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C O N F I D E N T I A L SECTION 01 OF 05 KYIV 000275 SIPDIS E.O. 12958: DECL: 02/22/2020 TAGS: PREL, PGOV, ECON, UP SUBJECT: SCENESETTER: NATIONAL SECURITY ADVISOR JONES' ATTENDANCE AT YANUKOVYCH INAUGURATION Classified By: Ambassador John F. Tefft. Reasons 1.4 (b/d.) Summary ------- 1. (C) Your visit to Kyiv for Viktor Yanukovych's inauguration February 25 comes at a time -- not unusual for Ukraine -- of political and economic tumult. More than two weeks after the February 7 second round of Presidential election, PM Yuliya Tymoshenko has still not recognized Yanukovych's victory, and is not likely to. Indeed, her parliamentary faction is threatening to boycott the inauguration. Yanukovych's Party of Regions is, meanwhile, negotiating with Tymoshenko's coalition partners to bring down her government. President Obama's call of congratulations to Yanukovych left a highly favorable impression and could help move Yanukovych forward on such issues as agreeing to eliminate fresh HEU from three sites in Ukraine. Yanukovych advocates a multivectoral foreign policy; although he wants to reset relations with Russia, he also seeks productive relations with the EU and the U.S. His first trip abroad as President will be to Brussels, likely on March 1. 2. (SBU) Ukraine has made many economic gains since independence in 1991, but its transformation to a well-functioning market economy is far from complete. Yanukovych is taking up the reigns at a difficult time. He must cut government expenditures to restart international, including IMF, lending; improve the business climate to bring back investment; and reform the banks so that businesses can gain access to credit and begin to grow again. End Summary. No Concession ------------- 3. (SBU) PM Tymoshenko has refused to concede the Presidential election, the second round of which took place on February 7, to Regions Party leader Viktor Yanukovych. Facing defeat in court, Tymoshenko abruptly withdrew her appeal of the results of the election (she lost by 3.48 percent) on February 20, claiming the court was biased against her. Election observers, the Central Election Commission, exit polls and internal polling were unanimous in concluding that Yanukovych had won and that the election was essentially free and fair. Tymoshenko is considering a boycott by her bloc of the inauguration ceremony February 25, claiming Yanukovych's election was illegitimate. In a nationally televised address February 22, Tymoshenko again alleged that Yanukovych had won by fraud, that he was the tool of oligarchs, and that he would sell out Ukraine's national interests. Taking Down the Tymoshenko Government ------------------------------------- 4. (SBU) Your visit also coincides with efforts by Yanukovych's Party of Regions to take down the Tymoshenko government. While the Presidential election has, constitutionally, no direct bearing on the governing coalition in parliament, Yanukovych's Party of Regions is seeking to use momentum from Yanukovych's win to try and break Tymoshenko's coalition and remove her from office. Regions hopes to entice Tymoshenko's main coalition partner, Our Ukraine-People's Self Defense (OU-PSD), to abandon Tymoshenko and join a Regions-led coalition. They hope to achieve this in the week following the inauguration. Regions is willing to offer the Prime Ministership to a candidate more amenable to OU-PSD. If Regions is unable to get OU-PSD to flip, it will pursue a vote of no confidence. If that passes, Tymoshenko would remain as caretaker PM -- and a sharply divided President-PM cohabitation would prevail -- until pre-term parliamentary elections in the fall. 5. (C) Senior Yanukovych advisors offer the odds of a Regions-OU/PSD coalition at anywhere from ninety percent to about even. Fourth place finisher in the Presidential election's first round, Arseniy Yatsenyuk, appears a likely compromise candidate for PM in a Regions-OU/PSD coalition. OU-PSD lacks centralized leadership making it more difficult for Regions representatives to cut a deal. Regions' trump card, however, is the fact that many OU-PSD members fear losing their seats in early parliamentary elections, making them more inclined to accept a deal from Regions. Reset with Russia ----------------- 6. (C) Yanukovych will usher in a change in direction and tone in Ukrainian policy toward Russia. Dmitriy Medvedev, KYIV 00000275 002 OF 005 who refused all contact with Yushchenko since at least August, has already invited Yanukovych to visit Moscow in March. Yanukovych's team seeks to renegotiate the January 2009 gas deal that Tymoshenko worked out with Putin, saying, in effect, that Putin took Tymoshenko to the cleaners. They tell us that they want to examine the relationship in its entirety and are willing to make concessions in return for concessions. Key areas we need to watch include: -NATO: Membership is not on the agenda, securing one of Moscow's primary goals. However, Yanukovych has emphasized he wants to maintain contact with NATO including through training and exercises. Regions invited NATO SYG Rasmussen to the inauguration (although it appears NATO will be represented at a lower level). -Black Sea Fleet: Yanukovych has announced he is open to renegotiate the lease for the Russian Black Sea Fleet, based in Sevastopol, which expires in 2017. Yanukovych would seek substantially higher rent. Regions leaders appear to see this issue as a bargaining chip to get concessions in other areas, such as the gas deal. -Russian Language: Yanukovych will seek to make Russian language official for education and other purposes in areas where Russian speakers are a majority. Regions claims that this is consistent with European norms. Yanukovych had campaigned on a pledge to make Russian a second state language, but he does not have the votes in the Rada to change the constitution to make this happen. -Customs Union: Yanukovych has talked favorably about increasing trade and economic ties with Russia, Belarus and Kazakhstan and flirted rhetorically with the idea of joining the Customs Union; however, his advisors recognize that joining a Customs Union would be incompatible with both WTO and an EU Free Trade Agreement, so he is unlikely to go that far. Partnership with U.S. -------------------- 7. (C) Party of Regions leaders have made efforts to reach out to the Embassy to reassure us that productive relations with the U.S. are a top priority for Yanukovych. Senior Yanukovych advisors have told us that President Obama's call of congratulations made a major positive impression on Yanukovych. Yanukovych and his advisors are cognizant of the importance the Obama administration places on nuclear security; they are aware of the Administration's interest in removing fresh HEU from three sites in Ukraine. Your visit offers the opportunity to capitalize on current good will toward the U.S. and move this issue forward. We should seek a GOU decision to agree to remove the HEU this year. This would pave the way for a productive April Summit and excellent start in our relations with the Yanukovych team. We would also like to get Yanukovych's commitment to support a Rada vote to allow foreign military exercises in Ukraine in 2010. Regions blocked this in 2009, largely for political reasons. We can use your visit to try and secure Regions' commitment to support that legislation in early 2010. Yushchenko ---------- 8. (SBU) Viktor Yushchenko ends his tenure after having gotten only about five percent of the vote in the first round of the Presidential election. His appeal now extends only as far as Lviv and other limited areas of Western Ukraine. He is widely blamed -- not least by many who voted for him in 2004 -- for his poor management, incessant quarreling with Tymoshenko at the expense of national interests, needless antagonizing of Russia, and his penchant for seeking declarations of membership from NATO and the EU instead of focusing on the hard work of economic and military reforms that would have moved such aspirations toward concrete reality. 9. (C) Yushchenko spent most of the presidential campaign, as he had much of his time in office, bashing Tymoshenko. His relations with Yanukovych are, by contrast, civil. Yushchenko hurt Tymoshenko in round two -- possibly making the difference in the margin of victory -- by urging voters to vote "against all." Some claim that Yushchenko has made a deal with Yanukovych. Yushchenko recognized Yanukovych's election as the "legitimate President of Ukraine" when Tymoshenko withdrew her court case February 20 and signed a decree to support Yanukovych's inauguration. Crimea KYIV 00000275 003 OF 005 ------ 10. (C) Considered a possible flashpoint following the August 2008 Georgia war, Crimea has been quiet in recent months. Although Tymoshenko alleged electoral fraud in Crimea, observers reported that the election proceeded quietly there. Yanukovych won overwhelmingly in Crimea. His election has the potential to further reduce the political temperature in the region and diminish the pronounced alienation Crimeans feel toward Kyiv. Pro-Kremlin nationalist groups have been largely dormant for over a year. The last time anti-American sentiment was noticeable was in January 2009 when, following signature of the US-Charter on bilateral relations in December 2008, pro-Russian nationalists held rallies protesting a provision which called for exploring the possibility of opening a U.S. post in Simferopol, Crimea's capital. Economic Overview ---------------------- 11. (SBU) In the last five years, the only major economic reform Ukraine has undertaken is adopting legislation for its accession to the World Trade Organization in May 2008. Per capita income has more than doubled since 1991 (to over $3,210 in 2008), despite economic decline throughout all of the 1990s. But in terms of purchasing power parity, which reflects living standards, Ukraine's GDP still ranks only 99th in the world: just 22% of the European Union level and 40% of Russia's level. 12. (SBU) The world's economic crisis hit Ukraine hard. As global liquidity froze up, Ukraine was excluded from global finance. Several industries -- construction, metallurgy, mining and machine-building -- saw their output fall by about half. Only agriculture escaped the crisis. Ukraine saw its economy shrink by 15% in 2009 for various reasons. First, it maintained a fixed exchange rate to the US dollar. Currency inflows in 2007 and 2008 increased money supply, causing double-digit inflation, which reached 31% in 2008. Imports rose more than exports. Structural problems in the economy aggravated the crisis. Steel accounted for over 40% of Ukraine's exports, and steel prices and exports plummeted. Political gridlock and a poor business climate turned off foreign investors, and foreign direct investment (FDI) inflows dropped by more than 50% in 2009. 13. (SBU) In need of financing, including to make monthly gas payments to Russia, Ukraine had no option but to turn to the IMF and devalue its currency at the end of 2008. To top it all off, banks, which were already suffering, came under additional pressure as non-performing loans skyrocketed. Customers, who had taken out hard-currency loans, could no longer pay their mortgages and car loans, which overnight became almost two times as expensive for those receiving salaries in local currency. 14. (SBU) The tasks facing Yanukovych thus are immense. For Ukraine to regain footing on the path to long-term growth and stability that would contribute to the country's security and sovereignty, Yanukovych and his team must first work with the IMF to put its $16.4 billion program back on track. The program, with approximately $6 billion still to be disbursed, has been on hold since November. The IMF has said that Ukraine must pass a realistic 2010 budget, keeping the deficit to about 4% of GDP. This will require Yanukovych to take what are likely to be painful and unpopular measures, such as raising consumer gas prices, introducing pension reform, and limiting the wage and pension increases his party pushed through the Parliament in late 2009. Without the IMF program, however, investor confidence in Ukraine is unlikely to return. 15. (SBU) After fiscal reform, the government must make improvements to the business climate to stimulate growth. This should include deregulation and tax reform to improve competitiveness, judicial and administrative reforms to tackle corruption, and land sector reform to increase agricultural output. Ukraine last year became a net importer of meat and dairy products for the first time. Finally, financial sector reform must move forward to strengthen banks, abilities to support investment into the economy. Messages for Yanukovych ----------------------- 16. (SBU) Following might be appropriate for your bilateral with Yanukovych: KYIV 00000275 004 OF 005 -President Obama enjoyed speaking with you. We welcome your readiness to use our strategic partnership charter as the basis of our relationship. The Administration looks forward to working with you across the full range of issues. -Reiterate importance President Obama attaches to the Nuclear Security Summit. Look forward to your attendance. You could make a major contribution by agreeing to remove fresh HEU from the three sites in Ukraine. U.S. willing to help fund this. -Look forward to Ukraine continuing security cooperation with US and with NATO. Seek early Rada passage of legislation permitting foreign troops to conduct exercises in Ukraine in 2010. -Endorse Yanukovych's stated goal of Ukraine signing Association Agreement and Free Trade Agreement with EU. Would be a major impetus to reform. Messages for Tymoshenko ----------------------- 17. (SBU) Possible messages if you meet with Tymoshenko: -Look forward to continuing to work with you. -You have important role to play in government or in opposition. Democratic process is important. -Orange Revolution was about transparent and competitive elections, civil society and freer media. Ukraine has made major strides in these areas since 2004. Ukraine should be proud that international observers found the election to be essentially free and fair. A tribute to how far Ukraine has come. -Ukrainian elites should work together to help the economy escape from its current morass. -Look for your support with legislation permitting foreign military exercises in Ukraine in 2010. Messages for Poroshenko ----------------------- 18. (SBU) Possible messages in the event of a meeting with FM Poroshenko: -Look for success of April Nuclear Summit, particularly in security agreement to move forward on HEU issue. -Offer state of play on post-START negotiations. (Ukraine had sought to be a participant in Post-START process.) -Express hope that Ukraine can sign Association Agreement and Free Trade Agreement with EU in 2010. Key to energizing reforms. Possible Economic Points ------------------------------ 19. (SBU) In your discussions with Ukraine's leaders you may want to: -Encourage Ukraine to work with the IMF to cut government expenditures. The IMF program must be put back on track before investors will return and before other international financial institutions, such as the World Bank and EBRD, will resume lending. -Stress the need for energy sector reform. Renegotiating the gas contract with Russia, which Yanukovych has said he intends to do, will not be enough. The prices consumers -- both households and heating companies -- pay must be increased. Subsidies to industries must be narrowed. Cooperation with the international donor community to rehabilitate gas pipelines and other infrastructure will also be important -Reiterate U.S. support for reform that will improve the business climate. We have a number of projects, such as USAID assistance to improve the government procurement law, which will help reduce corruption. Tax and customs reform, land sector reform, and judicial reform will also help bring back investors. KYIV 00000275 005 OF 005 -Stress that our firms are also ready to help Ukraine's economy grow. Companies such as Westinghouse, however, will not remain in the market if they continue to face problems with regulators. Westinghouse has recently been told it will not receive a license for the nuclear fuel it has been developing for Ukrainian nuclear power plants (with millions of dollars of USG support). Westinghouse fuel would help Ukraine diversify away from its 100% dependence on Russia nuclear fuel. -Emphasize the importance of paying off value-added tax (VAT) arrears, which exceed $2.4 billion overall, with over $300 million to U.S. agricultural exporters alone. U.S. firms raise VAT arrears as a significant barrier to further investment in Ukraine. -Highlight the need for continued work to shore up the financial sector; including a need to address deficiencies in Ukraine's anti-money laundering and counter-terrorist financing regime. The international Financial Action Task Force (FATF) on February 19 listed Ukraine as a high-risk country. TEFFT