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May 29, 2008

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Reference ID Created Released Classification Origin
08KYIV1047 2008-05-29 15:56 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Kyiv

DE RUEHKV #1047/01 1501556
P 291556Z MAY 08

E.O. 12958: N/A 
REF: KYIV 904 
Treat as Sensitive but Unclassified.  Not for Internet 
To Secretary Gutierrez from Ambassador William Taylor 
1. (SBU) Summary:  Your visit to Ukraine comes as the fragile 
two-vote majority coalition struggles to move ahead with an 
ambitious agenda as dissension between the two parties 
increases.  All eyes are on whether Prime Minister Tymoshenko 
and President Yushchenko can work together better than they 
did in 2005 when Tymoshenko was dismissed after seven months 
of infighting; in the past few weeks, their relationship has 
become particularly strained amid mutual recriminations that 
the other is trying to sabotage the government's work. 
Nevertheless, Yushchenko and Tymoshenko have made numerous 
public statements noting that the orange coalition will 
remain in place.  Both are also working separately on 
amending the constitution, which has become a key political 
issue.  Economic growth is likely to remain strong this year, 
but inflation has surged and inflationary expectations are 
growing rapidly.  Although Ukraine on May 16 joined the WTO, 
it still has a long way to go to improve its business 
climate.  The energy sector is still marked by corruption and 
mismanagement, and is badly in need of new investment. 
Nearly all policy makers agree that Ukraine needs to 
modernize the sector and diversify its sources of energy, yet 
no government has been able to develop and implement a 
coherent long-term strategy to achieve this goal.  Recent 
moves by the GOU to undercut its only Production Sharing 
Agreement (PSA), with the U.S. company Vanco, are causing 
some to question whether the GOU is sincere about attracting 
foreign investment to develop domestic energy resources.  End 
Major Parties Already Focusing on Presidential Elections 
--------------------------------------------- ----------- 
2.  (SBU) Although all three main political parties in the 
Rada (parliament) advocate similar approaches to economic 
reform and a foreign policy that calls for greater 
integration into Europe, their main focus is on the 
presidential election, now less than two years away, which 
has prevented them from cooperating on many issues.  After 
the January disclosure of a secret letter requesting a 
Membership Action Plan from NATO signed by the President, 
Prime Minister, and Rada (Parliament) Speaker, opposition 
Party of Regions used the NATO issue as a pretext to block 
the Rada's work for most of February and pander to their 
Eastern Ukrainian electorate which is suspicious of closer 
ties with NATO.  A political compromise was finally reached 
on March 6 and the Rada returned to work.  Now, infighting 
within the ruling coalition between the Prime Minister's 
faction BYuT and the President's faction Our Ukraine-People's 
Self Defense (OU-PSD) has once again derailed the Rada's 
work.  The Rada majority has managed to pass a few laws, 
often with help from minority parties, but a new, more 
sustainable compromise is needed to pass key legislation, 
such as needed budget amendments and remaining WTO-related 
A New Government Starts Quickly, Then Stalls 
3.  (SBU) Pre-term elections in September 2007, held to end 
months of political stalemate, saw Tymoshenko's BYuT faction 
pick up a large number of seats, leading to a new coalition 
and establishment of a new Government.  PM Tymoshenko hit the 
ground running after her December 18 confirmation; she got a 
budget passed in eight days, completed her government program 
for the upcoming year, which was sent to the Rada for 
approval, and made some progress in fulfilling campaign 
promises, such as to return lost savings from the defunct 
Soviet-era state savings bank.  In forming the coalition, 
BYuT and Our Ukraine split the government portfolios evenly, 
resulting in the surprise election of Yushchenko loyalist 
Arseniy Yatsenyuk, then the 33-year old Foreign Minister, as 
Speaker of the Rada in mid-December. 
4. (SBU) Yushchenko and Tymoshenko's historically rocky 
relationship and mutual distrust between their parties have 
raised questions about the long-term stability of their 
coalition.  In recent weeks, Yushchenko and Tymoshenko have 
been attacking each other publicly, eventually leading 
Tymoshenko's BYuT to blockade the Rada session hall. 
KYIV 00001047  002 OF 003 
Nevertheless, both insist there is no alternative to the 
current coalition.  The coalition managed to pass the budget, 
but has since failed to get its 228 (out of 450) MPs into 
their seats for several key votes, leaving a number of bills 
and nominations hanging.  Both Tymoshenko and Yushchenko have 
reached out to Yanukovych, the former prime minister and now 
leader of the opposition, but thus far his Party of Regions 
has not been a constructive opposition.  The Rada spent the 
nal two weeks of January and most of February hamstrung as 
Regions blockaded the rostrum following the public disclosure 
of the letter requesting a MAP for Ukraine at the Bucharest 
Summit.  Since then, infighting within the coalition over 
personnel changes and legislative priorities has produced a 
parliament that is only sporadically productive.  All parties 
are looking ahead to the next presidential elections in late 
2009/early 2010, and calculating their alliances and their 
policy views accordingly. 
Economy Growing, but Inflation on the Rise 
5. (SBU) Ukraine's economy remains buoyant despite ongoing 
political turmoil.  Real GDP growth was 7.2 percent in 2007, 
and is expected to reach between 5.5 and 6.5 percent this 
year.  However, inflation is now at close to 20 percent, with 
April's inflation figures (note:  nominally 30 percent April 
07 to April 08, but distorted by low April 07 figures.) 
marking a ten-year high.  Rapid income growth has caused a 
surge in imports and a widening of the current account 
deficit.  The central bank has accumulated ample foreign 
exchange reserves to defend the currency, and is now allowing 
the currency to strengthen in an attempt to combat inflation. 
 The outlook for the economy remains positive as incomes are 
still growing and Ukrainian companies are investing heavily 
to modernize their productive capacity.  A major drop in 
world steel and chemical prices, contagion from the worldwide 
credit crisis and/or runaway inflation now pose the main 
risks to the economy in the mid-term. 
6.  (SBU) In their public rhetoric, the country's top 
politicians all promise pro-business regulatory reforms and 
advocate integration into the world economic system.  The 
actual pace of economic reform remains slow, however, and 
political leaders have resorted to administrative measures, 
such as restricting exports of sunflower oil, to combat 
rising food prices.  The investment climate remains 
challenging, with the World Bank recently ranking Ukraine 
139th out of 178 countries as a place to do business.  The 
Overseas Private Investment Corporation (OPIC) remains closed 
to Ukraine because of the government's failure to settle a 
claim arising out of an expropriation in the 1990s.  In spite 
of these challenges some movement on economic reform is 
discernible.  The GOU is currently negotiating with the USG 
over the conditions for OPIC's return to Ukraine, and the 
country became the 152nd member of the WTO on May 16. 
Unfortunately, that historic moment was marred by Ukraine's 
failure to fulfill key WTO commitments, including passing the 
law that would lower its import duties upon accession to 
levels promised during the accession process, because of the 
political deadlock in the parliament. Looking forward, the 
ongoing modernization of commercial life and the opening of 
the economy to the outside world will likely lead to a 
gradual, if uneven, adoption of economic reform. 
Ukraine and Energy 
7. (SBU) The geopolitics and economics of energy continue to 
play a central role in Ukraine.  Energy consumption per 
capita remains the highest in the world, and the energy 
infrastructure is decaying.  Ukraine remains heavily 
dependent on gas and oil imports from Russia and Central 
Asia, and is the main transit country for Russian gas 
shipments to central and western Europe.  Nominal import 
prices for gas have increased almost fourfold in the past 
three years, and Russia has signaled it wants to eventually 
move to price levels charged to Western European customers. 
Most Ukrainian policymakers agree that Ukraine must diversify 
its sources of energy and move towards a market-based energy 
relationship with Russia, but Kyiv has yet to develop a 
long-term strategy to achieve these goals. 
8. (SBU) The USG has encouraged Ukraine to open its energy 
market to more foreign investment.  Few Ukrainian energy 
companies have the technical and financial resources to bring 
domestic production up to potential.  Houston-based Vanco in 
KYIV 00001047  003 OF 003 
October 2007 signed Ukraine's first-ever production sharing 
agreement (PSA) for oil and gas exploration in the Black Sea. 
 In May of this year, however, the GOU annulled the PSA, 
citing specious reasons.  Ukraine's already poor investment 
climate image is likely to worsen if the GOU fails to 
reinstate Vanco's permit (reftel).  There are some bright 
spots, however.  Within the framework of the USG-supported 
Nuclear Fuels Qualification Project, Westinghouse has signed 
a contract to supply Ukrainian reactors with fuel starting in 
2011.  This will help Ukraine diversify its sources of fuels 
for its nuclear power plants, all of which currently get 
their fuel from Russia.  New Jersey-based Holtec in September 
signed a $250 million deal to build a spent nuclear fuel 
storage facility at the Chornobyl Nuclear Power Plant. 
Forces within the Ukrainian energy establishment, likely 
acting at the behest of Russian interests, had been trying to 
torpedo these projects.  These projects' success, or lack 
thereof, will be important signals whether Ukraine has the 
will to move towards more energy diversity in the face of 
Russian geopolitical and economic interests. 


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