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08KYIV2434, UNSTEADY UKRAINE RESPONSE WORRIES IMF TEAM

December 11, 2008

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Reference ID Created Released Classification Origin
08KYIV2434 2008-12-11 15:41 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv

VZCZCXYZ0001
PP RUEHWEB

DE RUEHKV #2434/01 3461541
ZNY CCCCC ZZH
P 111541Z DEC 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 6910
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY

C O N F I D E N T I A L KYIV 002434 
 
SIPDIS 
 
DEPT FOR EUR, EUR/UMB, EEB/OMA 
TREASURY PASS TO TTORGERSON 
 
E.O. 12958: DECL: 12/11/2018 
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: UNSTEADY UKRAINE RESPONSE WORRIES IMF TEAM 
 
REF: A. KYIV 2412 
     B. KYIV 2413 
     C. KYIV 2207 
 
Classified By: ECONOMIC COUNSELOR EDWARD KASKA, REASONS 1.4(B) AND (D) 
 
 1.  (C) Summary.  An IMF team led by Ceyla Pazarbasioglu, in 
Kyiv to assess Ukrainian implementation of the Fund's $16.4 
billion Stand-By Arrangement (SBA), offered mixed reviews of 
GOU anti-crisis efforts during her December 10 meeting with 
the Ambassador.  Pazarbasioglu complimented Minister of 
Finance Viktor Pynzenyk and National Bank of Ukraine (NBU) 
Governor Stelmakh for "trying to do the right thing" but 
lamented political weakness and conflicts of interest in 
their respective institutions.  Her insights on Ukraine's 
2009 budget, bank recapitalization program, and external 
financing gap were mostly dour, as was her assessment of the 
potential for GOU bungling of Prominvestbank's 
nationalization.  Pazarbasioglu called for greater EU 
engagement in the eastern European financial crisis, perhaps 
through a Brady Bond-type solution to the region's debt and 
liquidity problems.  She asked for the U.S. government to 
weigh in with EU counterparts on the Brady Bond idea, as well 
as consider providing a qualified banking advisor to serve as 
an impartial member of the Prominvestbank board.  End summary. 
 
IMF Back in Ukraine 
------------------- 
 
2.  (SBU) Pazarbasioglu and her crew of policy and technical 
advisors traveled to Kyiv on December 1-11 for an interim 
look at Ukraine's adherence to the SBA's conditionalities. 
Pazarbasioglu arrived just over a month after the SBA was 
finalized, seeking to contain apparent problems with GOU 
coordination and program implementation.  During her stay, 
Pazarbasioglu met with senior government officials, private 
businessmen (including those she called "billionaires"), and 
a group of foreign ambassadors.  She requested a separate 
private conversation on December 10 with the U.S. Ambassador 
to provide a candid readout of her trip and request U.S. 
backing for IMF supported programs. 
 
Unsteady Hands at Finance, NBU 
------------------------------ 
 
3.  (C) Assessing two of Ukraine's primary decision makers in 
the financial crisis, Pazarbasioglu mixed praise with 
stinging criticisms, repeated often to us by senior IMF 
officials.  On the Minister of Finance: Pynzenyk "cares and 
is trying to do the right thing," said Pazarbasioglu.  "I 
don't think he has the Prime Minister's backing, but I hope 
he stays."  Pazarbasioglu's erstwhile lieutenant (see comment 
in paragraph 11), resident IMF representative Balazs Horvath, 
observed that Pynzenyk lacks political clout.  Isolated from 
PM Yulia Tymoshenko, he operates as if a "Damocles sword is 
hanging over him."  On the NBU Governor, Pazarbasioglu and 
Horvath both spoke of their admiration for Stelmakh's 
personal integrity.  In general, "Pynzenyk and Stelmakh talk 
to each other," said Horvath, though there is a lack of 
policy coordination between the Minister of Finance and the 
NBU Governor, reflected at all levels.  The IMF has taken the 
unusual role of "hand holding" between the two institutions 
in an effort to coordinate strategy and create safeguards for 
the SBA. 
 
4.  (C) Pazarbasioglu said the top NBU management "doesn't 
understand or have expertise to deal with a flexible exchange 
rate."  "This is doubly difficult," she said, "when the 
banking system is fragile and there is an environment of 
political uncertainty."  The NBU's clumsy management of the 
hryvnia depreciation in November caused reserves to fall by 
over $2 billion.  Pazarbasioglu said that the IMF was forced 
to demand a halt on NBU interventions after the NBU 
repeatedly sold dollars in a non-transparent manner, often 
below market rates.  Only after the IMF provided a technical 
advisor to the NBU did the central bank begin to conduct more 
transparent currency auctions that priced foreign exchange 
near the market rate.  Pazarbasioglu expects the hryvnia to 
stabilize in the short term.  She did say, however, that the 
hryvnia could depreciate further due to the inflation 
differential to the dollar, perhaps to a rate of "8 UAH/$1 or 
even 10 UAH/$1." 
 
5.  (C) As an institution, the NBU has a "Soviet mentality" 
toward its core economic functions, and it thinks "very 
differently" from other central banks.  Pazarbasioglu 
recalled an example of the NBU's explanation of its monetary 
policy controls.  Stelmakh equated any potential interest 
rate increase with higher rates of inflation, even as Ukraine 
struggles with falling GDP and a large current account 
deficit.  Pazarbasioglu and Horvath reiterated accusations of 
conflicts of interest at the NBU's council, where business 
and political influences
seep into the central bank's policy 
making.  NBU council head Petro Poroshenko was singled out as 
a particular epitome of the council's deleterious role. 
 
Financing Gap 
------------- 
 
6.  (SBU) Pazarbasioglu confirmed that a supposed $27 billion 
financing gap, cited in PM Tymoshenko's November 4 letter to 
Treasury Secretary Paulson and again during the Ambassador's 
December 4 conversation with Minister Pynzenyk (Ref A), is 
not an IMF projection.  The IMF has not changed its 
projection of the financing gap for 2008-2010, which remains 
at roughly $16.4 billion for 2008-2010, and is meant to be 
covered by the SBA.  Pazarbasioglu emphasized, however, that 
the IMF program made certain assumptions, particularly that 
i) the GOU would implement SBA conditionalities, ii) most 
bank debt due in 2009 would be rolled over, and iii) the 
world economy would rebound in the second half of 2009. 
Although she had not seen the $27 billion projection cited by 
the GOU, she understood how the GOU arrived at the figure. 
If less bank debt were rolled over, if outstanding sovereign 
debt faced cross-triggers, or if the IMF's assumptions about 
the global economy did not hold, then the financing gap could 
be much larger than what the IMF has projected. 
 
Ukraine's 2009 Budget 
--------------------- 
 
7.  (SBU) Having previewed the Ministry of Finance's draft 
2009 budget in tandem with the World Bank (Ref B), the IMF 
agrees with the World Bank's assessment that the budget is 
not yet close to being balanced.  The biggest culprits are a 
huge drop in revenues, combined with a large deficit in the 
pension fund, according to the IMF.  Pazarbasioglu expressed 
satisfaction that the Ministry had based its austere fiscal 
policy on conservative revenue assumptions.  However, even as 
the draft plan would cut public wages and eliminate nearly 
all capital spending, pensions would continue to push the 
government's overall costs.  The IMF has recommended serious 
pension reform to the GOU, as Ukraine faces a rare 
convergence of short and long-term adjustment needs.  (Note: 
The SBA conditionality of a 2009 balanced budget is driving 
immediate cutting measures, while projections of the 
country's rapidly aging population may force the GOU to take 
a broader approach to a reform package. End note.) 
 
Banking Diagnostics 
------------------- 
 
8.  (SBU) The IMF gave a "thumbs-up" to the ongoing 
diagnostic audits of Ukraine's 17 largest banks.  The audit 
process is due to finish by December 15, when examiners will 
present their initial findings to the GOU and IMF. 
Originally, the IMF had asked external auditors to 
investigate 30 percent of the banks' loans.  Because the 
sector has recently experienced deteriorating loan 
performance, however, the IMF team revised its request and is 
now asking auditors to include reports on 50 percent of all 
bank loans.  Pazarbasioglu expects the auditors to file for 
extensions and submit final reports around the end of the 
year. 
 
USG Assistance Request 
---------------------- 
 
9.  (SBU) Pazarbasioglu considered Prominvestbank's impending 
nationalization to be a mixed blessing.  A high-profile 
casualty of Ukraine's recent financial crisis, Prominvestbank 
could serve as a "critical precedent" for future GOU 
interventions in Ukraine's wobbly banking sector.  On the 
other hand, the IMF estimates that there is currently little 
NBU capacity to administer problem pwQ MQZBn the 
boards of Ukraine's failed banks, with Prominvestbank serving 
as a significant test case.  According to Pazarbasioglu, this 
effort to add impartiality and bridge the roles of the 
Ministry of Finance and the NBU has been endorsed by Minister 
 
of Finance Pynzenyk and Deputy Prime Minister Nemyria. 
(Note:  The GOU announced plans on December 10 to take over 
Prominvestbank -- the sixth largest bank in Ukraine and 
subject of much rumor and speculation in the country's 
financial circles (Ref C) -- after a bid by the Klyuyev 
brothers collapsed due to a lack of external financing.  End 
note.)  The IMF had been concerned that "strategic investors" 
secured their bid through political connections in parliament 
and close ties to the NBU's council, and Pazarbasioglu 
stressed the need to prevent a similar event from happening 
in the future. 
 
10.  (SBU) Pazarbasioglu also asked that the USG weigh in 
with EU counterparts to encourage them to implement a 
solution to the financial crisis that has spread throughout 
eastern Europe.  She suggested the model of U.S. Brady Bonds 
that helped Latin American countries restructure debt in the 
late 1980s and early 1990s.  The IMF said that Europe should 
play a special role in the region, because its banks had 
pushed expansions of capital lending and reaped huge profits 
as a result.  (Note: Embassy Kyiv conveyed these requests to 
Treasury on December 10.  End note.) 
 
Comment 
------- 
 
11.  (C) Pazarbasioglu and Horvath were aligned in their 
thinking on every topic discussed, despite apparent personal 
tensions between them.  Horvath took the opportunity of 
Pazarbasioglu's late arrival to inform the Ambassador of his 
immediate departure from Kyiv.  He said his exodus from IMF 
had been in the works for some time, due to an internal IMF 
dispute earlier in 2008 over the planned closure of the 
Ukraine mission (to which he had been opposed).  For her 
part, Pazarbasioglu expressed no regret that Horvath was 
leaving, even though Post has considered him a valuable 
contact and first-rate analyst of Ukraine's economic 
problems.  There are plans to replace Horvath, but 
Pazarbasioglu speculated that a new resident IMF 
representative would not arrive until late January 2009. 
 
12.  (C) Pazarbasioglu and Horvath's impressions of NBU 
Governor Stelmakh and Minister of Finance Pynzenyk were 
notably more charitable that their general appraisal of the 
GOU's crisis response.  That they separated the Minister and 
the Governor from their institutions sheds light on the fact 
that the IMF views each man as lacking control or power more 
broadly in the government. 
PETTIT

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