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Cablegate: Ukraine: Scenesetter for Visit of Commerce

VZCZCXRO6107
PP RUEHBW RUEHIK RUEHLN RUEHPOD RUEHVK RUEHYG
DE RUEHKV #1047/01 1501556
ZNR UUUUU ZZH
P 291556Z MAY 08
FM AMEMBASSY KYIV
TO RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZG/NATO EU COLLECTIVE PRIORITY
RUEHC/SECSTATE WASHDC PRIORITY 5694

UNCLAS SECTION 01 OF 03 KYIV 001047

SENSITIVE
SIPDIS

USDOC FOR 4231/ITA/OEENIS/NISK/CLUCYK
DEPT FOR EUR/UMB, EE/EEC/IEC - LWRIGHT

E.O. 12958: N/A
TAGS: ECON PREL PGOV EINV UP
SUBJECT: UKRAINE: SCENESETTER FOR VISIT OF COMMERCE
SECRETARY GUTIERREZ

REF: KYIV 904

Treat as Sensitive but Unclassified. Not for Internet
Distribution.

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
summary.

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
bills.

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
final 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.
TAYLOR

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