PRESIDENTIAL ECONOMIC ADVISOR STRESSES NEED FOR

C O N F I D E N T I A L KYIV 000301 SIPDIS STATE FOR EUR/UMB AND EEB/OMA E.O. 12958: DECL: 02/25/2020 TAGS: ECON EFIN ENRG PGOV UP SUBJECT: PRESIDENTIAL ECONOMIC ADVISOR STRESSES NEED FOR REFORM, CAUTIONS REALISM Classified By: Ambassador John F. Tefft for Reasons 1.4 (b) and (d) ¶1. (C) Summary. Respected economist and Party of Regions' Member of Parliament Iryna Akimova stressed the need for fiscal discipline, financial sector reform, and improvements to the investment climate during her February 23 meeting with the Ambassador. She also recognized the need to focus on tax, land, and other reforms that would address corruption to bring growth back to Ukraine. With a strong sense of realism, however, Akimova cautioned that reforms may not progress as fast as needed due to uncertainties over the formation of a new parliamentary coalition and the difficulties of selling tough measures to voters. Akimova, the head of a widely respected think tank funded by Ukrainian oligarch Akhmetov, was also Party of Regions' Shadow Minister of Economy before being named First Deputy Head of Yanukovich's Presidential Administration on February 25. End Summary. CRUCIAL REFORMS NEEDED -------------- ¶2. (C) During a February 23 meeting with the Ambassador, Iryna Akimova, who is a respected economist and Party of Regions parliamentary member, identified several key areas that need to be addressed as the government tackles economic reform: -- restore trust in policy and institutions among Ukrainian people and international investors; -- remedy the fiscal situation by increasing fiscal discipline and cutting expenditures; -- implement the new state procurement law to reduce corruption; -- reform the energy sector, including increasing energy efficiency before raising tariffs; -- restore trust in banking sector; -- improve the investment climate, including VAT reform; -- implement tax, pension, land, and health care reforms. FISCAL SITUATION -------------- ¶3. (C) Describing the current fiscal situation as "very bad," Akimova stressed that fiscal discipline would be very important. She acknowledged that the annulment of the controversial social standards law that pushed through increases to wages and pensions was unlikely, saying that it "somehow must be honored." However, Akimova thought the government had other opportunities to cut expenditures and increase revenues. Implementing the new state procurement law would help cut expenditures. She estimated that up to 70% of government spending had been done without the benefit of competitive tender processes and that about one quarter of the money that cycled through the public procurement process in 2009 (approximately $5 billion) had been "stolen." Akimova praised the new state procurement law as a good start to secure additional budget revenues and restore fiscal order. Nonetheless, the law was not perfect, she warned, and "political will is of utmost importance." But even with government savings, Ukraine would not be able to keep its budget deficit below IMF-mandated 4%, Akimova said. She suggested that instead of clinging to an "unrealistic" target, Ukraine should produce a clear mid-term plan to reduce the current deficit and settle at a more realistic number, like 8% or 2010. ENERGY REFORM -------------- ¶4. (C) The energy sector remains a key area for reform, as subsidies to state gas company Nafohaz continue draining the budget. An increase in gas tariffs to households was inevitable, Akimova said, but its timing remained open for discussion. "As an economist, I say raise the tariffs now," Akimova said, but cautioned that, politically, this might prove a tough call. Moreover, parliamentary support would be necessary to push through the much needed, but unpopular, measures. She suggested that it might be more feasible to push through reforms that increase energy efficiency before raising gas prices. Energy efficiency would allow consumers to use less gas, thus an increase in prices would be easier to accept. BANKING SECTOR AND MONETARY POLICY -------------- ¶5. (C) Another critical task for the government is to restore trust in the banking sector. The "situation (in the banking sector) is not critical but it is serious," Akimova said, stressing that finishing the recapitalization of Ukraine's systemic banks, including Nadra Bank, was crucial. An unsolved question, according to Akimova, was the situation of troubled small- and medium-size banks, which do not find themselves in the too-big-to-fail category. The discussed solutions include creating a government-owned "bad-asset" bank or providing additional government support to larger banks that could then take over their troubled, smaller cohorts. Akimova liked the idea of creating a "bad bank" initially, but she said it may no longer be feasible because of the expense of doing so to the government. ¶6. (C) Akimova warned that preventing further devaluation of the hryvnia was an important task. With a large share of bank loans denominated in foreign currencies, further weakening of the currency could lead to a second wave of banking crisis, putting additional pressure on Ukraine's fragile economy. Naming a reliable head of the National Bank of Ukraine (NBU) will be crucial to keep maintaining responsible monetary policy, Akimova added, saying that the last two years of infighting between the government and the NBU were "ridiculous." INVESTMENT CLIMATE / INTERNATIONAL AUDIT -------------- ¶7. (C) Since Ukraine has been virtually shut off from international capital markets, it needs to attract foreign investment to ensure balance of payments, Akimova said, stressing the importance of improving the country's investment climate. According to Akimova, the priority for the government will be to show it respects property rights. She said investors should not have to fear nationalization or re-privatization of their assets. Improving the tax code will be another important step, especially addressing value-added tax (VAT) arrears. Akimova elaborated that VAT arrears could not all be paid back in 2010, but she hoped the government would come up with a plan to resolve the issue. In her view, VAT arrears also increased corruption, as companies felt the need to resort to other methods for receiving refunds. The government also needed to take steps to ease administrative burden in conducting business, particularly in the construction sector, Akimova said. ¶8. (C) Commenting on corruption, Akimova opined that while results might not be imminent, the government needed a "credible story" of dealing with the pervasive problem. As a start, she suggested an international audit of state-owned companies such as Ukrzeleznitsya, the national railway company, and of certain government ministries. In her opinion, these audits should be done quickly. She said that President Yanukovich planned to use one of the Big Four international accounting firms for the audits. Akimova told Acting Economic Counselor on February 26 that she did not envision a full audit of public finance by an accounting firm, however. She elaborated that the IMF had already done such an audit and would update its look at public finance when it returns to Ukraine. PENSION AND OTHER REFORMS -------------- ¶9. (C) Reform of the pension system was necessary, although, in a slight shot at current Prime Minister Yuliya Tymoshenko, Akimova said that at the time when Yanukovych left office as PM in 2007 the pension deficit was zero. Nonetheless, several measures would need to be taken, she said, including raising the retirement age and abolishing certain retirement privileges. Akimova offered several ideas on financing pension reform, including establishing a "fund for future generations" which would accumulate revenues from state privatizations or by using profits from the activities of the NBU. ¶10. (C) Akimova was less clear on health care reform. While admitting that the current system was unsustainable, she said she was unsure of what system would be right for Ukraine. Moreover, any alternative proposals would face severe resistance from the medical professional lobby, she said. ¶11. (C) Commenting on the agricultural land reform, Akimova spoke out strongly against the existing status quo. She favors ending the moratorium on agricultural land sales and thought this could be achieved within one to two years. According to her, the Ukrainian agricultural sector should be much more competitive and existing legislation was a barrier to its development. Akimova said that while the status quo has many strong supporters, there is also a growing movement to change the law, allow land sales, and reform the agricultural sector. COMMENT -------------- ¶12. (C) Speaking as an economist, Akimova emphasized the need for economic reforms, the faster the better. However, as a politician, she acknowledged their price and admitted that implementation might take longer than desired. Unlike many other Party of Regions' officials, Akimova appears unscathed by corruption scandals and is generally considered a capable technocrat. Her appointment as the First Deputy Head of the Presidential Administration shows that Akimova has Yanukovich's ear and bodes well for the prospect of economic reform. TEFFT