YANUKOVYCH ACOLYTES PREACH ECONOMIC ORTHODOXY

C O N F I D E N T I A L SECTION 01 OF 04 KYIV 002124

SIPDIS

STATE FOR EUR/UMB AND EEB/OMA

E.O. 12958: DECL: 12/09/2029
TAGS: ECON PGOV ENGR PREL EFIN UP
SUBJECT: YANUKOVYCH ACOLYTES PREACH ECONOMIC ORTHODOXY

REF: A. KYIV 1920

B. KYIV 2110

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


1. (C) Summary. Viktor Yanukovych's top economic advisors
are counseling liberal market reforms, despite the Party of
Regions' pre-election populist appeals. Shadow Minister of
Finance Mykola Azarov and shadow Minister of Economy Iryna
Akimova separately told embassy officers that Yanukovych as
president would seek to renegotiate Ukraine's gas contracts
with Russia, tighten government spending, support EU
integration, and implement tax and other reforms to improve
the business climate.


2. (C) Whereas Azarov, considered to be Regions' power
behind the candidate, railed against the IMF for undue
flexibility toward the Tymoshenko government, Akimova was
more conciliatory, choosing to directly blame the Prime
Minister for her misuse of IMF loan funds. Azarov and
Akimova touted the recent Regions-backed social standards law
as necessary for the most vulnerable populations, though both
clarified this by stating Yanukovych would limit the law's
fiscal impact. End summary.


3. (U) This is the second in a series of cables on the
economic platforms of Ukraine's presidential candidates.

YANUKOVYCH'S ECONOMIC PLAN
--------------


4. (C) According to Party of Region's shadow Minister of
Economy Iryna Akimova, Yanukovych's core pledges on the
economy were to:

-- increase economic growth and social standards
-- improve the investment climate and secure property rights
-- reform tax administration, lower taxes, and reduce red
tape
-- reverse recent increases of state debt
-- heighten fiscal discipline
-- bolster the bank recapitalization scheme
-- ensure the independence and accountability of the National
Bank of Ukraine (NBU)
-- promote coordination between the NBU and the Ministry of
Finance

REGIONS ON TYMOSHENKO'S LEGACY
--------------


5. (C) Akimova told Econoffs that Yanukovych would
capitalize on Tymoshenko's mishandling of Ukraine's economic
crisis. Akimova explained that Regions' key concern was
increased GOU debt. She warned that short-term borrowing
could lead to macroeconomic instability and cause exchange
rate pressure, further bank failures, and a "second wave"
shock to the real sector and households.


6. (C) Shadow Minister of Finance Mykola Azarov separately
told Emboffs that Ukraine's economy and financial system had
been "totally ruined". Ukraine was entering 2010 with no IMF
program, a depleted borrowing limit, a huge budget deficit,
and had extensive corporate debt that would need to be rolled
over in 2010. Roughly 30% of the loans in the banking sector
were high risk or non-performing, according to Azarov's
calculations.

FISCAL POLICY
--------------


7. (C) Azarov complained Tymoshenko had not only wasted IMF
Stand-By Arrangement (SBA) loan monies over the last year;
she had also burned through $2 billion in IMF Special Drawing
Rights (SDRs) for budget and gas payments. Tymoshenko's
"incomprehensible" economic policy-making had left a depleted
treasury in December and "nothing" for the January 7 gas
payment.


8. (C) Ukraine would have to endure strict fiscal discipline
in 2010. A Party of Regions government would have "no
option" but to cut expenditures by 20%, even though it would
be "difficult" and "unpopular", said Azarov. Regions would
impose trict control over spending. According to Azarov,
this was an "elementary" step to rein in the corruption of
Tymoshenko's government.


9. (C) Akimova separately explained that Ukraine's UAH 40

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billion (roughly $5 billion) unfinanced core budget deficit
had caused Tymoshenko to issue short-term securities (with
3-6 month maturities) at interest rates around 30%. This
"desperate" plan resembled Ponzi schemes in late 1990s
Russia, especially since there were no clear sources of
financing for the rollovers of this debt that would be needed
in April. Nonetheless, commercial banks were buying
Tymoshenko's risky but profitable debt rather than lending,
further drying up remaining liquidity.


10. (C) Sovereign external debt payments due in 2010 were
$2.3 billion, an amount Akimova believed was manageable if
the GOU did not accrue more short-term obligations. However,
the size and speed of state debt accumulation was "scary" and
"enormous" -- 36% of GDP by the end 2009 (total sovereign
plus sovereign-guaranteed borrowing),44-46% in 2010, and up
to 60% of GDP (the Maastrict red line) in a couple of years,
according to Regions' projections from current trends.


11. (C) On the Regions-backed social standards law
criticized by the IMF (ref A),Akimova explained that
Yanukovych supported a "reasonable" approach. It was
important to raise minimum wage and pension payments for
Ukraine's poorest citizens, especially if gas and utility
prices increased. However, Akimova insinuated that Regions
would not favor re-indexing all public sector wages and
pensions based on the new subsistence minimum. Re-indexing
of social payments is the prerogative of the Cabinet of
Ministers, she noted. An increase in minimum wages and
pensions does not necessarily trigger increases across the
board, according to Akimova, contrary to what the Tymoshenko
government had publicly implied.


12. (C) Azarov noted that the international community had
been "misled" by Tymoshenko's "unreliable calculations" on
the cost of wage and pension increases. Tymoshenko was
"bluffing" to gain an electoral advantage. Her suggestion
that increases in social standards would cost UAH 70 billion
was nowhere near the real cost of the law, which Regions
calculated would be closer to UAH 6 billion ($750 million) in

2010. Azarov said the recipients of the increases in minimum
wages and pensions would likely spend their additional
payments on domestic products (butter, eggs, bread) and
stimulate the domestic economy.

TAX POLICY
--------------


13. (C) Akimova vowed to put order into the State Tax
Administration (STA),whose inefficiencies were among highest
in the world. She promised that Yanukovych would lower
enterprise profits taxes (EPTs) from 25% to 19% by 2011 to
stimulate investment, arguing that "if government can't fund
investment, then the private sector has to be incentivized."
Akimova supported a five-year moratorium on EPTs for small
and medium-sized enterprises, and she said a 3-4 year
moratorium on changes to tax legislation was necessary to
provide greater stability and transparency for investors.


14. (C) Azarov, who once headed the State Tax Administration
and the Rada budget committee, commented that VAT refund
arrears would be a "huge" burden for a successor government,
especially since the STA had already collected advanced
enterprise profit taxes into 2010. The Party of Regions
would support tax and pension reform after the economy
returned to 2-3% growth, according to Azarov.

BUSINESS CLIMATE
--------------


15. (C) Akimova separately confirmed that Tymoshenko had
demanded advance payment of enterprise profit taxes through
the first quarter of 2010. Companies with wage arrears had
received threats from tax and labor authorities. Tymoshenko
had claimed she would take over privatized firms if they
failed to make payroll. In an environment where savings
rates and investment had plummeted, Tymoshenko was scaring
off both domestic and foreign investors, according to
Akimova. Yanukovych would campaign on the slogan that
Regions could be trusted to respect business contracts and
privatizations.

A "NAIVE" IMF
--------------


16. (C) The IMF had lost an opportunity to use its "colossal
leverage" over the GOU, suggested Azarov. The Party of
Regions wanted to fulfill the IMF action plan, but it could

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not be "tougher than the cop". The IMF was "naive" to
believe Tymoshenko's promise to raise rates for gas
consumers. A lack of IMF prodding for real reform had been a
"disservice" to Ukraine and had caused Regions to determine
the international community was providing political support
for Tymoshenko, whose government had been kept afloat with
IMF financing. Ukraine needed at least $20 billion to
survive in 2010. Pointedly Azarov asked, "Are you
(Americans) ready to provide this? If not, why did you
maintain this stance with the IMF?"


17. (C) Akimova's criticisms of the Fund were more nuanced.
Accumulating debt could be necessary in a crisis; IMF money
should have been targeted to stabilize the financial and real
sectors. Instead IMF monies were spent on gas payments,
leaving systemic problems untouched, said the Regions'
representative. The IMF program had hardly addressed
Ukraine's underlying macroeconomic instability. Recent signs
of growth were only due to the base effect (a dramatic drop
in H2 2008 GDP).


18. (C) Most concerning to Akimova was the IMF's allowance
for dramatic increases of internal borrowing. The budgeted
limit in 2009 domestic borrowing was UAH 37 billion, but the
GOU had already taken on UAH 62 billion in new liabilities,
using Cabinet of Ministers' decrees to get around borrowing
restrictions.

TYMOSHENKO'S ENERGY POLICY: A BETRAYAL
--------------


19. (C) Azarov told us that Ukraine had misplayed the "aces
in its hand" with Russia. "Putin had won and Ukraine had
lost" from Tymoshenko's negotiation of gas contracts that
"betrayed her country", according to Azarov.


20. (C) If Yanukovych won the presidential election, he
would push to renegotiate all gas deals with Russia. Current
prices for gas imports will lead to an "impossible" situation
in the chemicals industry, which requires heavy gas inputs
and is not profitable when import prices are above $250 per
thousand cubic meters. According to Azarov, the gas price
for domestic consumers should rise 20% to recover import
costs.


21. (C) Azarov reasoned that the coziness between Tymoshenko
and Putin at the November Yalta talks did not undermine the
Party of Regions' claim that it is the faction to best
restore "friendly, neighborly" relations with Russia.
Regardless of who is in power, according to Azarov, it is
"vital" for Ukraine to have a constructive policy towards
Russia.


22. (C) For her part, Akimova expressed concern that the
Yalta announcement by Putin and Tymoshenko had not led to a
written deal waiving fines for lower gas intake. Akimova
worried that per the original terms of the January 19, 2009
gas supply contract, Ukraine could be penalized between $8-9
billion for the under-purchase of gas in 2009. Akimova
called Putin's promise "an instrument of political and
economic pressure" and said the Russians were willing to
"actualize" their leverage any time. (Note: Both Gazprom and
Naftohaz leadership have stated that they have signed
agreements revising volumes and waiving penalties for 2009.
Akimova is the only person from whom we have heard concern
over the lack of a written agreement since the
Gazprom/Naftohaz statements were released. End note.)


23. (C) Akimova thought it would be difficult to get Russia
to reconsider terms of the gas contracts. Coming to a
successful negotiated outcome would be a purely political
question. Akimova advocated for gas contract talks "with all
three partners" (EU, Russia, Ukraine),which would be the
"only way" to gain greater transparency and efficiency.


24. (C) Akimova said price increases for household gas
consumers were inevitable. Tymoshenko had avoided raising
household prices in 2009, but the GOU had implicitly
acknowledged in its declared 2010 revenue expectations that
it was anticipating increases, according to Akimova.


25. (C) Regions' experts had calculated that gas price
increases would lead to inflation rates of 15-20%. Targeted
subsidies for most vulnerable population were therefore
needed, as were efforts to show Ukrainian citizens that the
government was doing its utmost to reform utilities and
increase energy efficiency. Akimova quipped that people
would not pay more if they continued to see gushers of hot

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water leaking on the streets, alluding to the inefficiencies
of municipal heating companies.

EU INTEGRATION
--------------


26. (C) "EU integration was the direction Ukraine had
chosen," stated Akimova. Yanukovych "more than supports" EU
integration and would continue reforms to bring Ukraine in
line with EU standards. There was "no other way", Akimova
said unequivocally. "Efforts at harmonization were difficult
but a necessary step to allow Ukraine to use its economic
advantages."


27. (C) Azarov commented that the Western media had unfairly
stereotyped Yanukovych as solely pro-Russian. Yanukovych was
the "most pro-Ukrainian candidate", and he recognized that
Ukraine was increasingly "more European in its essence".
Azarov speculated that EU integration would happen
automatically as a factor of Ukraine's development, and
reforms would occur because they were of "systemic"
importance.

BANKING SECTOR
--------------


28. (C) Financial stability was still missing, said Azarov.
Bank recapitalization had been conducted via "administrative
resources". Although it had had the effect of increasing
government debt, bank recapitalization was not stimulating
new lending for the real economy.


29. (C) Akimova had been closely observing trends in the
exchange rate, as any upward movement would be a "disaster"
for banks and could lead to another banking crisis. The NBU
and Ministry of Finance needed to stabilize the exchange rate
through collaborative monetary and fiscal policy-making. A
Yanukovych presidency would support NBU reforms to enhance
both its independence and accountability, Akimova noted. The
NBU Council should not contain any Rada MPs, due to inherent
conflicts of interest. (Not%Hy;Qpragmatic, pro-business wing.
Despite their differences in style and background, each made
notably orthodox arguments promoting economic reform, while
tamping down concerns over populist social spending
legislation. Most evident was their separate but
consistently pragmatic approach to Russia on energy, their
willingness to make fiscal sacrifices, and their diagnoses of
what had driven away (or could re-entice) investment. If
elected President, Yanukovych could be expected to continue
to draw advice from his top two economic policy advisors on
how to escape what Azarov called the most difficult moment in
Ukraine's post-independence history. With their
business-friendly policies, it is clear why many of Ukraine's
oligarchs support Yanukovych, and why a growing numbers of
foreigners doing business in Ukraine are comfortable with a
Yanukovych presidency.
TEFFT