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09KYIV620, ABSENT BILATERAL FINANCING, UKRAINE NEEDS BROADER

April 8, 2009

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09KYIV620 2009-04-08 18:49 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv

VZCZCXRO2763
PP RUEHDBU
DE RUEHKV #0620/01 0981849
ZNY CCCCC ZZH
P 081849Z APR 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 7591
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 SECTION 01 OF 03 KYIV 000620 
 
SIPDIS 
 
DEPT FOR EUR, EUR/UMB, EEB/OMA 
 
E.O. 12958: DECL: 04/07/2019 
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: ABSENT BILATERAL FINANCING, UKRAINE NEEDS BROADER 
IFI SUPPORT 
 
REF: A. KYIV 591 
     B. KYIV 576 
     C. KYIV 497 
     D. KYIV 360 
 
Classified By: AMBASSADOR WILLIAM B. TAYLOR, REASONS 1.4 (B) AND (D) 
 
1.  (C) Summary. As the IMF mission team looks set to return 
to Kyiv on April 9, President Yushchenko and Prime Minister 
Tymoshenko have assured the IMF of their intention to see 
through more budget cutbacks when the Rada votes on key laws 
on April 14.  Nonetheless, it appears that Ukraine's ensuing 
projected budget deficit will remain far too large to 
refinance on either the country's miniscule domestic capital 
market or through foreign borrowing, where an appetite for 
Ukraine's risks remains nonexistent.  Despite the GOU's 
efforts to secure large-scale bilateral budget support -- 
including a request to the United States from Yushchenko for 
a "symbolic" political pledge of direct aid -- local 
representatives of G-7 countries tell us their home offices 
are not prepared to extend loans to Ukraine.  Russia, too, 
has put discussions over a loan package on hold.  If Ukraine 
is to avoid monetizing the deficit through central bank 
borrowing, its only sources of additional budget support will 
likely come from the IMF and the World Bank.  End summary. 
 
Fiscal and Macroeconomic Worsening 
---------------------------------- 
 
2.  (C) The IMF has told us that its Ukraine mission team, 
led by Ceyla Pazarbasioglu, will return to Kyiv on April 9. 
In an effort to get its program back on track, the IMF will 
focus on legislation that would reduce Ukraine's expected 
budget deficit to manageable levels.  Both Yushchenko and 
Tymoshenko have publicly declared their intention to pass 
remaining anti-crisis bills on April 14.  By virtue of BYuT's 
performance on March 31, Tymoshenko has proven she can back 
assurances with votes (Ref B).  The President's powers of 
persuasion appear more limited, or else he may not be putting 
these powers to the test.  Yushchenko notably did not respond 
when the Ambassador asked him on April 8 to push for votes in 
the Rada. 
 
3.  (C) Many Kyiv-based analysts now forecast that Ukraine's 
2009 budget deficit could be close to 10 percent of GDP (at 
about $13 billion, nearly double initial IMF estimates).  The 
budget deficit figure could bloom to 14 percent if bank 
recapitalization costs amount to $7 billion, as is now 
projected by some analysts.  Financing needs for bank 
recapitalization will be met by a combination of capital 
increases by shareholders, EBRD/WB/IMF loans, and bank 
consolidations.  But even if the GOU enacts legislation to 
cut pension spending and restructure state energy company 
Naftohaz's budget outlays and debt payments, it would still 
need anywhere between $2.6 and 10.4 billion, depending on 
domestic sources of financing.  The IMF will address these 
more pessimistic estimates, likely through a revision of its 
budget deficit projections, after the mission team returns to 
Kyiv this week. 
 
Bilaterals Balk at Direct Budget Support 
---------------------------------------- 
 
4. (C) Kyiv-based reps of potential bilateral donors are 
balking at the idea of direct loans to Ukraine, due to their 
own fiscal problems, as well as the widely shared conviction 
that additional financing should flow through multilateral 
institutions and be anchored by existing conditionalities and 
monitoring practices.  U.K ambassador Leigh Turner 
acknowledged at a roundtable with the IMF, World Bank, and 
other G7 ambassadors that London would not be in a position 
to offer direct support, a position confirmed on March 19 by 
the Foreign Office in a widely circulated letter by Tim 
Hitchens, Director for European Political Affairs.  "It is a 
question of political reluctance at home, driven by our own 
fiscal crisis," British embassy political section chief 
Duncan Allan told us on March 25, "but London believes the 
IFIs can deliver without major domestic political 
ramifications." 
 
5. (C) Similarly, the German, Italian, French, and Japanese 
ambassadors have stated their governments' unwillingness to 
heed Kyiv's call for bilateral aid.  The Europeans, each in 
their own fashion, collectively and individually have said 
no.  Nonetheless, long-time regional analyst Anders Aslund 
voiced a more optimistic prognosis on budget assistance, 
 
KYIV 00000620  002 OF 003 
 
 
telling the Ambassador on April 3 that Ukraine's best bet 
would be for IFI support, augmented by certain European 
bilaterals, such as Sweden, Finland, and Austria, since these 
countries have either sufficient funds and/or the most to 
lose from their banks' exposure to Ukraine.  To our 
knowledge, however, none of these
 countries has expressed a 
willingness to lend directly to Ukraine.  Aslund opined that 
the EU, with its balance of payments support funds, would 
also need to consider co-financing.  "So far, the EU has 
stopped at its border, but 'friendly and financially 
interested' countries will be trying to give the idea much 
greater exposure." 
 
6. (C) Separately, Japanese diplomat Megumi Osugi-Stepien 
told us that a spirited discussion over financial assistance 
had arisen during PM Tymoshenko's recent trip to Tokyo.  The 
Japanese have reacted with particular vehemence to Ukraine's 
recent decision to raise tariffs on imported cars by 13 
percent (Ref C), since roughly 80 percent of Japan's exports 
to Ukraine are automobile-related.  The tariff issue had 
torpedoed any consideration of financial assistance, and it 
was unclear whether Japan would be open to a loan even in 
absence of the tariff hike.  But Osugi-Stepien told us on 
April 7 that if the Japanese finance ministry were to 
consider additional money for Ukraine, it would deliver such 
assistance through an IFI vehicle.  "The money would still be 
from us," she said, "but IMF or World Bank lending would 
allow us to have greater safeguards." 
 
7. (C) Osugi-Stepien also told us that, according to minutes 
of Tymoshenko's meeting with Japanese PM Aso on March 25, Aso 
told Tymoshenko that the IMF's program to tackle the 1998 
Asian financial crisis had imposed unrealistically difficult 
conditionalities on Asian countries, and that Ukraine now 
needed to use those lessons to find its "own way" to continue 
spending.  Osugi-Stepien shared with us that the Japanese 
MFA's internal meeting transcript indicated Tymoshenko 
smiling at Aso's remark.  Osugi-Stepien also said that 
Minister of Economy Danylyshyn's claims, made in Tokyo at the 
end of the visit, that Japan had agreed to a $5 billion loan 
package under more favorable terms than the IMF Stand-By 
Arrangement (SBA), resulted from either unprofessional 
journalism or a deliberate misstatement by the Minister.  The 
Japanese embassy felt compelled to declare publicly that the 
GOJ had been "surprised" to learn from Danylyshyn that it was 
considering budget assistance. 
 
8. (SBU) Outstanding negotiations over a Russian $5 billion 
loan likewise have been derailed.  Moscow "indefinitely 
postponed" bilateral economic talks between Prime Ministers 
Putin and Tymoshenko that had been scheduled for early April, 
due to the joint EU-Ukraine declaration on gas transit, 
issued on March 23 in Brussels.  Russian President Medvedev 
explicitly linked the two issues in a statement on March 31, 
saying it would be difficult to grant financial credits to 
cover Ukraine's budget deficit until the two states resolved 
their gas dispute.  He added, "Our Ukrainian colleagues have 
asked us to give money.  How can we give money if we cannot 
agree on such a crucial issue?"  According to reputable local 
media reports, the Russian embassy in Kyiv has indicated that 
preparations for the economic talks continue, though no date 
has yet been set by Putin and Tymoshenko.  It is as yet 
unclear whether the agreement on gas transit cooperation, 
announced on April 8 in Moscow, will make Russia more willing 
to extend budget support to Ukraine. 
 
9. (C) After a meeting with G-8 and neighboring country 
ambasssdors on April 8, Yushchenko pulled aside the 
Ambassador to request a "symbolic" pledge of support for 
Ukraine as a "political" gesture.  He stated that Russian 
assistance would have "too much of a political component" on 
its own, but it could be balanced by a signal from the USG. 
Yushchenko pleaded for the United States not to leave Ukraine 
"one-on-one" with Russia.  Even a "modest sum" would show 
that the United States was not indifferent.  The President 
reasoned that a U.S. pledge would also afford Ukraine greater 
leverage in accepting Russian assistance. 
 
A More Lenient, Generous IMF? 
----------------------------- 
 
10. (C) Our Kyiv-based G-7 interlocutors began expressing 
their skepticism of bilateral budget support even before the 
G-20 announced a significant capital infusion for the IMF. 
The announcement prompted the local media to speculate 
whether the G-20 declaration could lead to a bolstered 
 
KYIV 00000620  003 OF 003 
 
 
package for Ukraine.  Prior to the announcement, Kyiv-based 
IMF resident representative Max Alier had already implicitly 
acknowledged that the Fund was calculating how it might 
increase its program in target countries such as Ukraine. 
When asked by the Ambassador on March 24 whether the IMF 
would consider providing more monies for Ukraine's budget 
deficit, Alier said, "We are bureaucrats and we serve (our 
masters)."  Despite the fact that the Fund does not typically 
lend to meet countries' fiscal needs, Alier has hinted that 
the IMF has discussed this for Ukraine, especially in light 
of the lack of forthcoming bilateral support (Ref A). 
 
Enlarging the World Bank Envelope 
--------------------------------- 
 
11. (SBU) With a projected program of $1.25 billion for 
Ukraine in 2009, the World Bank has reached the upper limit 
of its annual "envelope," local World Bank representatives 
have told us.  Provided that the IMF program is on track and 
that Ukraine undertakes six key structural measures, the 
World Bank would disburse a $500 million Development Policy 
Loan for 2009 budget support and up to $750 million in loans 
for bank recapitalization (Ref D).  The World Bank's 
Kyiv-based Senior Economist Pablo Saavedra told us that 
existing policy criteria would normally preclude additional 
lending, even if World Bank shareholders were to increase the 
Bank's overall capital.  According to formal World Bank rules 
governing its treasury and operations, there are limited 
avenues for using the Bank as an instrument by which to route 
country-targeted external financing, said Saavedra. 
 
12. (C) Nonetheless, the World Bank can be used as a 
"platform" for additional external lending in two ways.  One 
would be through a so-called "top off" program, which 
Saavedra said was a mechanism the Bank and other donors have 
used to co-finance budget support after the World Bank 
reached its annual lending limit.  A "top-off" could provide 
an additional budget support mechanism for Ukraine, said 
Saavedra, if bilateral donors would choose to bundle their 
support with the World Bank's structural reforms and planned 
2009 loan packages. 
 
13. (C) Another way the World Bank could serve as a bridge 
between Ukraine's fiscal needs and potential donor assistance 
would be to convene a Consultative Group, in which case a 
needs assessment and donor pledges would be solicited. 
"There is no model for this; it would be done in an ad hoc 
fashion," said Saavedra.  In his discussion with the 
Ambassador, Anders Aslund commented positively about a 
potential Consultative Group, which he said
 would convene 
major IFIs, as well as interested bilateral donors.  Aslund 
also said that western donors should "multilaterize" the 
Russians, preempting the need for bilateral budget support. 
 
Comment 
------- 
 
14. (C) Our G-7 interlocutors mostly agree that Ukraine 
cannot fund its 2009 budget deficit without external 
financial assistance.  IMF envoy Pazarbasioglu will likely 
broach this subject during her trip to Kyiv, asking G-7 
ambassadors again for bilateral budget support.  We would 
support consideration of a symbolic pledge of USG direct 
budget assistance for political reasons.  Yet, we expect that 
the G-20's multi-billion dollar capital infusion for the IMF 
will only strengthen the already prevalent view among our 
interlocutors that IFIs should be the international 
community's optimal vehicle for financing Ukraine's fiscal 
deficit. 
TAYLOR

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