pensions had
already grown from 27.3% of GDP in 2004 to 30.1% in 2008.
Parnyuk noted that wages as percentage of GDP were on track
to jump significantly in 2009, even without increases
required by the social spending law.

Harmful Effects of the Social Spending Law
--------------


6. (C) Businesses would need to increase wages to keep
workers at the expense of investment that might bring
economic growth, Parnyuk said. Parnyuk thought that in 2009
the social spending bill would require UAH 8 billion (nearly
$1 billion) to implement, much more than estimates from the
Presidential Secretariat, which put the increase at roughly
UAH 1 billion. Parnyuk argued that increased expenditures on
wages and pensions would cause the shadow economy to grow,
unemployment to increase, and stimulate those without work to
continue to seek work abroad. He also argued that Ukraine
would need to borrow more to finance the government deficit,

KYIV 00001943 002 OF 002


leading to inflation.

GOU To Fund "Protected" Budgetary Items Only
--------------


7. (C) Parnyuk confirmed that the GOU needed at least $3.75
billion (UAH 30 billion) to cover budgetary obligations for
the rest of the year, without the increased wages and
pensions required by the social spending law. He speculated
that the government would be reduced to funding only
"protected" items in the budget (like wages to teachers,
doctors, and law enforcement) but would not fund other items.
Although Parnyuk thought the Prime Minister would try to
avoid pension arrears, he said that some missed payments
might be unavoidable. Parnyuk noted that arrears for goods
and services were already accruing to the government.

National Bank Should Hold The Line
--------------


8. (C) The National Bank of Ukraine (NBU) should continue to
stand firm against monetizing the budget deficit, Parnyuk
stated, as NBU emissions would lead to "growth-destroying"
inflation. Parnyuk also worried that monetization would send
the wrong signals to the country's leadership. In his view,
the government should be forced to reform, something that
would not happen if the NBU or the IMF bailed the GOU out
time and again. Parnyuk commented that IMF funding for
budgetary support scares off international investors. He
noted that this tendency stood in contrast to the policy
advocated by former Minister of Finance Viktor Pynzenyk, who
had welcomed the discipline of an IMF program because he was
convinced it would bring reform to Ukraine and send positive
signals to international investors.

2010 Budget
--------------


9. (C) Parnyuk commented that it might be best for the 2010
budget, which PM Tymoshenko had submitted for parliamentary
consideration, to stall in the Rada (Ukraine's parliament).
Pressures were too great to inflate spending in advance of
the presidential election. If no budget were passed, the
government would continue to operate at 2009 levels, and
continue to make social payments at 2009 levels.
Technically, the Rada Budget Committee had until October 20
to forward the budget for its first reading by the full Rada
membership. Only after the first reading should the bill be
sent back to the CabMin for approval or changes. The second
reading of the budget should be completed by November 20; and
the third and final reading by December 1, according to
normal procedures.

Comment
--------------


10. (C) While Parnyuk's views may differ from those
publically espoused by his superiors at the Ministry of
Finance, they reflect the thinking of a careful economist
with the best interests of the economy in mind. Parnyuk's
concern that the government had not yet been forced to reform
and was delaying the pain of real economic adjustment by
borrowing or monetizing is well placed. At this point, real
economic reform has no chance in Ukraine before the January
election. Similarly, with the IMF program already off track,
it appears likely the GOU will continue to stall on cutting
2010 budget expenditures. However, as the treasury is
depleted and gas payments mount, future Ukrainian authorities
will have few options in early 2010 other than to implement
some of the needed reforms and entice the IMF back to
Ukraine. End Comment.

PETTIT