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September 4, 2009

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Reference ID Created Released Classification Origin
09KYIV1519 2009-09-04 15:17 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv

DE RUEHKV #1519/01 2471517
R 041517Z SEP 09

C O N F I D E N T I A L SECTION 01 OF 03 KYIV 001519 
E.O. 12958: DECL: 09/03/2019 
REF: KYIV 1487 
Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) and 
1.  (C) Summary.  The IMF mission team concluded its visit in 
Kyiv on September 4 without a major public announcement, but 
close observers have acknowledged to us that the Fund's 
program may have gone off track.  The visit was originally 
envisioned as a visit to provide technical assistance and 
oversight for the Ministry of Finance's 2010 draft budget, a 
source of unease for the IMF in the run-up to Ukraine's 
January 2010 presidential elections.  Nonetheless, growing 
concerns about Ukraine's lack of fiscal discipline, its 
non-transparent financial sector activities, and unfulfilled 
promises on gas pricing reforms (reftel) caused the IMF to 
dispatch mission director Ceyla Pazarbasioglu.  Talks with 
Ukraine's authorities have been characterized to us as 
"difficult" and a way for the Fund to begin "saving face." 
End summary. 
2.  (SBU) Over the course of this week's negotiations, the 
IMF has made no formal statements to the public.  However, on 
August 31, IMF resident representative Max Alier sharply 
criticized Ukraine's authorities for deviating from agreed 
upon actions, alluding to the possibility that the Fund would 
postpone additional disbursements or pull the plug on its 
program altogether.  Analysts have speculated that Alier's 
statements were an opening salvo, intended to set the stage 
for a tougher stance by Pazarbasioglu. 
3.  (C) IMF banking advisor Jochen Andritzky told Econoff on 
September 4 that Pazarbasioglu had come to Ukraine to monitor 
the Ministry of Finance's progress on the 2010 budget.  When 
pressed, however, Andritzky quickly acknowledged that 
Pazarbasioglu, in fact, had been concerned about the whole 
IMF program and was dispatched to assess progress on broader 
conditionalities.  The Kyiv-based Andritzky could not say 
whether Pazarbasioglu had taken a strong line on the lack of 
gas price increases, or how the IMF would deal with the 
monetization of the country's fiscal deficit.  But he did 
agree that there was a "growing consensus" that Prime 
Minister Tymoshenko had extracted money from the IMF while 
offering very little in return.  Recognizing the GOU may have 
the ability to weather its financial storms in the months 
before the presidential election without another loan 
tranche, Andritzky did not discount the possibility that a 
lack of action by the GOU would force the Fund to suspend its 
lending.  He pointed to IMF shareholders as the source of 
political pressure to be "soft" on Ukraine, especially those 
with significant banking exposure. 
4.  (C) Other embassy sources close to the IMF negotiations 
indicated that Pazarbasioglu had expressed her dismay about 
the "lies" of the government.  Pazarbasioglu reportedly told 
former Finance Minister Viktor Pynzenyk that Prime Minister 
Tymoshenko had "misled" the IMF mission in July regarding her 
government's willingness to hold down the budget deficit and 
enact gas price reforms. 
5.  (C) EBRD's principal economist (and former IMF senior 
economist) Alex Pivovarsky told us on September 4 that 
Pazarbasioglu had characterized Ukraine's actions as having 
"crossed a boundary."  Pazarbasioglu apparently said that she 
had "put her trust" in the Prime Minister but had been "taken 
advantage of."  Pivovarsky further commented that the talks 
with the National Bank of Ukraine (NBU) and the GOU had been 
described to him as "difficult -- just short of yelling 
sessions."  According to the EBRD's conversations with 
colleagues in Washington, Pazarbasioglu's tougher stance 
reflected the belief among senior IMF officials that this 
mission trip was a way for the Fund to begin "saving face." 
6.  (C) London-based Pivovarsky said that the EBRD had 
already calculated that the IMF program would go off track. 
He said that despite the "significant carrot" of $3.8 billion 
(2.5 billion SDR) that had been slated for November 
disbursement, there was little chance of a fourth tranche 
before the presidential January election.  The Fund simply 
was "paying the price for the political consequences of its 
decisions," he said, alluding to the "flexibility" the Fund 
has shown to date with Ukraine.  In the EBRD's view, the IMF 
had no other choice than to walk away before the elections. 
KYIV 00001519  002 OF 003 
It would be a "disservice to the country" to refrain from 
pushing Ukrainian authorities to adopt policies necessary to 
stabilize the country. 
7.  (C) In two meetings this week with Acting NBU Governor 
Shapovalov, Pazarbasioglu apparen
tly raised concerns about 
NBU interventions in the forex market, which IMF banking 
advisor Andritzky said had been implemented in a "confidence 
destroying" manner.  The IMF reiterated its call for all 
banks to have equal access to NBU refinancing at market 
rates.  In recent weeks, Shapovalov had publicly acknowledged 
that the NBU continued to sell foreign exchange below UAH 
8/$1 dollar to undisclosed recipients, who presumably then 
would have pocketed the arbitrage.  Andritzky told us he had 
informally floated the idea of adding a new IMF 
conditionality on refinancing disclosures, which he said had 
been well-received in the banking community.  He also said 
that the IMF was toying with the idea of monitoring the 
banking system at the "micro" level to better root out 
NBU-fostered theft.  Equating these two actions to what the 
Fund would require of a country like Afghanistan, Andritzky 
commented that the level of corruption in Ukraine could 
"hardly be worse." 
8.  (C) Even after receiving entreaties to clean up its forex 
interventions, NBU Vice Governor Krotyuk apparently urged 
Pazarbasioglu to go public with commentary about the state of 
the IMF's Ukraine program.  Andritzky told us that the NBU 
perceives that it is doing a "splendid" job fighting the 
crisis, especially compared to the "botched" handling of the 
budget by the Tymoshenko government.  Krotyuk had expected 
that the IMF would publicly compliment the NBU. 
Pazarbasioglu apparently declined to offer comment. 
9.  (C) On September 3, Pynzenyk told our source, BNP Paribas 
head of office Dominique Menu, that the GOU's budget figures 
had become more and more unrealistic, and that there had 
developed an imperative to cut spending, increase public 
debt, and push privatizations.  The former Finance Minister 
called the GOU's current efforts of monetizing the budget 
deficit, estimated to be at least 3% of GDP thus far in 2009, 
to be extraordinarily dangerous, particularly in an 
environment where GDP declines in the first half of 2009 may 
mean that the GOU has over UAH 27 billion (roughly $3.1 
billion) less revenue than expected.  Analysts project 
Ukraine's deficit will grow to between 6-8% of GDP (not 
counting bank recapitalizations and Naftohaz debt) by the end 
of 2009. 
10.  (C) Menu said that he and other foreign bankers were 
especially concerned about a rapid depreciation of the 
hryvnia, which is already the world's worst performing 
currency of late.  Pivovarsky expected that the hryvnia would 
overshoot due to market concerns about the IMF program and 
Ukraine's budget and banks, though he expected the currency 
would recover in early 2010 if investor confidence rallied. 
The overshooting would be painful for banks that had extended 
sizable foreign currency-denominated credits.  Pivovarsky 
predicted balance sheets would worsen and more 
recapitalization of banks would be necessary.  He questioned 
the will of foreign-owned banks to ante up another round of 
cash, if the NBU did not demonstrate it would enforce the 
same capital adequacy requirements for Ukraine's 
domestically-owned banks. 
11. (C) The IMF expects the hryvnia exchange rate to hit UAH 
9/$1 dollar, which Andritzky characterized as the equilibrium 
rate that "we have all been expecting -- though perhaps not 
this soon."  However, Andritzky did not discount that the 
exchange rate would overshoot, in part as a result of the 
NBU's non-transparent measures and its inability to rein in 
the "lack of trust" in the market.  He said some traders had 
held off selling dollars all week, but some had begun to come 
back into the market on September 4 as the inter-bank rate 
approached UAH 9/$1 dollar. 
12.  (SBU) President Yushchenko told journalists on September 
KYIV 00001519  003 OF 003 
3 that Tymoshenko's government had "seriously undermined" 
cooperation with the IMF, suggesting that Ukraine had failed 
to meet five of six conditionalities that were necessary for 
disbursing the Fund's fourth loan tranche.  Without 
specifically naming any preconditions, he insinuated that 
Tymoshenko's government had been unable to "rationalize" its 
budget goals.  Alluding to Russia, Yushchenko also warned of 
"foreign markets" that would offer "non-transparent" loan 
conditions, suggesting that Tymoshenko and Putin had come 
closer to a finalizing a bilateral financing deal that would 
include the GOU "trading" what he called "national assets." 
The President said he would attempt to stop any 
privatizations of chemical or power generation plants and 
would oppose the sale of Odesa Portside Plant, rumored to be 
of interest to Russian industrial concerns. 
13.  (U) On September 3, Deputy Prime Minister Hryhoriy 
Nemyria denied reports that the IMF had expressed formal 
concerns about the implementation of its lending program.  He 
commented that the IMF had not sent a letter to Ukraine 
expressing dissatisfaction with Ukraine's failure to raise 
domestic gas prices.  Nemyria told reporters that 
Pazarbasioglu had noted to him personally that she did not 
wish to give interviews in Ukraine or send official letters 
to the authorities.  Nemyria said that the IMF mission visit 
was related to consultations on the 2010 budget and was not a 
program review, which would remain slated for late October or 
early November. 
14.  (SBU) The IMF's Pazarbasioglu and Alier have scheduled a 
brief with G-7 and E.C. ambassadors on September 5 in Kyiv. 
Embassy Kyiv will attend and report septel. 
15.  (C) The IMF may have had no other choice than to send a 
hard-hitting message to the Ukrainian authorities.  The bulk 
of the Fund's conditionalities have been left undone, and 
Ukrainian officials have given no impression they will take 
on any tough decisions before the January 2010 presidential 
election.  The Fund may have concluded that it would be 
better for both Ukraine and the IMF's long-term interests if 
the program temporarily goes off track than for more 
liabilities to migrate to the public balance sheet without 
the necessary, concomitant reforms to spur growth. 




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