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August 11, 2006

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Reference ID Created Released Classification Origin
06KIEV3129 2006-08-11 13:45 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv
DE RUEHKV #3129/01 2231345
P 111345Z AUG 06


C O N F I D E N T I A L SECTION 01 OF 03 KIEV 003129 



E.O. 12958: DECL: 08/11/2016 

Classified By: A/DCM Michelle Logsdon for reasons 1.4(a,b,d). 

1.  (C) Summary:  First Deputy PM and Finance Minister Azarov 
told the Ambassador that by the end of 2006, Ukraine would 
join the WTO.  He pledged that the government would have a 
careful and well-balanced policy in place to deal with 
Ukraine's large negative trade balance.  On the energy 
situation, Azarov said that Ukraine would invite investors, 
including Russia, to help manage the natural gas pipeline 
transit system, but only in return for substantial new 
investment in the system and on the condition that Ukraine 
always maintain a minimum 51 percent share.  Ukraine's 
challenge would be to develop energy-efficient industries 
over the next 5-7 years.  Azarov was interested in the 
Ambassador's presentation of how Ukraine might qualify for a 
full Millennium Challenge Account program and gratefully 
accepted the USG offer of a macroeonomic expert to be 
attached to the Prime Minister's office.  On politics, Azarov 
said that negotiations on "Our Ukraine" joining the coalition 
would continue in September when the Rada resumed work.  End 

2.  (C)  Comment.  Azarov, who was First Deputy PM and 
Minister of Finance from 2002-2005, looked relaxed and happy 
to be back in his old office in the Cabinet of Ministers, and 
the audible buzz of visitors in his outer office testified to 
his key role in the new Yanukovych government.  Speaking in 
Russian, Azarov made a definite impression as a man focused 
on the future and finding practical solutions to current 
problems, only criticizing his predecessors for leaving him a 
difficult situation with regard to gas ("when I handed over 
the office to then-PM Tymoshenko NaftoHaz had no debts and 21 
million cubic meters of gas in our storage facilities") and 
questioning several last-day decisions made by the Yekhanurov 
government just before Regions took office ("they took ten 
decisions on the last day that involved more than 1 billion 
USD and I put a hold on these decisions until we could 
evaluate them").  Azarov was particularly attentive to the 
discussion of MCC and promised to appoint someone in his 
office to work with the USG on the program.  End Comment. 

WTO - In By the End of 2006 
3.  (SBU)  In response to the Ambassador's question about 
different comments coming from the Government about when 
Ukraine might join WTO, Azarov stated plainly that Ukraine 
wanted to be in the WTO by the end of 2006.  Azarov thanked 
the Ambassador for past USG support on this issue and 
expressed hope that the USG would also provide the same kind 
of support to this government.  Azarov said that Ukraine 
still needed to adopt several laws and then reach agreement 
with Kyrygzstan on a bilateral agreement, but both of these 
problems could be resolved.  In fact, in Azarov's view, the 
problem with the Kyrygz wasn't WTO-related at all. The 
Ambassador noted that the USG would be happy to help, we had 
already made efforts with the Kyrgyz, and that Washington 
would be pleased with Azarov's commitment to wrap up WTO 
accession by year's end. 

4.  (SBU)  Regarding possible increases in import tariffs, 
Azarov noted that Ukraine had a big problem with a negative 
trade balance.  In the first six months of 2006, the trade 
deficit stood at USD 3 million; by year's end it could easily 
be USD 6 billion. In addition, Ukraine's currency reserves 
stood at just USD 18 billion.  It was critical for the 
Government to find a way to reestablish a balance in trade. 
Azarov noted that a strategy was needed -- it would clearly 
involve increasing exports and thinking about the exchange 
rate, and while utilizing the opportunities allowed within 
the WTO, to limit imports, especially non-critical and 
non-energy products.  There were six countries with which 
Ukraine had a negative trade balance of nearly USD 7 billion 
-- more than USD 1.6 billion with China (all non-energy), USD 
3 billion with Russia and USD 1 billion with Germany.  Azarov 
stressed that he was not talking about increasing customs 
duties - this had been a media distortion - but instead was 
committed to finding a careful and well-balanced policy. 
"Business should not be afraid."  He acknowledged the WTO's 
"standstill principle" (that while applying for membership, a 
country should take no steps to restrict trade) and said that 
Ukraine was aware of what it could do while it was in this 
"transition period." 

5.  (U)  Azarov was enthusiastic about the Ambassador's offer 
of help from a full-time USG macroeconomic expert who had 
worked with previous Prime Ministers and was ready to be of 
service to Azarov and PM Yanukovych.  Noting that he had 
"always had help from the U.S." in this position, Azarov said 
that Ukraine was facing a number of challenges, especially in 
the steel sector, from the expected increases in energy 

KIEV 00003129  002 OF 003 

prices.  He was "ready to sign an official letter" to
ask the 
USG for his help and suggested that he meet with our USG 
expert on August 15. 

Energy Sector - Ukraine to Hold 51 Percent 
6.  (SBU)  Referring to his August 10 meeting with Deputy PM 
Kluyev and discussion of energy security issues, the 
Ambassador asked Azarov how he planned to manage NaftoHaz 
Ukraine's huge debt and the terms of its repayment to 
RosUkrenergo and Gasprom.  Azarov said that when he left 
office in January 2005 (he was acting PM at that time) and he 
turned over NaftoHaz's USD 3.5 billion balance sheet to 
then-PM Tymoshenko, the company had no debts and 21 million 
cubic meters of natural gas in its storage facilities.  Plus 
Ukraine had contracts for the supply of natural gas with both 
Turkmenistan and Russia, valid until 2011.  Today, NaftoHaz's 
debt stood at USD 2.5 billion and was a large burden for the 
budget.  He bemoaned the fact that all of this had happened 
in just 18 months, and stressed the need for an international 
audit and the use of international accounting standards in 
order to make NaftoHaz more transparent. 

7.  (C)  Noting that he had raised our concern about control 
of pipelines with DPM Kluyev, the Ambassador asked how 
Ukraine would deal with Russian interest in gaining control 
over the pipeline system in exchange for lower prices for 
natural gas or debt forgiveness.  Azarov said that Ukraine 
had a different formula in mind.  Ukraine would allow Russian 
investors (and others) to get involved in the management of 
the pipeline system in exchange for substantial investment. 
However, Azarov stressed, Ukraine would always control at 
least 51 percent of the operation.  Otherwise Ukraine would 
lose control of the system and soon be paying USD 230 to 250 
per cubic meter for gas.  "We understand this very well." 

8.  (C)  Azarov said that Ukraine's long-term dilemma was the 
need to restructure its industries to be prepared to pay 
world prices for natural gas.  However, a 5-7 year transition 
period was critical for the Government to institute a serious 
energy-savings program and prepare the economy to deal with 
international prices.  The Ambassador noted that the U.S. was 
ready to help in this area - we had a USD one million pilot 
energy savings program and advice from experts that would be 
offered to a large industrial firm through a competitive 
selection process.  Azarov bemoaned the fact that Ukraine was 
not seizing these opportunities, noting that the World Bank 
had long tried to implement more than USD one billion dollars 
in energy savings projects.  There were also opportunities to 
raise money for these projects from the international 
financial markets - USD 2.5 billion could be attracted 
annually.  If Ukraine used these opportunities, the 
Government would be able to restructure much of its 
industrial base within the next five years. 

VAT Refunds - Critical for U.S. Business 
9.  (SBU)  The Ambassador asked Azarov about an August 9 
statement that the Government planned to freeze the payment 
of all VAT refunds, arguing that this was an important issue 
for U.S. investors.  Azarov acknowledged the concern and 
pledged that within a week this problem would be resolved. 
According to Azarov, on August 2, the last day of its 
existence, the Yekhanurov Government had taken nine decisions 
that involved more than USD one billion.  The Yanukovych 
Government was concerned about the possibility of corruption, 
given the large sums of money involved, and had frozen all 
nine decisions until they could be studied.  Azarov told the 
Ambassador that he could reassure the U.S. investors involved 
that the VAT refund system would be reinstituted within a 

Interest in MCC 
10.  (SBU)  In response to the Ambassador's short description 
of the MCC program, Azarov expressed great interest in the 
program and listened attentively to the details about the MCC 
Threshold Program and the importance of progress on 
anti-corruption.  Azarov told the Ambassador that he would 
appoint someone from his office to be involved with the USG 
on the MCC program. 

Coalition Politics - Still Talking to Our Ukraine 
--------------------------------------------- ---- 
11.  (SBU)  Azarov confirmed that negotiations with Our 
Ukraine about forming a new coalition would continue in 
September when the Rada reconvened.  At this point, the 
Anti-Crisis Coalition, that had brought Yanukovych to power, 
consisted of 244 deputies from the Party of Regions, 
Socialists, Communists and a number of MP's from Our Ukraine 

KIEV 00003129  003 OF 003 

and BYuT.  Regions had worked hard on a coalition agreement 
with Our Ukraine, but it was "a different kind of 
organization."  Even though most "Our Ukraine" deputies were 
in favor of establishing a coalition, others did not think it 
was a good idea.  Azarov said that Regions welcomed an 
expansion of the coalition because it would strengthen the 
government's foundation.  However, if it didn't happen, "we 
will simply continue to cooperate with Our Ukraine."  As 
Azarov noted, in spite of the lack of a formal coalition 
agreement, Our Ukraine was well-represented in the Cabinet. 
He also mentioned that during the period of negotiations, 
Regions had stayed in close touch with President Yushchenko 
to ensure that he wanted to cooperate --"we are interested in 
the support of the President (Yushchenko), and we are ready 
for compromise." 

12.  (SBU)  In Azarov's view, the recently-signed "Universal" 
would not be the basis for a new coalition agreement.  The 
Universal was a declaration of the vision for the country. 
Regions and Our Ukraine had agreed on a good coalition 
agreement back in the May/June time frame.  The Socialists 
had signed on, but the Communists had disagreed with a number 
of points.  According to Azarov, there had been no time to 
finalize negotiations in August and the negotiating process 
would continue again in September. 

13.  (U) Visit Embassy Kiev's classified website: 




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