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Monday, September 21, 2015 - 14:49
Russian roulette

The Ukrainian government has been struggling for several months to strike a deal with private sovereign bond holders to restructure its debt. Negotiations are at a standstill while the economic and financial situation of the country becomes alarming. The Ukrainian economy contracted by 17% (y-o-y) in Q1 2015, after a 6.5% contraction in GDP in 2014.
Ukraine engaged in negotiations with private holders of sovereign bonds some months ago in the framework of the IMF deal signed in March 2015 providing, among others, a $15-billion relief on debt held by private creditors to 2018.
Ukraine has asked investors, led by the US asset manager Franklin Templeton, for a 40% principal debt reduction, arguing that the country is facing liquidity and solvability problems. Creditors, highlighting that Ukraine faces “only” a liquidity crisis, have offered to re-profile the debt, without any face-value write down.


Says Anne-Sophie Fèvre at Coface, “The country is deprived of its major sources of revenues. Ukraine has lost control of regions in the East where huge industrial and mining resources are concentrated: Lugansk and Donetsk output represented almost 15% of GDP and 20% of exports. Furthermore, Ukraine’s export revenues are being derived mainly from commodities (iron ore, steel) where market prices are under extreme pressure.”
Household demand is being dampened by skyrocketing inflation (57.5% in June y-o-y) and high interest rates (the key rate was raised to 30% by the central bank in March 2015) and a huge reduction in public spending (social security payments fell by more than 50% in real terms between January and May).
Strict capital control is being kept to try to stabilise Ukraine’s currency, the hryvnia, which has lost 80% on a yearly basis (40% since January). Exchange rate stabilisation is crucial for external debt sustainability because 60% of public debt is denominated in USD and Ukrainian companies, banks and households are heavily indebted in foreign currency.
The public-debt-to-GDP ratio is surging due to the slump in GDP and is expected to exceed 90% of GDP in 2015 (40% in 2013).
She says the banking sector is severely affected by the economic crisis and the depreciation of Ukraine hryvnia. Some public banks have been recapitalised and the sector is under consolidation (24 banks have been closed in 2015). PrivatBank, the biggest private bank, has attempted to restructure its debt but its creditors have rejected the extension of maturity of 2015 and 2016 Eurobonds.
“Ongoing negotiations with private debtors are crucial for the sustainability of the Ukrainian debt. The failure of the discussions would cause a severe blow to Ukraine’s credibility for investors and make it more difficult to regain access to markets in the future.”
Ukraine has so far repaid interest owed to private creditors, including $120-million on July 24. But huge debt payments remain due in 2015: $500-million in September, EUR600-million in October and $3-billion in December (to Russia).
“Talks with Russia are difficult,” says Fèvre. “Beyond political issues, major economic and financial issues are at stake between the two countries. Gas supply from Russia was suspended in July after a breakdown on pricing talks. Moscow has so far refused to discuss any restructuration of the $3-billion bond, whose status remains in debate: if it is regarded as a private debt, it ought to be included in ongoing negotiations for restructuration. If not, it will have to be repaid in full in December, any default on sovereign debt will trigger a suspension of the IMF programme.”
The financial support from the international community could avoid a short-term default, but not secure medium term solvency. Progress in negotiations with private creditors is part of the deal reached with the IMF. The decision to drawdown the second tranche ($1.7-billion) is expected to be confirmed at the IMF Board scheduled for 31st July 2015.
This will give some relief to the government, but only temporary relief. With ongoing low fiscal and export revenues, depleted reserves (around two months of imports),
Ukraine may sooner or later face difficulties to meet its payment obligations.
A compromise with creditors is likely, before the September maturity date, but probably on a haircut less than the 40% expected by the Ukrainian government. It would be a first step but the Ukrainian situation will remain very fragile as long as the ongoing conflict in the East is focusing the attention and resources of the Ukrainian government, delaying the enforcement of deep reforms allowing sustainable growth and revenue flows for the government.

Copyright © Insurance Times and Investments® Vol:28.9 1st September, 2015
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