Identifier
Created
Classification
Origin
09KYIV229
2009-02-02 16:41:00
CONFIDENTIAL
Embassy Kyiv
Cable title:  

UKRAINE ASKS A GUARDED IMF TO SUPPORT A BUDGET

Tags:  EFIN EREL ETRD ECON PREL XH UP 
pdf how-to read a cable
VZCZCXYZ0001
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DE RUEHKV #0229/01 0331641
ZNY CCCCC ZZH
P 021641Z FEB 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7197
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY
C O N F I D E N T I A L KYIV 000229 

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 02/02/2019
TAGS: EFIN EREL ETRD ECON PREL XH UP
SUBJECT: UKRAINE ASKS A GUARDED IMF TO SUPPORT A BUDGET
DEFICIT

Classified By: AMBASSADOR, REASONS 1.4(B) AND (D)

C O N F I D E N T I A L KYIV 000229

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 02/02/2019
TAGS: EFIN EREL ETRD ECON PREL XH UP
SUBJECT: UKRAINE ASKS A GUARDED IMF TO SUPPORT A BUDGET
DEFICIT

Classified By: AMBASSADOR, REASONS 1.4(B) AND (D)


1. (C) The IMF told the Ambassador on February 1 that the GOU
says it cannot run a balanced budget this year. It has asked
the IMF for flexibility on this key conditionality of the
$16.4 billion loan package, Ceyla Pazarbasioglu, head of the
IMF mission performing the first formal review of the loan
package, told the Ambassador. Ukraine now hoped to get
additional financial support from the international community
to reduce the need to finance the deficit via central bank
borrowing. The GOU was preparing a new budget proposal for
the IMF, Pazarbasioglu said, adding that any changes in the
loan program would require IMF board approval. Acknowledging
that a balanced budget had become difficult in the worsening
economic environment, Pazarbasioglu nonetheless stated that
the IMF was not yet convinced that the GOU, President
Yushchenko and the Rada were actually prepared to take the
difficult political steps needed to keep a budget deficit
manageable. The IMF was also concerned about the
inflationary impact of a deficit financed through central
bank borrowing.


2. (C) When formulating its response to Ukraine's request,
the IMF would also take into consideration what, if any,
additional financial support donors might extend to Ukraine,
Pazarbasioglu said. She called the World Bank's financial
support to date "timid," said EU countries were not
interested, and asked whether the USG would extend financial
support to Ukraine. Pazarbasioglu called the current
economic situation dire, but still "manageable" if things did
not get worse. The NBU and GOU still needed "to get their
act together" on the next steps of bank recapitalization, but
the IMF was encouraged by news that a coordinator might be
named to manage the difficult relationship between NBU and
the Ministry of Finance. Pazarbasioglu said PM Tymoshenko
chided the IMF for not weighing in heavily with Morgan
Stanley after it called an outstanding loan to Ukraine. The
Ambassador promised to follow up with Washington on

Pazarbasioglu's request for USG budgetary support. End
summary.

GOU Asks IMF Approval to Run a Deficit
--------------


3. (C) The IMF's Ceyla Pazarbasioglu told the Ambassador on
February 1 that the GOU was insisting it could not run a
balanced budget this year, and was seeking IMF flexibility on
this key conditionality of the $16.4 billion Stand-By
Arrangement (SBA). Pazarbasioglu, who leads the IMF mission
completing the first formal review of the SBA, acknowledged
that economic conditions in both Ukraine, and around the
world, had deteriorated since the program was adopted last
October. A key assumption of the program - that the world
economy would rebound in the second half of 2009 - was
looking less likely, she said.


4. (C) However, running a deficit was one matter, but
financing it was another, and raising the funds was nearly
impossible in the current environment, she said. Ukraine
would unlikely be able to borrow much either domestically or
abroad. The domestic market was not sufficiently developed
to cover the vast borrowing foreseen in the 2009 budget, and
international markets would probably remain closed to Ukraine
even if the world economy improved. The GOU could expect to
borrow little from domestic banks, and the IMF was no longer
confident that state-owned banks Ukreximbank and Oschadbank
were as strong as was often claimed in Ukraine. Hence the
GOU would have little option but to monetize the debt, i.e.
borrow from the National Bank of Ukraine (NBU),if it were to
run a sizable deficit that went beyond the borrowing (for
bank recapitalization and project finance) that the IMF had
foreseen in the SBA, she said.


5. (C) Monetizing the debt also had implications for
inflation, and for the IMF's efforts to reestablish
confidence in the NBU, she said. She pointed out that part
of the SBA loan, when used to recapitalize banks, would also
be monetized, potentially adding to inflationary pressures.
The NBU, as an institution, had lost trust in both Ukraine
and abroad because of its handling of the Hryvnia
devaluation, and a large monetization of the debt could
further undermine whatever confidence remained.

IMF Board Would Need to Approve Changes in Loan Program
-------------- --------------


6. (C) Pazarbasioglu said the IMF was engaged in an ongoing
discussion with the GOU on whether, and by how much, the IMF
was willing to tolerate a budget deficit. The GOU was
preparing a series of measures to modify the budget and
reduce the deficit, and Pazarbasioglu said she hoped to reach
a basic understanding with the GOU before the IMF mission
left Ukraine on February 6. Any agreement to accept a budget
deficit would need subsequent IMF board approval. That
approval would only be forthcoming if the IMF got clear
commitments from the GOU to reign in the deficit, and if the
IMF were confident that President Yushchenko and the Rada
would support whatever commitments the GOU made to the IMF.
Pazarbasioglu added that she feared that any agreement could
unravel quickly amidst the political infighting between PM
Tymoshenko and Yushchenko.

GOU Looks To Donors to Plug Budget Hole
--------------


7. (C) When framing its response to the GOU request, the IMF
might also take into consideration what budgetary assistance
other donors and/or governments would be willing to give
Ukraine, she said. While applauding the technical assistance
that the international community was providing, she indicated
that no governments had provided significant budgetary
support. She described the World Bank's support to date as
"timid." (Note: The World Bank lent Ukraine $500 million in
direct budget support in late 2008, is planning to provide up
to $750 million for bank recapitalization this year, and may
extend additional budget support at the end of the year, the
World Bank's Lalit Raina told us.) Pazarbasioglu and IMF
residential rep Max Alier said the GOU had already asked
numerous governments for direct financial support.
Pazarbasioglu asked the Ambassador whether the USG would be
willing to provide support as well. The Ambassador confirmed
that Deputy PM Turchinov had asked him directly for support
last week, and said he would broach the request with
Washington. Pazarbasioglu ruled out a modification of the
SBA. The IMF would not increase the total package, nor would
it accelerate disbursements scheduled for later this year or
in 2010, she said.

"Black Holes" in Pension Fund, Naftohaz
--------------


8. (C) Pazarbasioglu said deficits in the pension fund and at
Naftohaz were the "two black holes" in the budget. Pension
spending equal to 15 percent of GDP was not sustainable, she
said. She said neither Tymoshenko nor Yushchenko was
apparently willing to take the politically difficult steps to
reign in the budget deficit, and she expressed exasperation
that both Tymoshenko and Yushchenko never missed an
opportunity to attack each another. Hence both were reticent
to act out of fear of being undermined by their political
opponent. The IMF would thus insist on assurances that the
Rada and Yushchenko would support any additional agreements
that the GOU struck with the IMF.


9. (C) Pazarbasioglu suggested the GOU might limit wage and
pension increases to less than the rate of inflation, or
increase domestic energy tariffs faster than had been
foreseen in the SBA. (Note: PM Tymoshenko shared the GOU's
plans with the Ambassador on February 2. Post will report
septel.) All budget amendments would require Rada approval.
Hence parliamentary buy-in, and a commitment by the President
not to attack an arrangement with the IMF, were critical, she
said. She added that the IMF may also take into
consideration true structural changes that point to a serious
intent to reform the economy, even if they do not save much
money this year. As an example, she cited badly needed
reforms to the pension system, such as changes in the
retirement age or an improved targeting of benefits.

Situation Dire, But "Manageable"
--------------


10. (C) Although the economic situation had deteriorated
substantially since October, it was still manageable if
things did not get worse, Pazarbasioglu said. Ukraine should
meet its sovereign debt obligations without a problem, but
the IMF was receiving more reports that the non-banking
corporate sector might default of much of its debt. The IMF
was trying to get a better understanding of the non-bank
corporate debt, she said.

Fulfilling Conditionalities To Date

--------------


11. (C) Pazarbasioglu confirmed that the IMF was satisfied
that the NBU maintained reserves above the $26.7 billion
floor foreseen for December 31. She gave the NBU good marks
for the quality and timing of the recently completed
diagnostics of the country's 17 largest banks. The NBU board
now needed to act and make recommendations for individual
recapitalizations. The ball would then be in the MOF's
court, which "still needs to get its act together," as little
had been done to create a mechanism for state-funded
recapitalization.


12. (C) Pazarbasioglu criticized the poor cooperation between
the NBU and MOF, although she was encouraged that the GOU,
NBU and Rada might install an overall coordinator for the
recap and resolution process. Former NBU Governor and
current Swedbank chairman Sergey Tyhypko was being named as a
possible candidate for the position, she said. She expressed
concern at the continued absence of NBU Governor Stelmakh,
"because it's not clear who actually is in charge at the NBU."

Tymoshenko Chides IMF Over Morgan Stanley
--------------


13. (C) Pazarbasioglu acknowledged that the IMF has
participated in discussions with the GOU, its advisors and
Morgan Stanley over the GOU guarantee for the $465 million
loan to Ukravtodor. The IMF's Monetary and Capital Markets
Department led the discussions, which alerted all parties to
the implications that default could have for the SBA. Should
Ukraine default, an IMF board would need to approve the
continuation of the program. The board would do so if
Ukraine was making a serious effort to address the arrears,
she said.


14. (C) She said the IMF had cautioned the GOU about the need
to respect foreign debt obligations. The IMF was worried
about the number of cross-triggers in many of Ukraine's
sovereign debt borrowings. Because of the expected
monetization pressures emanating from the budget deficit, it
was unlikely that Ukraine could, in addition, monetize the
entire foreign debt that would suddenly come due in the wake
of a default, Pazarbasioglu said. She recounted her
discussions with Tymoshenko, who was furious that Morgan
Stanley called its loan after Ukraine was downgraded.
Tymoshenko criticized the IMF for not reigning in Morgan
Stanley, reasoning as follows: "The IMF gave Ukraine a loan,
the U.S. is a major shareholder in the IMF, and now a U.S.
company is trying to drive Ukraine into default."

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


15. (C) Tymoshenko's aforementioned comment notwithstanding,
Pazarbasioglu said the Prime Minister had finally begun to
understand the true scope of the economic problems facing
Ukraine. Last October this was not the case, Pazarbasioglu
said, when the IMF had the impression that Tymoshenko did not
understand, or want to understand, the full extent of the
crisis. Pazarbasioglu gave Yushchenko better marks, saying
that the President had grasped the challenges facing Ukraine
from the outset. Nonetheless, such joint understanding of
the gravity of the situation has not made Yushchenko and
Tymoshenko place their rivalries aside to address the crisis,
as demonstrated this past weekend, when both politicians hit
the airwaves to make the other responsible for the country's
problems. As Pazarbasioglu pointed out, the political
discord is making it difficult for the IMF to be flexible in
the face of a worsening economic situation, for it is losing
confidence that Ukraine's political leaders have the will to
support the tough actions that are needed for Ukraine to
overcome the crisis with IMF support. End comment.
TAYLOR