Cablegate: Ukraine: Scenesetter for Special Envoy Boyden

DE RUEHKV #0951/01 1401601
R 191601Z MAY 08




E.O. 12958: N/A


Treat as Sensitive but Unclassified. Not for Internet

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

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 MAP letter was disclosed, 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 - a new
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.
Nevertheless, both insist their 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

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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 Qent 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, arguing that the Speaker did not have the right to
sign such a request without explicit parliamentary approval.
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 Hyperinflation Looms

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. (U) In their public rhetoric, the country's top
politicians all promise pro-business regulatory reforms and
advocate integration into the world economic system. Ukraine
became the 152nd member of the WTO on May 16. The actual
pace of economic reform remains slow and political leaders
have resorted to administrative measures, such as restricting
exports of grain and sunflower oil, to combat rising food
prices. The World Bank recently ranked Ukraine 139th out of
178 countries as a place to do business. Looking forward,
however, 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
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 revoked Vanco's
subsoil permit, 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 with Ukrainian reactors
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

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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

© Scoop Media

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