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Cablegate: Ukraine "Not yet There" On 2009 Balanced Budget

VZCZCXRO2071
OO RUEHIK RUEHLN RUEHPOD RUEHSK RUEHVK RUEHYG
DE RUEHKV #2413/01 3441649
ZNR UUUUU ZZH
O 091649Z DEC 08
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6882
INFO RUCNCIS/CIS COLLECTIVE IMMEDIATE
RUEHZG/NATO EU COLLECTIVE IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC IMMEDIATE
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC IMMEDIATE

UNCLAS SECTION 01 OF 02 KYIV 002413

SIPDIS

DEPT FOR EUR, EUR/UMB, EEB/OMA
TREASURY PASS TO TTORGERSON

E.O. 12958: N/A
TAGS: EFIN EREL ETRD PGOV PREL XH UP
SUBJECT: UKRAINE "NOT YET THERE" ON 2009 BALANCED BUDGET

1. (SBU) Summary. The Ministry of Finance has granted a
preview of the draft 2009 budget to the IMF and World Bank.
The World Bank told us the GOU foresees a 2009 budget deficit
equal to 0.3 percent of GDP. After studying the draft,
however, the World Bank puts the deficit at 0.8 percent of
GDP. In either case the draft does not foresee a balanced
budget, a key conditionality of the IMF support program. The
draft budget contains strong reductions in real wages and
pensions, but also a drop in investment spending. In order
to balance the budget, the World Bank has recommended further
cuts in pensions, social privileges, and subsidies to coal
producers and to entities in the energy sector, including
Naftohaz. At the same time, it recommends increasing certain
budgetary items that will help the population and economy
deal with the fallout of the economic crisis. It is
recommending that Ukraine heighten support payments for the
country's most vulnerable citizens, and that it boost
investment outlays as the best way to help the real economy.
The USG, according to our interlocutor, can assist the IMF
and World Bank by "raising the issue" of these
recommendations with our Ukrainian counterparts. End summary.

GOU Budget Projections
----------------------

2. (SBU) On December 6, Minister of Finance Viktor Pynzenyk
invited the IMF and World Bank to review the government's
draft budget for 2009. At his office on a Saturday
afternoon, while his assistants compiled the budget's
individual chapters, Pynzenyk explained that the government
had made "hard decisions" on cuts in public sector wages,
goods and services, capital spending, and pensions. The
Minister claimed to have closed the deficit to less than 0.3
percent of GDP, with the ultimate goal of balancing the draft
2009 budget in the coming days, which currently constitutes
roughly 43-44 percent of GDP.

3. (SBU) Pablo Saavedra, the World Bank's Kyiv-based chief
economist, told us on December 9 that the Bank does not share
the GOU's forecast. In the World Bank's view, the proposed
budget still has a deficit of roughly 0.8 percent of GDP.

4. (SBU) Saavedra gave us an overview of the GOU draft. The
Ministry's current plan is to keep nominal public sector
wages at current levels. The action will cause real wages to
drop significantly in real terms, saving 0.8 percent of GDP.
The GOU is also planning significant reductions in public
sector consumption. Stemming the rapid growth in pensions
will pose the most difficult challenge to the GOU, he said.
Parallel to the budget process, the Ministry has prepared a
separate draft law that will cap increases in pensions in
nine different ways. If passed, the caps would save another
1.8 percent of GDP in next year's budget, even if pensions
remain poorly targeted once the law passes.

World Bank: More Cuts and Targeted Spending
-------------------------------------------

5. (SBU) The World Bank and the Ukraine government are in
line on 2009 revenue projections, with roughly $250 million
separating their estimates. According to Saavedra, both the
GOU and World Bank's conservative forecasts foresee revenues
falling by 2 percent of GDP in 2009, due to industrial
production declines, lower payroll tax collections from wage
contraction and unemployment, and drops in revenue from
import duties.

6. (SBU) Upon analyzing Pynzenyk's fiscal plan, the World
Bank expressed to the Ministry that its spending cuts are
admirable but "not there yet." To remove the difference
between the GOU's and World Bank's forecasts for the budget
deficit, the World Bank suggested better targeting of all
social expenditures. It recommended chopping vestige
Soviet-era privileges such as transportation fare reductions
afforded to veterans, students, and the elderly. According
to the World Bank, the greatest budget decreases can be made
through cuts in subsidies to coal producers (saving 0.5
percent of GDP) and to the government energy monopoly
Naftohaz and other entities in the energy sector, such as
municipalities that are forced to sell heating below cost
(saving 10 billion UAH or 1.8 percent of GDP).

7. (SBU) The World Bank said these cuts should be balanced
by increases in targeted spending for Ukraine's poorest
citizens. The government's most efficient social spending
currently reaches 70 percent of the poorest families in the

KYIV 00002413 002 OF 002


country, aiding, for example, vulnerable large families and
single mothers. Such under-funded programs should receive
double or triple their current allotments, according to the
World Bank, equivalent to roughly 0.4 percent of GDP.

8. (SBU) At the same time, the government should attempt to
spur growth and employment by boosting the investment
component of the budget, particularly by investing in
crumbling infrastructure, Saavedra said. Increasing
investment would be the best way for the budget to support
the real economy, he argued. However, the GOU tends to think
it can support the economy by giving special treatment to
favored individual sectors, mostly through subsidies or tax
breaks. The GOU has spent, on average, about 2 percent of
yearly GDP on investment over the past four years, far lower
than the 6 percent mark normally seen in more progressive
transformational economies. Infrastructure development
increases of 0.6 percent of GDP would improve transportation
links and port capacity, simultaneously adding value and jobs
to the overall economy, the World Bank believes.

Bank to Provide $1.2 Billion in Budget Support in 2009
--------------------------------------------- ---------

9. (SBU) The World Bank intends to release the third $500
million tranche of its DPL3 loan to Ukraine by the end of
December. It also plans to loan Ukraine up to $1.2 billion
in budget financing in 2009. Of this, $750 million would be
used for bank recapitalization and resolution, and only
dispersed on a case by case basis as concrete needs arise.
(Note: The IMF program considers outlays for bank
reconstruction, bank resolution, and state-supported project
finance programs to be exceptions to its overall balanced
budget conditionality.)

World Bank and USG Collaboration
--------------------------------

10. (SBU) Saavedra appealed for U.S. government support of
the World Bank's budget proposals to the GOU. He emphasized
that a U.S. push for transparent infrastructure investment
could counter worsening conditions in the real economy, as
well as dash inefficient subsidies to favored or politically
well-connected interests in the coal and energy sectors.
Saavedra expressed enthusiasm for the Department of Treasury
technical assistance team slated to visit Kyiv in
mid-December, calling needs in the Ministry of Finance and
the National Bank of Ukraine "critical."
TAYLOR

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