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Cablegate: Impact of Crisis: Ukrainians Suffering, but Not Rioting

VZCZCXRO9044
RR RUEHDBU RUEHLN RUEHSK RUEHVK RUEHYG
DE RUEHKV #1607/01 2611221
ZNR UUUUU ZZH
R 181221Z SEP 09
FM AMEMBASSY KYIV
TO RUEHC/SECSTATE WASHDC 8429
RUCNCIS/CIS COLLECTIVE

UNCLAS SECTION 01 OF 03 KYIV 001607

SIPDIS

STATE FOR EB/IFD/OIA AND EUR/UMB

E.O. 12958: N/A

TAGS: EINV ETRD EFIN
SUBJECT: Impact of Crisis: Ukrainians Suffering, But Not Rioting

1. (U) Summary. Real GDP contraction -- estimated to be 12%-15% for
2009 as a whole -- accumulating wage arrears, and a growing shadow
economy have set Ukraine back in its economic development to the
level of 2003, according to former Finance Minister Victor Pynzenyk.
Despite increased hardship and growing poverty, the economic
downturn has not given rise to widespread public unrest in Ukraine.
A vast social safety system and the cushion provided by the shadow
economy mitigate some of the social impact of the crisis, although
lower wages and the resulting lower contributions to social security
funds call into question the sustainability of the social security
system. Political agendas in the run-up to the January Presidential
make it likely that the underfunded social security system will
remain in place at the expense of needed reform to facilitate
economic recovery. End Summary.

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Poverty Levels Rise
---------------------

2. (U) Surveys by the Federation of Labor Unions (FPU) as well as by
the Kyiv International Institute of Sociology (KIIS) conducted in
June 2009 find that 81% to 90% of the population was affected by the
general downturn in the economy. Ukraine's still-small middle class
has been hit the hardest by the crisis, facing both wage cuts and a
comparatively high level of outstanding bank loans. The industrial
south and east have faced the largest decline in wages and increase
in unemployment. The 2007 World Bank poverty study on Ukraine
identified young families with children as having the highest risk
of poverty. This finding remains valid and has been exacerbated in
the current crisis, according to local think tanks. KIIS Director
Volodymyr Paniotto points to the increases in poverty indicators, as
more respondents this year cannot afford to buy enough clothing and
food. 67% of Ukrainians have had to change their spending patterns
due to the economic crisis, according to the survey of Ukraine's
Sociology Institute. 60% of the survey respondents cut back on
clothing, and 52% cut back on food. The number of respondents who
identified themselves as middle class went down from 38% in 2008 to
28% in 2009 in favor of self-identification as members of the poor,
according to the same survey.

--------------------------------------------- ----
Direct Influence of the Banking Crisis is Limited
--------------------------------------------- ----

3. (U) The direct influence of the banking crisis and abrupt decline
in housing prices on the general population was limited due to the
lack of depth in financial markets and comparatively low level of
mortgage borrowing. While mortgage lending grew rapidly over recent
years, its total volume reached only 5% of GDP in early 2008, much
lower than the roughly 40-50% European average. Only about 17.7% of
the population report that they have difficulties in paying their
bank loans, and about 10% of the population has had difficulties
withdrawing their deposits from distressed banks, according to the
June Sociology Institute survey. The financial crisis had the
largest direct influence on young households, making their
dollar-denominated mortgages unsustainable. This category of the
population was defined as having the highest poverty risk by the
2007 WB poverty survey on Ukraine, indicating their limited ability
to sustain their debt burden in the current crisis.

-------------------------------
Higher Prices and Lower Incomes
-------------------------------

4. (U) Growing prices are seen as the major consequence of the
crisis by 80% of the population, according to both KIIS and
Sociology Insitute surveys. Volodymyr Pantiotto, however, admits
that the impact of price increases may be exaggerated by the public
due to the high level of press attention. Still, the 60% hryvnia
devaluation since October 2008 has made imports, which include such
consumer goods as clothing and durables, more expensive, and was an
important factor behind the 14.7% increase in consumer prices in
June 2009 compared to June 2008.

5. (U) The public attributes lower incomes and wage delays to the
crisis. 45% of KIIS survey respondents reported receiving lower
incomes, and 14% reported delays in wage payments, with the highest
frequency of these reports from the industrial eastern and southern
regions. The end of 2008 saw accumulation of new wage arrears.
While wage arrears have been a major problem since the 1990s, their
level had stabilized by 2008 at about UAH 700 million. As the crisis
erupted for Ukraine in November 2008, wage arrears more than
doubled, reaching UAH 1.7 billion by January 1, 2009. Wage arrears
averaged UAH 1.2 billion in the first half of 2009, peaking at about
UAH 1.7 billion at the end of both Q1 and Q2. This level of wage
arrears was last seen in 2004. The sharpest decline in wages was
registered in the construction industry, followed by metallurgy and
machine-building. Along with actual wage non-payment, many
companies have resorted to cutting the total income earned by
employees. There are many anecdotal reports that the amount of

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wages paid on the shadow economy has decreased. Also, many
industrial companies have stopped issuing bonuses and additional
payments, which had equaled as much as 100% of basic wages prior to
the crisis.

----------------------------------
Unemployment Potential Risk Factor
----------------------------------

6. (U) Unemployment, according to the ILO methodology, reached 9.5%
of the labor force, up from 6.4% in 2008 and close to the EU average
for 25 countries at 8.5% in the first quarter of 2009. In addition,
according to Ukrstat, about 1.5 million employees had shortened
working days or were on mandated leave as of June, bringing the
total number of unemployed and those on shortened working days to
14% of the labor force. Unwillingness of companies to lay off their
workers is partially explained by the experiences of industrial
companies in the 1990s, when vast personnel cutbacks caused
industries to lose large portions of their qualified labor force and
made industrial recovery very difficult. The highest unemployment
is expected in export-oriented sectors, such as chemical production
and metallurgy, as well as construction, according to Labor Minister
Lyudmila Denisova. Director of the Demographics Institute, Elena
Libanova, told EconStaff that the GOU's effort to retain jobs may
not be well targeted, as it mostly deals with the metallurgy sector.
The December 2008 memorandum signed by the GOU with metallurgy
companies requires them to maintain existing employment levels in
exchange for GOU measures to limit gas and electricity prices for
the plants. While export-oriented sectors are the largest
foreign-currency earners, they are not the largest employers.
Metallurgy, for example, employs 1.5 million of Ukraine's labor
force of 21 million. GOU stimulus to the machine-building sector,
which is a larger employer (employing close to 2 million out of
Ukraine's 21 million laborers) would have greater impact, according
to Libanova. According to the survey of the Sociology Institute,
88% of the population is concerned about losing their jobs, up from
54% in 2008; 74% (54% in 2008) are concerned about non-payment of
wages.

-------------------------------
Less Impact on Rural Population
-------------------------------

7. (U) While the industrial eastern and southern regions were hit
hard by the wage cuts at industrial enterprises, the impact on the
rural population has so far been limited. Agriculture was the only
sector which demonstrated growth in the first half of 2009 at 2.6%,
y-o-y, as contrasted with a 31% decline in industrial production
during the same period. Rural areas historically have
lower-than-average incomes and very limited access to credit, which
made them less exposed to financial crisis. The rural population
also consumes fewer imported goods. A December 2008 regulation to
restrict eligibility for unemployment benefits to those unemployed
for 3 months or more could be detrimental to the rural population,
as rural laborers traditionally receive unemployment benefits during
the low agricultural season. However, according to Libanova, this
regulation is not enforced, mitigating the impact on the rural
population for now.

--------------------------------------------- --
The Shadow Economy Cushioned the Crisis' Impact
--------------------------------------------- --

8. (U) Despite a roughly 20% GDP decline in the first half of the
year, the real level of disposable incomes went down by only 12.9%,
suggesting the shadow economy provides a cushion to the impact of
the crisis. The shadow economy was estimated at 36% of GDP in the
first quarter of 2009, 7% larger than the same period in 2008,
according to the preliminary report of the Economy Ministry. Root
causes of the shadow economy are generally accepted to be political
instability and ineffective tax policies, and its growth can be
partially attributed to an increase in so-called "survival
activities," which include operating small retail trade businesses
and growing vegetables on small private plots. In the mining region
of Donetsk, an increase in the activities of illegal coal mines is
likely. Recently a shadow steel mill with an annual turnover of UAH
30 million (about USD 3.5 million) was found in Donetsk, the local
press reported. There is also anecdotal evidence that medium and
small businesses switch to shadow payment of wages to cut costs, and
use barter to avoid problems with the distressed banking system.
The share of shadow wage payment has increased, but is still much
lower than during the 1990s, according to Paniotto.

------------------------------------
Unsustainable Social Transfer System
------------------------------------
9. (U) The economic downturn and growing shadow economy puts
pressure on the government's ability to sustain large social
security payments. Currently social transfers equal almost 50% of
total residential incomes in Ukraine. High levels of social

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transfers also increase the general mood of dissatisfaction among
the working population and act as a disincentive to finding
employment for those collecting benefits. For instance, the subsidy
a family receives for a newborn child reaches up to UAH 50 thousand
(USD 6 thousand), which is equal to 2 years of the average wage in
Ukraine. This dwarfs the wages earned by most of the population and
leads workers to consider themselves to be poor rather than middle
class, according to Libanova. Still, in the run-up to the
presidential elections, political consensus on reform of the social
protection system is lacking. For example, the Party of Regions,
led by one of the top three presidential candidates, Victor
Yanukovych, insists on raising wages and pensions already this year.
The party proposes to raise the minimum pension to UAH 1300 (USD
162) from UAH 572 (USD 71); and minimum monthly wage to UAH 1500
(USD 188) from UAH 669 (USD 84). According to various calculations,
the law would require an additional UAH 10 to 40 billion in
budgetary financing. This has the potential to bust the budget and
runs contrary to IMF program requirements. Still, the political
appeal of raising social standards is such that the Party of Regions
has chosen to block the Rada (parliament), demanding adoption of the
bill before any other work could proceed. The Rada remains blocked.


--------------------------------------------- ---------
GOU Anti-Crisis Efforts Criticized for Lack of Coordination
--------------------------------------------- ---------

10. (U) Suffering from constant political discord, the GOU has not
been able to come up with a coordinated package of anti-crisis
measures. The range of memoranda signed by the GOU with enterprises
representing steel and chemical producers was criticized as
sporadic. The ILO representative in Ukraine, Vasyl Kostrytsja, told
EconStaff of the agency's efforts to encourage use of social
partnership institutions, such as a trilateral dialogue among the
government, employers and labor unions to come up with anti-crisis
measures. In particular, the agency wants to organize regular
trilateral meetings to analyze the market situation, develop a
safety net package to limit the impact of the crisis, and promote
small and medium entrepreneurship. Such efforts have not had much
success so far.

-------
Comment
-------

11. (U) Existing social outlays and a large shadow economy will
continue to mitigate the real impact of Ukraine's economic downturn
on the population in the short term. However, both constitute a
drag on the government's budget and broader economic growth.
Unfortunately, reform efforts will not be taken up seriously before
the January presidential election, delaying Ukraine's ability to
engineer a strong economic recovery once the global economy
rebounds.

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