Identifier
Created
Classification
Origin
09KYIV256
2009-02-06 13:35:00
CONFIDENTIAL
Embassy Kyiv
Cable title:  

UKRAINE: IMF APPEALS TO G7, EU TO FINANCE BILLION

Tags:  EFIN ETRD ECON PREL XH UP 
pdf how-to read a cable
VZCZCXYZ0001
PP RUEHWEB

DE RUEHKV #0256/01 0371335
ZNY CCCCC ZZH
P 061335Z FEB 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7223
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 000256 

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 02/06/2019
TAGS: EFIN ETRD ECON PREL XH UP
SUBJECT: UKRAINE: IMF APPEALS TO G7, EU TO FINANCE BILLION
DOLLAR BUDGET SHORTFALL

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

Summary
-------

C O N F I D E N T I A L KYIV 000256

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 02/06/2019
TAGS: EFIN ETRD ECON PREL XH UP
SUBJECT: UKRAINE: IMF APPEALS TO G7, EU TO FINANCE BILLION
DOLLAR BUDGET SHORTFALL

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

Summary
--------------


1. (C) On February 5 IMF Mission Director Ceyla Pazarbasioglu
told the G7 and EU ambassadors that Ukraine faces a $3.75 to
$6.25 billion budget shortfall this year. She appealed to
the ambassadors for direct financial support for Ukraine's
budget, arguing that Ukraine had no other options to finance
the deficit without borrowing directly from the central bank.
If the GOU cuts spending substantially and Ukraine's
political leadership publicly joins forces to sell the cuts
to the population, then Ukraine is deserving of international
support, because the alternative - a severe destabilization
of the economy - would be in nobody's interest, she argued.
Pazarbasioglu said she cannot yet recommend that the IMF
Board disburse the next $1.87 billion tranche of the $16.4
billion Stand By Arrangement (SBA). Before doing so, the IMF
will require a revised budget that cuts expenditures and is
more fiscally sustainable, and a clear and open commitment by
President Yushchenko, PM Tymoshenko and Rada speaker Lytvyn
to back the measures. Pazarbasioglu was confident that
Ukraine would fulfill these conditionalities, because the
leadership "now understands what it means if we pack up and
leave." The World Bank supported the IMF appeal and offered
to use one of its loan facilities as a conduit to channel
additional assistance. None of the ambassadors present
indicated whether their countries might support the appeal,
but the Japanese ambassador said his country had been
approached by the GOU and had already declined. End summary.

IMF Makes Appeal to G7, EU
--------------


2. (C) IMF Mission director Ceyla Pazarbasioglu told the G7
and EU Ambassadors on February 5 that Ukraine's budget will
face a budget shortfall of up to UAH 50 billion ($6.25
billion) this year. Acknowledging that the balanced budget
foreseen in the $16.4 billion Stand By Arrangement (SBA) was
no longer realistic, she said the IMF and World Bank had
revised downward their forecast for this year, and are now

expecting Ukraine's economy to contract by five percent. The
expected funding shortfall will be roughly four percent of
GDP, Pazarbasioglu said, and cannot be covered by
conventional sources of borrowing. It was unlikely that the
international markets would recover sufficiently to serve as
a source of borrowing, there was no domestic government debt
market, and the struggling banking system could not lend to
the GOU as well, "unless it somehow convinces the population
to put the billions of dollars now under the mattresses back
into the banks," she said. The last remaining domestic
option was direct borrowing from the National Bank of Ukraine
(NBU),which would monetize the budget shortfall and further
destabilize the financial sector and economy as a whole.


3. (C) Pazarbasioglu appealed to the ambassadors for direct
financial support to help Ukraine meet the expected budget
gap, arguing that the situation had deteriorated faster and
further than the IMF or anyone had expected when the $16.4
billion Stand By Arrangement (SBA) was approved in October.
Direct budgetary support would help stabilize Ukraine's
fiscal situation and give it and the IMF "breathing space" to
move forward implementing the SBA more broadly. The country
deserved international support, if the political leadership
and parliament did everything in their power to improve the
budget and displayed political unity, she argued. The
alternative -- a severe destabilization of the economy -- was
in nobody's interest, she said.

Current Budget Has $6.25 Billion Gap With Realistic
Assumptions
--------------


4. (C) The current budget, which forecasts a deficit equal to
3 percent of GDP, was based on unrealistic assumptions,
including a 0.4 percent growth rate, she said. A revised
budget forecast, using more realistic assumptions, leads to
the expected UAH 50 billion budget gap. The GOU has said it
can reduce spending by about UAH 10 billion ($1.25 billion),
but that further cuts were not possible both for structural
and political reasons. Separately, World Bank economist
Pablo Saavedra said the GOU was saying it could cut a further
UAH 5 billion ($625 million) at most. Allowing for a margin
of error, the remaining budget gap would be anywhere between
UAH 30 and UAH 40 billion ($3.75 - $5 billion),Pazarbasioglu

and Saavedra said. Pazarbasioglu said this year's budget, as
passed, does little except "pays wages and pensions and fills
holes at the pension fund and Naftohaz," and foresees
virtually no capital expenditure. IMF and World Bank experts
were now working with the GOU on budget cuts and
restructuring, a process that would take about two weeks.
Measures would focus on reducing subsidies for the pension
fund and Naftohaz and on restructuring the budget to make it
more sustainable over a longer period, she said.

New Budget, Political Unity Necessary for Next Tranche
-------------- --------------


5. (C) Pazarbasioglu planned to return to Washington on
February 6. She said the Mission was not yet ready to
recommend that the IMF Board approve disbursement of the next
$1.87 billion tranche in the SBA later month. Before making
a recommendation, the IMF would require a revised budget,
approved by the Rada (parliament),that substantially reduces
the expected funding gap in the budget. The budget would
also need to show more fiscal sustainability, as the IMF now
expects the world economic crisis to continue into 2010.
Finally, and most importantly, the IMF will require clear
public commitments by President Yushchenko, PM Tymoshenko and
Rada Speaker Lytvyn that they will jointly support the needed
budget cuts, and jointly sell them to the Ukrainian public.
She said that the IMF also hoped to have assurances of
additional international support when it went into the Board
meeting to approve the disbursement. As things now stand,
that meeting would take place in late February at the
earliest.


6. (C) Pazarbasioglu said the never-ending political
infighting between Yushchenko and Tymoshenko was a major
obstacle to a more realistic budget. Conceptually,
Tymoshenko now understood the fiscal restrictions facing
Ukraine, and showed detailed knowledge of the budget during a
four hour planning session with the IMF Mission. However,
she told Pazarbasioglu that she could not support further
budget cuts because she knew that she could not sell them
politically, as Yushchenko would attack her for whatever
steps she took.


7. (C) Political unity will therefore be a key conditionality
for disbursement of the next tranche, Pazarbasioglu said.
She pointed out that Marek Belka, director of the IMF's
Europe Department, came to Kyiv at short notice this week to
deliver a stern message to Ukraine's political leadership on
the need for decisive action, political unity, and "political
truth" directed towards the Ukrainian public. Pazarbasioglu
said Belka received political commitments from Yushchenko,
Tymoshenko, Lytvyn, and even Party of Regions MP Azarov, who
surprisingly joined the IMF's meeting with Lytvyn.
Responding to a question from a skeptical German ambassador,
Pazarbasioglu confirmed that they received these commitments
individually, in separate meetings, but never met with the
political leadership in a joint environment. Nonetheless,
Pazarbasioglu was confident that Ukraine would fulfill the
IMF's conditions, and that the IMF Board would approve the
disbursement of the next tranche as foreseen in the SBA,
because Ukraine "now understands what it means if we pack up
and leave." Their expressed willingness to demonstrate unity
was convincing, although she conceded that many might think
her to be "romantic and naive" to expect Yushchenko and
Tymoshenko to put their bitter political rivalry aside for
the good of the country.

IMF Asks For Joint G7, EU Message
--------------


8. (C) Pazarbasioglu and World Bank Country Director Martin
Raiser also appealed to the assembled ambassadors to deliver
a joint message to Ukraine's political leadership on the need
to act together and decisively. It would be ideal if the
countries could offer a prospect of financial support in
return for Ukraine's compliance, but in any case delivering
the message would help the IMF at the present juncture,
Pazarbasioglu said. Both IMF and World Bank agreed to
participate in such a meeting.


9. (C) Earlier in the week, PM Tymoshenko said publicly that
the GOU had approached six countries for financial support,
and that two had already committed. None of the assembled
ambassadors said that their governments had pledged support.
In addition to the U.S., only Japan had been approached, and
its Ambassador said that his government had declined the

request.

World Bank Offers Conduit for Multilateral Support
-------------- --------------


10. (C) The World Bank's Raiser offered the World Bank's
Development Policy Loan (DPL) program as a conduit to deliver
multinational budget support, citing examples in other
countries where the World Bank and individual government
donors had teamed together to deliver support within the
framework of the DPL. The World Bank had budgeted a further
$1 billion DPL loan to Ukraine later this year. All DPL
loans are disbursed only after a recipient country meets
clearly specified benchmarks, and Raiser offered to integrate
the newest IMF conditionalities into the catalog of
benchmarks already foreseen for Ukraine, which will include
pension reform, improved targeting of social spending,
safeguarding of capital expenditures, and selected structural
economic reforms. None of the ambassadors present commented
on Raiser's proposal.

Other Topics
--------------


11. (C) Pazarbasioglu briefed the ambassadors on the state of
other components in the SBA:

External Financing Gap

-- The IMF is confident that parent banks will roll over the
debt of their Ukrainian subsidiaries this year, but is far
less confident that debt due by banks to non-parent lenders
abroad will be rolled over.

-- Other factors might help reduce the expected external
financing gap: the Hryvnia devaluation, swifter and deeper
than the IMF had expected, would help the current account
balance, and Ukraine's metal exporters were reporting a
certain stabilization in their exports, partly because of the
weaker Hryvnia.

Banking Sector

-- The banking system was still nowhere close to stability,
and pressure on deposits remained high. Much of the
nervousness leading to withdrawals was being caused by the
conflicting statements and mutual accusations of the
political leadership.

-- Although the NBU's bank diagnostics were of high quality,
still no substantial progress had been made to establish the
needed recapitalization and resolution mechanism.

NBU, MOF

-- Cooperation between the NBU and Ministry of Finance was
improving. However, both remained leaderless, and the GOU
and President needed to act quickly to create a strong and
decisive leadership in both institutions.

-- A strong coordinator was needed to manage affairs between
the NBU and MOF on bank recapitalization and resolution, and
the IMF was optimistic that a person would be named shortly.

-- The NBU had lost credibility as an institution, not only
because of its own visible failings, but because the
Tymoshenko government had regularly attacked it and so
diminished its standing in the eyes of the Ukrainian public.
The attacks also forced the NBU leadership to become far too
cautious in many of its actions out of fear of political
reprisal.
TAYLOR