UKRAINE: IMF LIKELY TO SUPPORT RISKY GOU MOVE TO

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 000676

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA

E.O. 12958: DECL: 04/15/2019
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: UKRAINE: IMF LIKELY TO SUPPORT RISKY GOU MOVE TO
STABILIZE PUBLIC FINANCES

REF: KYIV 576

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

Summary and Comment
--------------


1. (C) On April 14 Prime Minster Yulia Tymoshenko moved
quickly after the Rada again failed to include key
IMF-related anti-crisis legislation on the agenda. Within
hours of the failed vote, the CabMin passed 19 resolutions
that aim to provide the fiscal discipline that the IMF
expects in return for disbursing the long-overdue, $1.87
billion second tranche of the Stand-By Arrangement. The
action was clearly prepared long before the Rada vote, and
now appears to have had the full support of the IMF, which
has indicated that it will accept the resolutions in lieu of
laws. The IMF now looks set to disburse the second tranche,
and its local rep even indicated that the payment could be
made in the form of direct budget support. The IMF is less
open to the GOU suggestion to combine the disbursement with
the payment of the third, significantly larger tranche that
could be disbursed in May. Using resolutions instead of laws
is a risky strategy, as both the President and Rada deputies
could formally challenge the GOU moves in the courts, but the
IMF now takes the view that the GOU had few other options in
the current political environment. However fragile and
institutionally questionable the resolutions may be, they are
the quickest option that the GOU has to meet IMF
expectations. End summary and comment.

Tymoshenko Acts Quickly After Yushchenko Fails to Deliver
-------------- --------------


2. (C) On April 14 the Rada again failed to address three
laws aimed at implementing key IMF conditionalities. None of
the drafts received enough votes to be put on the agenda.
The roll call ran largely along the lines of the unsuccessful
March 31 votes on the same legislation (reftel),with
ostensibly pro-presidential MPs failing to support the
measures. It is unclear whether Yushchenko could not, or
chose not, to deliver the votes of MPs still considered loyal
to him.


3. (C) Afterwards PM Tymoshenko convened an extraordinary
meeting of the CabMin, which quickly adopted 19 resolutions
that aim to achieve the same fiscal results foreseen in the
legislation. In a subsequent meeting with the Ambassador,
Tymoshenko said that all CabMin members, including those
ministers with close ties to President Yushchenko, supported
the measures with little debate. Tymoshenko told the
Ambassador that IMF Mission director Ceyla Pazarbasioglu
participated in the CabMin meeting and subsequently approved
the measures. According to Tymoshenko, the actions will
allow Pazarbasioglu to recommend to the IMF Board that the
overdue, $1.87 billion second tranche of the Stand-By
Arrangement be disbursed to Ukraine.

IMF Accepts Resolutions in Lieu of Laws
--------------


4. (C) The local media quoted Pazarbasioglu as saying that
Ukraine had now done all it could under the present
circumstances. The IMF would now discuss the individual
resolutions with the GOU in greater detail in the coming
days. IMF resident rep Max Alier confirmed to us on April 15
that the IMF had not yet studied the resolutions in detail,
but looked prepared to accept the results. "Of course having
the measures approved by the Rada would have been more
kosher," Alier told us, "but if the Rada is not game then we
will have to live with the resolutions." Earlier, he told us
point blank that the IMF Mission team could not back out of
Ukraine a second time without disbursing the second tranche.
He said the IMF made a calculated decision that the GOU would
not get budget legislation passed, and decided to accept that
the GOU can tackle the fiscal deficit via resolutions.


5. (C) It now appears clear that the Tymoshenko government
had prepared the resolutions long in advance of the April 14
meeting. Tymoshenko and Deputy PM Nemyrya showed the
Ambassador the voluminous stack of resolutions and supporting
documentation, all of which would have required significant
planning in Ukraine's slow bureaucracy. The IMF was aware of
this fallback plan when the Mission returned to Ukraine last
week, with Pazarbasioglu telling the Ambassador on April 11
that she was impressed at the GOU's preparations of a

KYIV 00000676 002 OF 003


comprehensive "Plan B" for the event that the Rada vote
failed. At that time she had already indicated that the IMF
would be open to accepting resolutions in lieu of laws if
they achieved similar fiscal results. She said the measures
would leave a forecast budget deficit of roughly 4 percent of
GDP, which at current exchange rates equals roughly $4
billion.

Bank Recap Group to Designate 6-8 Banks
--------------


6. (C) Tymoshenko also told the Ambassador that she would
chair the first meeting of the newly created GOU board
dealing with bank recapitalizations on April 15. At the
meeting, which both IMF and World Bank will attend as
observers, the GOU would announce the first group of banks
that will receive recapitalization funds from the government.
Separately, Nemyrya had told the Ambassador that the board
would announce a group of six to eight banks that had been
identified using objective criteria. The results of the
stress tests conducted by the NBU earlier this year would
play a major role, as well as whether the bank was deemed
systemic (barometer would be the relative size of its deposit
base) and whether the bank was already under temporary NBU
administration, Nemyrya said.

Second Tranche in the Form of Budget Support?
--------------


7. (C) Tymoshenko said the GOU was asking the IMF to pay out
the $1.87 million tranche directly to the state budget, as
the situation on the foreign exchange market had stabilized
while the overall fiscal situation was deteriorating by the
day. She also said the GOU hoped to combine the disbursement
of the second and third tranches, which was originally
scheduled to be disbursed on May 15, and should total about
$3.6 billion, or double the amount of the second tranche.
Later on April 14 IMF resident rep Alier told us that a
payment directly to the budget was possible, and even likely.
Combining the tranches, however, was "a pie in the sky," he
said. In her discussion with the Ambassador, Tymoshenko had
acknowledged that the IMF had said combining the tranches
would significantly delay their joint disbursement, possibly
to the end of May. She asked the Ambassador that the USG
weigh in with the IMF to accelerate a joint disbursement, as
the political situation in Ukraine was making it increasingly
difficult to get anything done, and that the budget
desperately needed the funds.

Can Resolutions Work in Lieu of Laws?
--------------


8. (C) Cabinet of Ministers decrees are commonly used policy
tools in Ukraine's volatile political environment. We have
observed that the current GOU has resorted to resolutions on
trade-related issues when the Rada has either passed
legislation that violates Ukraine's international
obligations, or failed to support international commitments
that the GOU has promised. However, under Ukrainian law
cabinet resolutions are generally used for setting the
procedures to implement laws. They cannot contradict laws or
presidential decrees, and they are generally far easier to
reverse than acts of law.


9. (C) It remains to be seen whether the resolutions adopted
on April 14 will provide a sustainable policy environment in
the mid- to longer term. Cabinet of Ministers resolutions do
not carry the same status as laws passed by the Rada or
presidential decrees, and they are vulnerable to challenges
from both the President and from parliamentarians.
President Yushchenko can issue a decree suspending CabMin
resolutions while he challenges them in court. In addition,
a group of at least 45 Rada MPs can challenge the legality
of CabMin resolutions in court, during which time the
resolutions are automatically suspended.


10. (C) As yet, however, Yushchenko has not indicated that
he will contest the CabMin's actions. On April 15 he called
the GOU approach "exceptionally positive" but said the
results were not ideal from an economic point of view. He
said that the Presidential Secretariat would investigate the
legal, economic and political implications of the
resolutions. Separately, he had indicated that the price
hikes for energy could cause an increase in inflation. In
the Rada, pro-presidential Our Ukraine-People's Self Defense
deputy Vjacheslav Kyrylenko called the resolution hiking

KYIV 00000676 003 OF 003


pension contributions illegal, arguing that the payments are
akin to tax payments and hence fall under the purview of the
Rada. He did not indicate a willingness to formally
challenge the measures, however.

"Inconsistencies" Opened Path for Some Resolutions
-------------- --------------


11. (C) Nemyrya told the Ambassador that the GOU "used
inconsistencies in the law" when drafting the resolutions.
The Ministry of Justice, led by Yushchenko supporter
Onyshchuk, had reviewed the measures and deemed them to be in
accordance with the law, he said. For example, one
resolution will increase the monthly amount that small and
medium enterprises (SMEs) pay to the pension fund from 80 UAH
($10) to 208 UAH ($26) per month, a measure that should
increase revenue by 1.9 billion UAH ($237 million) for the
remaining eight months of 2009, Nemyrya said. SMEs have
enjoyed lower pension payments since former President Kuchma
issued a corresponding decree in 1998, he said. Hence the
CabMin was confident it could change the decree by passing a
resolution. Nemyrya said he expects Yushchenko's supporters
to attack the measures, but expressed confidence that the GOU
could defend its actions because the pension privileges that
SMEs enjoyed put other groups with higher pension fund
contributions, such as teachers, at a disadvantage and
actually forced them to subsidize the pensions of small
entrepreneurs.

12.(C) Two other resolutions aim at improving the financial
situation at Naftohaz. One resolution makes a
"recommendation" to the independent tariff regulator to
introduce higher, sliding scale gas and electricity prices
for retail households that consume large amounts of energy.
Another resolution introduces a 2 percent surcharge on the
price of natural gas delivered to some industrial users, a
measure that Energy Minister Prodan said would boost revenues
by UAH 560-580 million (about $70 million.)


13. (C) The resolutions pertaining to pensions appear to
contain measures nearly identical to the measures foreseen in
the failed pension reform draft. As yet it is unclear,
however, whether the energy-related resolutions will help
fully plug the holes in Naftohaz's finances. The failed
legislation had foreseen measures to compensate a UAH 6.1
billion ($762 million) deficit at Naftohaz which will arise
because the company sells gas domestically at
administratively set prices far below what it pays for gas
imports from Russia.

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


14. (C) The IMF understands the vagaries of Ukrainian
politics, and it is now clear that it would not make its
decision to disburse the next tranche dpendent on the
outcome of the April 14 Rada vote. It and the GOU are
walking a thin line with this approach, but in Ukraine's
volatile political environment this is the quickest option as
long as President Yushchenko is unwilling or unable to
convince his remaining supporters to support crisis-related
legislation. The IMF recognizes that Ukraine's fiscal
situation is deteriorating rapidly -- in the first three
months of this year, a time when the budget normally has a
seasonally induced surplus, the budget deficit was 1.5
percent of GDP. Hence action is needed. With no other
sources of budget support on the horizon, the IMF realizes
that taking the (unrealistic) high road won't help Ukraine in
the short- to medium-term, and would actually work against
what the Fund is trying to achieve in Ukraine. The
resolutions are still open to challenge by the President, or
Rada deputies. However fragile and institutionally
questionable, the resolutions are the quickest option that
the GOU had to meet IMF expectations. End comment.
TAYLOR