ABSENT BILATERAL FINANCING, UKRAINE NEEDS BROADER

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 000620

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 04/07/2019
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: ABSENT BILATERAL FINANCING, UKRAINE NEEDS BROADER
IFI SUPPORT

REF: A. KYIV 591

B. KYIV 576

C. KYIV 497

D. KYIV 360

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


1. (C) Summary. As the IMF mission team looks set to return
to Kyiv on April 9, President Yushchenko and Prime Minister
Tymoshenko have assured the IMF of their intention to see
through more budget cutbacks when the Rada votes on key laws
on April 14. Nonetheless, it appears that Ukraine's ensuing
projected budget deficit will remain far too large to
refinance on either the country's miniscule domestic capital
market or through foreign borrowing, where an appetite for
Ukraine's risks remains nonexistent. Despite the GOU's
efforts to secure large-scale bilateral budget support --
including a request to the United States from Yushchenko for
a "symbolic" political pledge of direct aid -- local
representatives of G-7 countries tell us their home offices
are not prepared to extend loans to Ukraine. Russia, too,
has put discussions over a loan package on hold. If Ukraine
is to avoid monetizing the deficit through central bank
borrowing, its only sources of additional budget support will
likely come from the IMF and the World Bank. End summary.

Fiscal and Macroeconomic Worsening
--------------


2. (C) The IMF has told us that its Ukraine mission team,
led by Ceyla Pazarbasioglu, will return to Kyiv on April 9.
In an effort to get its program back on track, the IMF will
focus on legislation that would reduce Ukraine's expected
budget deficit to manageable levels. Both Yushchenko and
Tymoshenko have publicly declared their intention to pass
remaining anti-crisis bills on April 14. By virtue of BYuT's
performance on March 31, Tymoshenko has proven she can back
assurances with votes (Ref B). The President's powers of
persuasion appear more limited, or else he may not be putting
these powers to the test. Yushchenko notably did not respond
when the Ambassador asked him on April 8 to push for votes in
the Rada.


3. (C) Many Kyiv-based analysts now forecast that Ukraine's
2009 budget deficit could be close to 10 percent of GDP (at
about $13 billion, nearly double initial IMF estimates). The
budget deficit figure could bloom to 14 percent if bank
recapitalization costs amount to $7 billion, as is now
projected by some analysts. Financing needs for bank
recapitalization will be met by a combination of capital
increases by shareholders, EBRD/WB/IMF loans, and bank
consolidations. But even if the GOU enacts legislation to
cut pension spending and restructure state energy company
Naftohaz's budget outlays and debt payments, it would still
need anywhere between $2.6 and 10.4 billion, depending on
domestic sources of financing. The IMF will address these
more pessimistic estimates, likely through a revision of its
budget deficit projections, after the mission team returns to
Kyiv this week.

Bilaterals Balk at Direct Budget Support
--------------


4. (C) Kyiv-based reps of potential bilateral donors are
balking at the idea of direct loans to Ukraine, due to their
own fiscal problems, as well as the widely shared conviction
that additional financing should flow through multilateral
institutions and be anchored by existing conditionalities and
monitoring practices. U.K ambassador Leigh Turner
acknowledged at a roundtable with the IMF, World Bank, and
other G7 ambassadors that London would not be in a position
to offer direct support, a position confirmed on March 19 by
the Foreign Office in a widely circulated letter by Tim
Hitchens, Director for European Political Affairs. "It is a
question of political reluctance at home, driven by our own
fiscal crisis," British embassy political section chief
Duncan Allan told us on March 25, "but London believes the
IFIs can deliver without major domestic political
ramifications."


5. (C) Similarly, the German, Italian, French, and Japanese
ambassadors have stated their governments' unwillingness to
heed Kyiv's call for bilateral aid. The Europeans, each in
their own fashion, collectively and individually have said
no. Nonetheless, long-time regional analyst Anders Aslund
voiced a more optimistic prognosis on budget assistance,

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telling the Ambassador on April 3 that Ukraine's best bet
would be for IFI support, augmented by certain European
bilaterals, such as Sweden, Finland, and Austria, since these
countries have either sufficient funds and/or the most to
lose from their banks' exposure to Ukraine. To our
knowledge, however, none of these countries has expressed a
willingness to lend directly to Ukraine. Aslund opined that
the EU, with its balance of payments support funds, would
also need to consider co-financing. "So far, the EU has
stopped at its border, but 'friendly and financially
interested' countries will be trying to give the idea much
greater exposure."


6. (C) Separately, Japanese diplomat Megumi Osugi-Stepien
told us that a spirited discussion over financial assistance
had arisen during PM Tymoshenko's recent trip to Tokyo. The
Japanese have reacted with particular vehemence to Ukraine's
recent decision to raise tariffs on imported cars by 13
percent (Ref C),since roughly 80 percent of Japan's exports
to Ukraine are automobile-related. The tariff issue had
torpedoed any consideration of financial assistance, and it
was unclear whether Japan would be open to a loan even in
absence of the tariff hike. But Osugi-Stepien told us on
April 7 that if the Japanese finance ministry were to
consider additional money for Ukraine, it would deliver such
assistance through an IFI vehicle. "The money would still be
from us," she said, "but IMF or World Bank lending would
allow us to have greater safeguards."


7. (C) Osugi-Stepien also told us that, according to minutes
of Tymoshenko's meeting with Japanese PM Aso on March 25, Aso
told Tymoshenko that the IMF's program to tackle the 1998
Asian financial crisis had imposed unrealistically difficult
conditionalities on Asian countries, and that Ukraine now
needed to use those lessons to find its "own way" to continue
spending. Osugi-Stepien shared with us that the Japanese
MFA's internal meeting transcript indicated Tymoshenko
smiling at Aso's remark. Osugi-Stepien also said that
Minister of Economy Danylyshyn's claims, made in Tokyo at the
end of the visit, that Japan had agreed to a $5 billion loan
package under more favorable terms than the IMF Stand-By
Arrangement (SBA),resulted from either unprofessional
journalism or a deliberate misstatement by the Minister. The
Japanese embassy felt compelled to declare publicly that the
GOJ had been "surprised" to learn from Danylyshyn that it was
considering budget assistance.


8. (SBU) Outstanding negotiations over a Russian $5 billion
loan likewise have been derailed. Moscow "indefinitely
postponed" bilateral economic talks between Prime Ministers
Putin and Tymoshenko that had been scheduled for early April,
due to the joint EU-Ukraine declaration on gas transit,
issued on March 23 in Brussels. Russian President Medvedev
explicitly linked the two issues in a statement on March 31,
saying it would be difficult to grant financial credits to
cover Ukraine's budget deficit until the two states resolved
their gas dispute. He added, "Our Ukrainian colleagues have
asked us to give money. How can we give money if we cannot
agree on such a crucial issue?" According to reputable local
media reports, the Russian embassy in Kyiv has indicated that
preparations for the economic talks continue, though no date
has yet been set by Putin and Tymoshenko. It is as yet
unclear whether the agreement on gas transit cooperation,
announced on April 8 in Moscow, will make Russia more willing
to extend budget support to Ukraine.


9. (C) After a meeting with G-8 and neighboring country
ambasssdors on April 8, Yushchenko pulled aside the
Ambassador to request a "symbolic" pledge of support for
Ukraine as a "political" gesture. He stated that Russian
assistance would have "too much of a political component" on
its own, but it could be balanced by a signal from the USG.
Yushchenko pleaded for the United States not to leave Ukraine
"one-on-one" with Russia. Even a "modest sum" would show
that the United States was not indifferent. The President
reasoned that a U.S. pledge would also afford Ukraine greater
leverage in accepting Russian assistance.

A More Lenient, Generous IMF?
--------------


10. (C) Our Kyiv-based G-7 interlocutors began expressing
their skepticism of bilateral budget support even before the
G-20 announced a significant capital infusion for the IMF.
The announcement prompted the local media to speculate
whether the G-20 declaration could lead to a bolstered

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package for Ukraine. Prior to the announcement, Kyiv-based
IMF resident representative Max Alier had already implicitly
acknowledged that the Fund was calculating how it might
increase its program in target countries such as Ukraine.
When asked by the Ambassador on March 24 whether the IMF
would consider providing more monies for Ukraine's budget
deficit, Alier said, "We are bureaucrats and we serve (our
masters)." Despite the fact that the Fund does not typically
lend to meet countries' fiscal needs, Alier has hinted that
the IMF has discussed this for Ukraine, especially in light
of the lack of forthcoming bilateral support (Ref A).

Enlarging the World Bank Envelope
--------------


11. (SBU) With a projected program of $1.25 billion for
Ukraine in 2009, the World Bank has reached the upper limit
of its annual "envelope," local World Bank representatives
have told us. Provided that the IMF program is on track and
that Ukraine undertakes six key structural measures, the
World Bank would disburse a $500 million Development Policy
Loan for 2009 budget support and up to $750 million in loans
for bank recapitalization (Ref D). The World Bank's
Kyiv-based Senior Economist Pablo Saavedra told us that
existing policy criteria would normally preclude additional
lending, even if World Bank shareholders were to increase the
Bank's overall capital. According to formal World Bank rules
governing its treasury and operations, there are limited
avenues for using the Bank as an instrument by which to route
country-targeted external financing, said Saavedra.


12. (C) Nonetheless, the World Bank can be used as a
"platform" for additional external lending in two ways. One
would be through a so-called "top off" program, which
Saavedra said was a mechanism the Bank and other donors have
used to co-finance budget support after the World Bank
reached its annual lending limit. A "top-off" could provide
an additional budget support mechanism for Ukraine, said
Saavedra, if bilateral donors would choose to bundle their
support with the World Bank's structural reforms and planned
2009 loan packages.


13. (C) Another way the World Bank could serve as a bridge
between Ukraine's fiscal needs and potential donor assistance
would be to convene a Consultative Group, in which case a
needs assessment and donor pledges would be solicited.
"There is no model for this; it would be done in an ad hoc
fashion," said Saavedra. In his discussion with the
Ambassador, Anders Aslund commented positively about a
potential Consultative Group, which he said would convene
major IFIs, as well as interested bilateral donors. Aslund
also said that western donors should "multilaterize" the
Russians, preempting the need for bilateral budget support.

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


14. (C) Our G-7 interlocutors mostly agree that Ukraine
cannot fund its 2009 budget deficit without external
financial assistance. IMF envoy Pazarbasioglu will likely
broach this subject during her trip to Kyiv, asking G-7
ambassadors again for bilateral budget support. We would
support consideration of a symbolic pledge of USG direct
budget assistance for political reasons. Yet, we expect that
the G-20's multi-billion dollar capital infusion for the IMF
will only strengthen the already prevalent view among our
interlocutors that IFIs should be the international
community's optimal vehicle for financing Ukraine's fiscal
deficit.
TAYLOR