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February 6, 2009

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Reference ID Created Released Classification Origin
09KYIV256 2009-02-06 13:35 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv


DE RUEHKV #0256/01 0371335
P 061335Z FEB 09

C O N F I D E N T I A L KYIV 000256 
E.O. 12958: DECL: 02/06/2019 
Classified By: AMBASSADOR, REASONS 1.4(B) AND (D) 
1. (C) On February 5 IMF Mission Director Ceyla Pazarbasioglu 
told the G7 and EU ambassadors that Ukraine faces a $3.75 to 
$6.25 billion budget shortfall this year.  She appealed to 
the ambassadors for direct financial support for Ukraine's 
budget, arguing that Ukraine had no other options to finance 
the deficit without borrowing directly from the central bank. 
 If the GOU cuts spending substantially and Ukraine's 
political leadership publicly joins forces to sell the cuts 
to the population, then Ukraine is deserving of international 
support, because the alternative - a severe destabilization 
of the economy - would be in nobody's interest, she argued. 
Pazarbasioglu said she cannot yet recommend that the IMF 
Board disburse the next $1.87 billion tranche of the $16.4 
billion Stand By Arrangement (SBA).  Before doing so, the IMF 
will require a revised budget that cuts expenditures and is 
more fiscally sustainable, and a clear and open commitment by 
President Yushchenko, PM Tymoshenko and Rada speaker Lytvyn 
to back the measures.  Pazarbasioglu was confident that 
Ukraine would fulfill these conditionalities, because the 
leadership "now understands what it means if we pack up and 
leave."  The World Bank supported the IMF appeal and offered 
to use one of its loan facilities as a conduit to channel 
additional assistance.  None of the ambassadors present 
indicated whether their countries might support the appeal, 
but the Japanese ambassador said his country had been 
approached by the GOU and had already declined.  End summary. 
IMF Makes Appeal to G7, EU 
2. (C) IMF Mission director Ceyla Pazarbasioglu told the G7 
and EU Ambassadors on February 5 that Ukraine's budget will 
face a budget shortfall of up to UAH 50 billion ($6.25 
billion) this year.  Acknowledging that the balanced budget 
foreseen in the $16.4 billion Stand By Arrangement (SBA) was 
no longer realistic, she said the IMF and World Bank had 
revised downward their forecast for this year, and are now 
expecting Ukraine's economy to contract by five percent.  The 
expected funding shortfall will be roughly four percent of 
GDP, Pazarbasioglu said, and cannot be covered by 
conventional sources of borrowing.  It was unlikely that the 
international markets would recover sufficiently to serve as 
a source of borrowing, there was no domestic government debt 
market, and the struggling banking system could not lend to 
the GOU as well, "unless it somehow convinces the population 
to put the billions of dollars now under the mattresses back 
into the banks," she said.  The last remaining domestic 
option was direct borrowing from the National Bank of Ukraine 
(NBU), which would monetize the budget shortfall and further 
destabilize the financial sector and economy as a whole. 
3. (C) Pazarbasioglu appealed to the ambassadors for direct 
financial support to help Ukraine meet the expected budget 
gap, arguing that the situation had deteriorated faster and 
further than the IMF or anyone had expected when the $16.4 
billion Stand By Arrangement (SBA) was approved in October. 
Direct budgetary support would help stabilize Ukraine's 
fiscal situation and give it and the IMF "breathing space" to 
move forward implementing the SBA more broadly.  The country 
deserved international support, if the political leadership 
and parliament did everything in their power to improve the 
budget and displayed political unity, she argued.  The 
alternative -- a severe destabilization of the economy -- was 
in nobody's interest, she said. 
Current Budget Has $6.25 Billion Gap With Realistic 
4. (C) The current budget, which forecasts a deficit equal to 
3 percent of GDP, was based on unrealistic assumptions, 
including a 0.4 percent growth rate, she said.  A revised 
budget forecast, using more realistic assumptions, leads to 
the expected UAH 50 billion budget gap.  The GOU has said it 
can reduce spending by about UAH 10 billion ($1.25 billion), 
but that further cuts were not possible both for structural 
and political reasons.  Separately, World Bank economist 
Pablo Saavedra said the GOU was saying it could cut a further 
UAH 5 billion ($625 million) at most.  Allowing for a margin 
of error, the remaining budget gap would be anywhere between 
UAH 30 and UAH 40 billion ($3.75 - $5 billion), Pazarbasioglu 
and Saavedra said. Pazarbasioglu said this year's budget, as 
passed, does little except "pays wages and pensions and fills 
holes at the pension fund and Naftohaz," and foresees 
virtually no capital expenditure.  IMF and World Bank experts 
were now working with the GOU on budget cuts and 
restructuring, a process that would take about two weeks. 
Measures would focus on reducing subsidies
 for the pension 
fund and Naftohaz and on restructuring the budget to make it 
more sustainable over a longer period, she said. 
New Budget, Political Unity Necessary for Next Tranche 
--------------------------------------------- --------- 
5. (C) Pazarbasioglu planned to return to Washington on 
February 6.  She said the Mission was not yet ready to 
recommend that the IMF Board approve disbursement of the next 
$1.87 billion tranche in the SBA later month.  Before making 
a recommendation, the IMF would require a revised budget, 
approved by the Rada (parliament), that substantially reduces 
the expected funding gap in the budget.  The budget would 
also need to show more fiscal sustainability, as the IMF now 
expects the world economic crisis to continue into 2010. 
Finally, and most importantly, the IMF will require clear 
public commitments by President Yushchenko, PM Tymoshenko and 
Rada Speaker Lytvyn that they will jointly support the needed 
budget cuts, and jointly sell them to the Ukrainian public. 
She said that the IMF also hoped to have assurances of 
additional international support when it went into the Board 
meeting to approve the disbursement.  As things now stand, 
that meeting would take place in late February at the 
6. (C) Pazarbasioglu said the never-ending political 
infighting between Yushchenko and Tymoshenko was a major 
obstacle to a more realistic budget.  Conceptually, 
Tymoshenko now understood the fiscal restrictions facing 
Ukraine, and showed detailed knowledge of the budget during a 
four hour planning session with the IMF Mission.  However, 
she told Pazarbasioglu that she could not support further 
budget cuts because she knew that she could not sell them 
politically, as Yushchenko would attack her for whatever 
steps she took. 
7. (C) Political unity will therefore be a key conditionality 
for disbursement of the next tranche, Pazarbasioglu said. 
She pointed out that Marek Belka, director of the IMF's 
Europe Department, came to Kyiv at short notice this week to 
deliver a stern message to Ukraine's political leadership on 
the need for decisive action, political unity, and "political 
truth" directed towards the Ukrainian public.  Pazarbasioglu 
said Belka received political commitments from Yushchenko, 
Tymoshenko, Lytvyn, and even Party of Regions MP Azarov, who 
surprisingly joined the IMF's meeting with Lytvyn. 
Responding to a question from a skeptical German ambassador, 
Pazarbasioglu confirmed that they received these commitments 
individually, in separate meetings, but never met with the 
political leadership in a joint environment.   Nonetheless, 
Pazarbasioglu was confident that Ukraine would fulfill the 
IMF's conditions, and that the IMF Board would approve the 
disbursement of the next tranche as foreseen in the SBA, 
because Ukraine "now understands what it means if we pack up 
and leave."  Their expressed willingness to demonstrate unity 
was convincing, although she conceded that many might think 
her to be "romantic and naive" to expect Yushchenko and 
Tymoshenko to put their bitter political rivalry aside for 
the good of the country. 
IMF Asks For Joint G7, EU Message 
8. (C) Pazarbasioglu and World Bank Country Director Martin 
Raiser also appealed to the assembled ambassadors to deliver 
a joint message to Ukraine's political leadership on the need 
to act together and decisively.  It would be ideal if the 
countries could offer a prospect of financial support in 
return for Ukraine's compliance, but in any case delivering 
the message would help the IMF at the present juncture, 
Pazarbasioglu said.  Both IMF and World Bank agreed to 
participate in such a meeting. 
9. (C) Earlier in the week, PM Tymoshenko said publicly that 
the GOU had approached six countries for financial support, 
and that two had already committed.  None of the assembled 
ambassadors said that their governments had pledged support. 
In addition to the U.S., only Japan had been approached, and 
its Ambassador said that his government had declined the 
World Bank Offers Conduit for Multilateral Support 
--------------------------------------------- ----- 
10. (C) The World Bank's Raiser offered the World Bank's 
Development Policy Loan (DPL) program as a conduit to deliver 
multinational budget support, citing examples in other 
countries where the World Bank and individual government 
donors had teamed together to deliver support within the 
framework of the DPL.  The World Bank had budgeted a further 
$1 billion DPL loan to Ukraine later this year.  All DPL 
loans are disbursed only after a recipient country meets 
clearly specified benchmarks, and Raiser offered to integrate 
the newest IMF conditionalities into the catalog of 
benchmarks already foreseen for Ukraine, which will include 
pension reform, improved targeting of social spending, 
safeguarding of capital expenditures, and selected structural 
economic reforms.  None of the ambassadors present commented 
on Raiser's proposal. 
Other Topics 
11. (C) Pazarbasioglu briefed the ambassadors on the state of 
other components in the SBA: 
External Financing Gap 
-- The IMF is confident that parent banks will roll over the 
debt of their Ukrainian subsidiaries this year, but is far 
less confident that debt due by banks to non-parent lenders 
abroad will be rolled over. 
-- Other factors might help reduce the expected external 
financing gap:  the Hryvnia devaluation, swifter and deeper 
than the IMF had expected, would help the current account 
balance, and Ukraine's metal exporters were reporting a 
certain stabilization in their exports, partly because of the 
weaker Hryvnia. 
Banking Sector 
-- The banking system was still nowhere close to stability, 
and pressure on deposits remained high.  Much of the 
nervousness leading to withdrawals was being caused by the 
conflicting statements and mutual accusations of the 
political leadership. 
-- Although the NBU's bank diagnostics were of high quality, 
still no substantial progress had been made to establish the 
needed recapitalization and resolution mechanism. 
-- Cooperation between the NBU and Ministry of Finance was 
improving.  However, both remained leaderless, and the GOU 
and President needed to act quickly to create a strong and 
decisive leadership in both institutions. 
-- A strong coordinator was needed to manage affairs between 
the NBU and MOF on bank recapitalization and resolution, and 
the IMF was optimistic that a person would be named shortly. 
-- The NBU had lost credibility as an institution, not only 
because of its own visible failings, but because the 
Tymoshenko government had regularly attacked it and so 
diminished its standing in the eyes of the Ukrainian public. 
attacks also forced the NBU leadership to become far too 
cautious in many of its actions out of fear of political 




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