Cablegate: Ukraine: Grain Export Quotas Lifted, but New Controls In

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DE RUEHKV #1422/01 1591047
ZNR UUUUU ZZH
P 081047Z JUN 07
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC PRIORITY 2653
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUEHRC/USDA WASHDC
RUCNCIS/CIS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHZG/NATO EU COLLECTIVE
RUEHBI/AMCONSUL MUMBAI 0052

UNCLAS SECTION 01 OF 03 KYIV 001422

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR ALIKONIS
DEPT PLEASE PASS USTR FOR CKLEIN/LMOLNAR/SOWEN
USDOC FOR 4201/DOC/ITA/MAC/BISNIS
USDOC FOR 4231/ITA/OEENIS/NISD/CLUCYK
USDA/FAS/OCRA/FOR J FLEMINGS
USDA/FAS/OCRA/FOR A THOMAS
USDA/FAS/OGA/ FOR J LAGOS
USDA/FAS/OGA/ FOR J TAYLOR
USDA/FAS/PECAD FOR M LINDEMAN
MUMBAI FOR WKLEIN

E.O. 12958: N/A
TAGS: EAGR ETRD PGOV UP
SUBJECT: Ukraine: Grain Export Quotas Lifted, but New Controls In
Store

KYIV 00001422 001.2 OF 003

1. (SBU) Summary: Citing crop damage from drought, the GOU appears
poised to institute a new regime of export restrictions on Ukraine's
grain market for the 2007/2008 market year. According to a June 4
decree, as well as the statements of GOU officials, the GOU will
build up its reserves of wheat while limiting exports. The reserves
are to be used to moderate bread price increases -- an important
issue for voters in an election year. The GOU meanwhile published a
resolution on June 8 allowing export of grain left over from the
current market year. Grain traders expect that they will be able to
export 300-400,000 tons before the market year ends on June 30. End
Summary

Bread Prices in an Election Year
--------------------------------

2. (U) Although recent rains have helped crops in northern and
western Ukraine, crops have suffered significantly from drought in
the oblasts of southern Ukraine. While agronomists all agree that
the lack of precipitation has significantly affected probable
yields, their estimates of the impact are not as severe as the
GOU's. After the drought, the GOU reduced its projections of the
wheat harvest from 19 down to 12.5 million tons. The consensus
projection by Ukrainian agronomists on June 4 was for a harvest of
15.4 million tons though Cargill's estimate is slightly more
pessimistic at 14.8 million tons.
Although the government claims that there are ten drought- affected
regions, Cargill sees crop yields as average or better in all
oblasts but four: Odessa, Nikolayev, Zaporizhya, and Kherson.

3. (SBU) In a sign that the campaign for the September 30 election
has begun, Prime Minister Yanukovych traveled On June 3 to
drought-stricken agricultural lands near Odessa where he publicly
pledged his government would help affected framers and ensure that
bread prices will not rise. According to a Cabinet of Ministers
press release, the PM charged Economy Minister Kinakh with keeping
bread prices in line. In like manner, President Yushchenko traveled
on June 5 to Kherson, where he met with leaders of oblasts affected
by the drought, endorsing relief to farmers, but intimating that
they should be allowed to sell grain at market prices. According to
Cargill, Deputy Prime Minister Slauta and Minister of Agrarian
Policy Melnyk have openly told the company that political concerns
over bread prices were behind the GOU's intention to continue
intervening in the grain market.

4. (SBU) First Deputy Prime Minister Mykola Azarov made clear to
Ambassador in a June 4 meeting that the GOU would institute controls
on grain exports for the 2007-2008 market year. Accompanied by
Deputy Prime Minister for agrarian policy Victor Slauta, Azarov
claimed that drought conditions in Ukraine's "bread basket" -- the
south-central and south-eastern regions -- made the step necessary.
He said the GOU would permit traders to honor already existing
contracts for wheat and load ships already en route, but, he intoned
gravely, that was "the maximum we can allow." Only a few days
earlier, on May 31, Minister of Economy Kinakh had assured the
visiting Staffdel Singh that grain export controls would not be
re-introduced.

2006/2007 Wheat Export Quotas Finally Lifted
--------------------------------------------

5. (SBU) Consistent with Azarov's statements, the GOU finally
published on June 8 the Cabinet of Ministers resolution of May 16
lifting the wheat export quota. In expectation of that resolution's
publications, traders already in May moved around 250,000 tons to
the ports and contracted ships to prepare for export. Although the
grain traders now are holding 960,000 tons of 2006 wheat, USDA
estimates that they will only be able physically to get 300-400
thousand tons out of the country by before the end of the market
year (June 30). (Comment: In meeting with Ambassador, Slauta feigned
surprise that grain traders had not yet taken advantage of the May
16 resolution, though he was well aware that the resolution was
still unpublished--and thus not in legal force--at that time. End
Comment.)

KYIV 00001422 002.2 OF 003

2007/2008 Plan: Export Limits and State Purchases
--------------------------------------------- ----

6. (U) The best indication of the GOU's current intentions toward
the grain market came in a June 4 Cabinet of Ministers resolution on
measures to address the drought currently affecting up to ten
oblasts. While parts of the resolution discussed relief measures
for drought-stricken farmers, it primarily comprised steps to
prevent grain exports (presumably beginning July 1) and to increase
government grain reserves. Key features of the resolution are
instructions to agencies to:

-- draft a resolution banning grain exports until the state can
replenish national and regional grain reserves (MinEcon and MinAg);
-- conclude forward contracts for 710,000 tons of milling wheat at
recent average spot market prices (Agrarian Fund)
-- conclude additional (amount unspecified) forward contracts for
purchases of milling wheat, paying 50% in advance (State Material
Reserve);
-- find funding through amendments to the budget and other sources
to finance grain purchases (MinEcon, MinFin, MinAg, and the State
Material Reserve);
-- recommend that local authorities establish 3-month supply grain
stockpiles by August 17, 2007; and,
-- consider adding corn and barley to the list of goods subject to
price regulation (Note: wheat is already on the list).

7. (SBU) In meetings with grain producers and traders, GOU
officials have been exploring ways of ensuring the government would
be able to maintain a reserve without resorting to renewed export
quotas. At the most recent meeting, on June 4, DPM Slauta and
Minister of Agrarian Policy Melnyk called on industry to make its
own proposals on how to meet the government's objectives. Slauta
and Melnyk laid out three conditions for industry's plans: 1) that
the state and millers be able to build up reserves in order to keep
bread prices at "reasonable market prices"; 2) that the grain
traders maintain their role as provider of liquidity to the
agricultural sector (by purchasing grain); and, 3) that the traders
commit to not "over-exporting" wheat, by submitting crop estimates
and a target for export quantities. (Comment: In the eyes of some
grain traders, these three conditions were tantamount to the GOU
telling them, "We want you to keep buying grain, but we want you to
sell it to us at discount prices, and meanwhile, you can't sell much
to world markets." End Comment.)

8. (SBU) The Ministers discussed with industry representatives in
more detail the GOU's intent to use state reserves to keep bread
prices low. Currently the Agrarian fund held 1 million tons of
wheat, and the government was looking to acquire another 1.5 to 2
million tons, they told the agricultural industry reps. Having
built up this reserve, the state would sell the grain at a discount
to millers (and perhaps meat producers) to keep prices low. The GOU
could also subsidize credits to the millers in order to finance
grain purchases, they said. Newspaper reports also reveal that the
GOU intends either through jawboning or through administrative
measures, to limit markups charged for transportation, and profit
levels at bakeries. (Note: Oblast governors already have authority
to regulate prices and markups on three basic types of bread,
produced by large bakeries. Most oblasts only limit the retail
markup over wholesale prices, though some fix retail prices and/or
explicitly limit profits of bakeries. End Note.)

Can Ukraine Build Reserves on the Cheap?
----------------------------------------

9. (SBU) It will not be easy for the GOU to finance such large
purchases of grain. At current F.O.B. prices, even the 710,000 tons
of wheat the GOU has officially decided to procure would cost $149
million. Amendments to the Ukrainian budget passed on May 31
allocated $20 million for grain purchases. The June 4 resolution
envisions further budget amendments amounting to $40 million, as
well as an undetermined amount of funding from sales of inventories
of the State Material Reserve. (Note: The State Material Reserve
stockpiles a variety of materials for strategic or emergency use.)

KYIV 00001422 003.2 OF 003

Grain traders are skeptical that farmers will willingly extend
credit for forward grain sales to the government, which has shown a
willingness to insist on delivery, while delaying repayment. In his
meeting with the Ambassador, Azarov hinted that the state had enough
leverage to ensure compliance from the farmers: he stated flatly
that the GOU offered enough agricultural subsidies that he was sure
grain prices would be acceptable. (Comment: Azarov is notorious
for his fiscal hawkishness and his statist instincts. The policy
described in the June 4 resolution is almost certainly his
handiwork. End Comment.)

Isn't There a Better Way?
-------------------------

9. (SBU) Both the Ambassador in his meeting with Azarov, and the
grain traders in their meetings with other GOU officials have
suggested that the least disruptive way for the government to
address the threat of rising bread prices would be to subsidize
bread purchases by the needy. Cargill estimated that if wheat were
sold at world prices in Ukraine, the cost to the government of
subsidizing the difference in bread prices for needy consumers (60%
of the population) would be approximately $100 million/year.
Cargill estimated the loss to farmers of restricting exports and
maintaining a differential between Ukrainian and world wheat prices
would be $1 billion. Azarov responded to Ambassador that
subsidizing bread consumption for a huge segment of the population
(he estimated that 80% of Ukrainians would require assistance) was
beyond the GOU's capacity. Slauta and Melnyk have likewise rejected
proposals for bread price subsidies as too costly for the budget.

Comment: Is This the Whole Story?
---------------------------------

10. (SBU) Building up state wheat reserves in order to provide
cheap grain for basic bread production would not be the most
market-disruptive option, if the GOU intended to buy at market
prices and to allow unrestricted exports. Since it appears the GOU
will do neither of those things, the likely policy will disrupt
trade and shift costs onto farmers and grain traders. The
beneficiaries of this policy will be those who receive subsidized
sale of state grain (millers and quite possibly meat producers) as
well as the voters spared higher bread prices. Since this is
Ukraine, the allocation of discount sales of state-owned grain
provides an attractive opportunity for corruption. Likewise, any
limitation on exports other than an outright ban could create
opportunities for moneymaking among those charged with allocating
export quotas or licenses.

Taylor

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