DPM NEMYRIA'S CASE FOR UKRAINE IMF TRANCHE

C O N F I D E N T I A L SECTION 01 OF 04 KYIV 002140

SENSITIVE
SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 12/15/2019
TAGS: EFIN EREL ETRD PGOV PINR UP XH
SUBJECT: DPM NEMYRIA'S CASE FOR UKRAINE IMF TRANCHE

REF: A. KYIV 2133

B. KYIV 2102

C. KYIV 1982

Classified By: Ambassador John F. Tefft for Reasons 1.4 (b) and (d)


1. (C) Summary. Deputy Prime Minister Nemyria made a strong
pitch to the Ambassador for the disbursement of a fourth IMF
loan tranche to Ukraine. He talked of unreasonable IMF
demands for the passage of a 2010 budget, explained why the
central bank could not monetize for budget and gas payments,
and projected that a Ukraine meltdown would have spillover
effects for the region. Nemyria admitted that Prime Minister
Tymoshenko's presidential campaign had been damaged by
President Yushchenko, whose efforts had worked to
"demobilize" and fragment "post-orange" voters. Nemyria is
currently en route to Washington with key advisors for
emergency follow-up meetings with the IMF. End summary.

MORE FREQUENT FLIER MILES
--------------


2. (C) In a December 15 meeting with the Ambassador, Nemyria
revealed his talking points for December 17 and 18 meetings
with senior IMF officials. Nemyria heads back to Washington
only ten days after talks with IMF Managing Director
Dominique Strauss-Kahn, and less than a week since Foreign
Minister Poroshenko saw IMF Deputy Managing Director Lipsky.
The follow-up trip was apparently prompted by Prime Minister
Tymoshenko's December 14 call with Strauss-Kahn, who
allegedly expressed his openness to ongoing negotiations with
Ukrainian authorities. Nemyria will be accompanied by acting
Finance Minister Ihor Umanskiy, Deputy Finance Minister (and
budget expert) Anatoliy Myarkovksiy, and economic advisor
Mariia Nikitova.

GOU HONING ITS POSITION
--------------


3. (C) Nemyria tipped his hand by reviewing the GOU's
revised negotiating position. Tymoshenko wanted to make the
case that passage of a 2010 budget was not a reasonable
conditionality. Pre-election "political fragmentation" had
meant that there was almost no chance a budget could be
reviewed and adopted in the Rada (Ukraine's parliament)
before March or April. Furthermore, even if the budget were
reviewed, revised, and adopted on multiple readings (ref C),
President Yushchenko would again spite Tymoshenko and veto
the bill.


4. (C) The fact that the Prime Minister, the Ministry of
Finance, and the National Bank of Ukraine (NBU) had signed
the IMF Letter of Intent (LOI) was the best possible sign of
cooperation, Nemyria argued (ref B). It was clear the
President would not sign the LOI for political reasons (the
lack of an IMF program harms Tymoshenko's candidacy).
Therefore, there was a need to "de-politicize" the IMF
process, the Deputy Prime Minister said.


5. (C) The GOU would propose to the IMF that the Ministry of
Finance and the NBU jointly sign a second LOI, with the PM
providing a side letter to give her assurance that she would
propose a budget in line with the IMF's expectations after
the election. The GOU would also argue that the lack of a
2010 budget was not harmful. Having a continuing
resolution-type budget in 2010 would act as a
"straight-jacket" on the GOU for at least three months (i.e.
until after the inauguration). Any budget passed by the Rada
before the election would be populist and bloated, Nemyria
stated.


6. (C) Tymoshenko and her cabinet were concerned that the
IMF's Lipsky and staff-level "mathematicians" failed to see
their point. Lipsky had insisted in his meeting with Foreign
Minister Poroshenko that the 2010 budget be passed. IMF
staff had been allowed to "dictate the pace of the program",
especially over whether budget passage should be a lynchpin
requirement. Timing was crucial, and the IMF board needed to
be convinced quickly. Ukraine was willing to "compromise"
and accept a partial $2 billion tranche (instead of the full
$3.8 billion).


7. (C) In addition to political reasons preventing the NBU
from purchasing GOU securities to pay Gazprom or meet budget
obligations (ref B),Nemyria pointed to other factors that
militated against monetization. 1) He said it was "against
the law" for the NBU to finance the government deficit. 2)
He claimed the NBU could not provide funds to the government
via commercial banks, since auditors would not be able to
approve such transactions. Nemyria noted that this argument
had been used in July by Yushchenko, when the President
rejected the IMF's suggestion that the NBU monetize GOU
securities to make gas payments. 3) Nemyria claimed
monetization could lead to interest rates of 50-60%, such as
in Russia and Ukraine during the late 1990s. He said
Tymoshenko had been firm with Strauss-Kahn on December 14
when she noted that monetization was not an option.


8. (C) Note: The first point above was mentioned by Nemyria
and Poroshenko to the IMF last week. Nonetheless, while
legislation governing the powers of the NBU bans direct
lending to the GOU to finance the budget deficit, it does not
forbid the NBU from buying government treasury bills.
According to NBU official figures, the central bank purchased
UAH 27.7 billion in domestic treasury bills during the first
nine months of 2009. The IMF estimates the NBU has room to
print billions more, while holding enough reserves to protect
movement in the exchange rate. On the second point above,
according to Ukrainian legislation, loans to any one borrower
should not exceed 25% of a bank's capital. However,
state-owned Oshchadbank, the government's chief conduit for
monetization, has 53% of its loan portfolio booked with
Naftohaz, a sum roughly equal to 120% of its capital. A
bigger problem with domestic debt issuance to commercial
banks is that it crowds out other investment, given that
t-bill yields now exceed 24-25%. On the third point above,
the 2009 situation is qualitatively different from the 1990s.
Inflation this year will not reach higher than 15%, and
Ukraine's overall sovereign debt burden remains relatively
modest. End note.

OUTREACH GONE GLOBAL
--------------


9. (C) Nemyria reported that Russia and Brazil had requested
an informal December 15 brief on Ukraine from the IMF board.
Strauss-Kahn told Tymoshenko that he had separately asked for
a brief from IMF executive directors and had planned to hold
sessions with the European, BRIC, and Nordic-Baltic groups on
Ukraine's behalf. The Deputy Prime Minister told the
Ambassador that he had recently met with the French, German,
and Chinese ambassadors. (Note: Key ally ambassadors
commented to the Ambassador on December 15 that they thought
both the Russians and the Chinese had been weighing in
heavily with the IMF. End note.)


10. (C) Nemyria reported that the German IMF executive
director had been the most cautious vis-a-vis emergency
lending to Ukraine. However, on the margins of the European
Peoples' Party congress in Bonn last week, Tymoshenko
apparently had been told by Chancellor Merkel that the German
Ministry of Finance planned to send updated instructions to
its representatives in Washington. Similarly, the French
Finance Ministry would send new instructions to its IMF
executive director, Nemyria told the Ambassador. (Note: Our
German embassy contacts told us on December 16 that Berlin
did not plan to back down from their firm approach to
Ukraine's IMF program. End note.)

IMF SDR ALLOCATIONS NOT ENOUGH
--------------


11. (C) Nemyria said that allocations of IMF Special Drawing
Rights (SDR) were nearly depleted. Most of the SDR
allocations had been used for gas and external payments.
According to the Deputy Prime Minister, the GOU had just
incurred an additional foreign currency obligation as a
condition of debt restructuring talks over a loan default by
Ukrzaliznytsa, the state railway company. The GOU would need
to pay an unspecified amount from the remaining SDRs to
Ukrzaliznytsa's creditors on December 29, Nemyria said.
(Note: We heard separately from Deputy Minister of Finance
Myarkovskiy that Ukraine had UAH 1.77 billion ($221 million)
in SDRs remaining. Nemyria made no mention of the GOU's use
of SDRs for November budget payments. Nemyria economic
advisor Nikitova admitted to us that SDRs were reported as
November revenue for IMF budget deficit calculations. End
note.)


12. (C) The Deputy Prime Minister assured the Ambassador
that gas prices for household consumers would increase by 25%
in April 2010. This figure was enough to make up lost
revenue from the Prime Minister's cancelled increases in
September, a move that breached one of the IMF's core
demands, argued Nemyria. Naftohaz executives were meeting on
December 15 over whether to buy more gas in December, rather
than wait until 2010 when prices will be higher. Nemyria
believed that if Naftohaz bought 5.5 billion cubic meters
(BCM) in December (for about $1.2 billion),it would not need
to purchase as much in Q1 2010. (Note: Naftohaz spokesman
Valentyn Zemlyansky told us on December 15 that Naftohaz
planned to take roughly 5.5 BCM and would make the payment
for December gas purchases, due January 7, by the end of the
month. End note.)


13. (C) If it came down to making tough spending choices,
Tymoshenko would opt to contain possible social unrest,
according to Nemyria. The top item on her crisis agenda was
making wage and pension payments, the second was meeting
Ukraine's monthly bill to Gazprom, and the third was all
remaining budget obligations, including payment of large and
growing VAT refund arrears. In response to the Ambassador's
questions, Nemyria commented that Ukraine needed more
stability before refunding VAT to exporters, though he noted
some SDRs had been used for that purpose in recent weeks.

DIM PROSPECTS WITHOUT IMF
--------------


14. (C) Nemyria concluded his review of Ukraine's position
on the IMF by stating that the Fund program had been a
success thus far. Ukraine's economy had stabilized; the run
on bank deposits had been stopped. But speculative,
short-term capital could flee from Ukraine at any time, and
parent banks were poised to pull stakes if things got too far
off track with the IMF, Nemyria added.


15. (C) The Deputy Prime Minister commented that his recent
media interviews were neither "blackmail" nor "soft
blackmail", as critics suggested (ref A). IMF staff simply
had not paid enough attention to the potential strategic
consequences of Ukraine's economy unraveling. There would be
a spillover to the region, Nemyria noted, especially
affecting fragile economies like neighboring Hungary. Any
strategic opportunity for reforming Ukraine after the
presidential election would be lost.

TYMOSHENKO'S ELECTION CHANCES
--------------


16. (C) The presidential election was now a contest between
Tymoshenko and opposition Party of Regions leader Viktor
Yanukovych. There was no longer "any talk of a third
candidate" (i.e. Arseniy Yatsenyuk). Yanukovych had an
impressive lead of 7-10%; he would likely preserve this
margin through the first round of balloting on January 17.
Nemyria commented that Yanukovych's core was solid but his
projected 2nd round support of 42% would be 6% less than in

2004.


17. (C) The biggest concerns for Tymoshenko were the
fragmentation and "demobilization" of the "post-orange"
electorate. Pro-European voters had split their allegiances
among a number of Ukraine's eighteen candidates, though in
aggregate they added up to more votes than Yanukovych could
expect to receive. The key was to attract those voters
between the first and second rounds, while eroding
Yanukovych's base in the east.


18. (C) President Yushchenko's criticism had hurt
Tymoshenko, especially his stroking of nationalist sentiment
with such statements as "she's selling Ukraine to the
Russians" or "she's on par with Yanukovych" or "she's never
been a Ukrainian patriot". Tymoshenko had made a decision
not to respond, but it was "really damaging". Yushchenko was
attempting to discourage support for Tymoshenko in the west,
a de facto policy of supporting Yanukovych.


19. (C) Nemyria said he did not expect large-scale voting
irregularities such as in 2004, but he speculated there could
be attempts to manipulate final tallies. He praised the idea
of Georgia sending observers to Donetsk oblast, one result of
Tymoshenko's unpublicized meeting with Georgian President
Saakashvili in Bonn last week.

PRESENTING TYMOSHENKO'S EURO-ATLANTIC CREDENTIALS
-------------- --------------

20. (C) Nemyria presented Tymoshenko as the obvious choice
in a "black and white" race. He pointed to the fact that
Yanukovych would recognize South Ossetia and Abkhazia (he had
twice announced his intention to do so). The Prime Minister
wanted to continue NATO integration, but she took seriously
the fact that NATO was a divisive issue. Tymoshenko
estimated that 23-25% of Ukraine's population supported
Ukrainian membership, a figure far below Yushchenko's
oft-mentioned claims of 33%, especially since the Georgia
conflict. A final decision on NATO would be left to a
referendum, according to Nemyria. In any case, Ukraine was
willing to continue taking an active role in humanitarian and
peacekeeping operations with Euro-Atlantic partners.

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


21. (C) Nemyria's points on the budget have validity if seen
through a narrow lens. It is likely true, for instance, that
any 2010 budget passed before the election would be rife with
populist pork. However, it is not clear that NBU Governor
Stelmakh would be willing to sign a follow-up LOI with just
the Ministry of Finance. Similarly, it does not necessarily
follow that a continuing resolution-type budget would be a
fiscal "straight-jacket", given the fact that it allows for
discretionary spending without specific line items.
Furthermore, we agree with the IMF that not only can
monetization happen via t-bill issuances to finance gas
purchases (and/or short-term wage and pension payments),
there would not necessarily be a major inflationary or
exchange rate effect. Nemyria's finance team will have to
make more poignant explanations to Washington interlocutors
to overcome these concerns.
TEFFT