Ukraine bonds: Keep calm and carry on paying

By:
Published on:

When Ukrainian state energy company Naftogaz paid $1.6 billion to redeem a bond maturing on October 1, one Twitter commentator accused the country’s policymakers of “defaulting on its citizens”.

To him, as to many others, using precious dollars to repay foreign fund managers, at a time when individuals were struggling to persuade banks to hand over the daily withdrawal allowance of $200, seemed the height of madness. As one local banker commented: "If Greece can default on its sovereign debt, why on earth can’t Ukraine?"

That the market considers default a far from remote possibility is evident from the yields on Ukraine’s Eurobonds. As parliamentary elections loomed in mid-October, returns on its July 2017s hit a new high of 16.3%.

Ukraine’s policymakers, however, are adamant that default or even restructuring is out of the question. The main reasons given are national pride and, more cogently, a desire to maintain access to international capital markets.

The big fund managers who hold most of the country’s Eurobonds have apparently promised ministers that they are ready to ramp up exposure to Ukraine at the smallest sign of stability – and, while to some extent they would say that, it is clear that a recovering Ukraine could offer great value to investors.

Also cited as a reason for not defaulting is Ukraine’s relatively light debt repayment schedule. With the Naftogaz bond out of the way, the next big redemption is not until December 2015, when the $3 billion so-called bail-out bond – issued by Russia to the Yanukovych regime at the end of last year – comes due.

That at least is the theory. In practice, that bond could come due considerably earlier, thanks to a clause that allows Russia to demand early repayment if Ukraine’s public debt tops 60% of GDP. Most analysts agree that GDP figures for the third quarter, due out at the end of October, will show that that level has already been breached.

What will happen then is anyone’s guess. Russian policymakers have given few hints as to their preferred course of action, but it seems a safe assumption that it will be designed to inflict the maximum amount of pain and embarrassment on Ukraine.

Demanding repayment would clearly score highly on both counts. Handing over $3 billion of scarce resources to a country that has annexed part of your territory and is in the middle of invading some of the rest, in payment of a debt incurred by the man who bled your country dry and is now being sheltered by the aggressor state, is always going to be politically and emotionally fraught.

Nevertheless, if Russia does call in its debt, Ukraine should make the payment – and not just because Putin’s people put a sting in the tail of the bond by issuing it under UK law, so that refusal to pay would likely trigger a cross-default on the rest of Ukraine’s international debt.

The fact is that, as the chairman of Ukraine’s largest bank succinctly puts it, what the country needs is "less emotion, more professionalism".

There is no excuse for default when the debtor has the means to pay, which Ukraine does – FX reserves stood at $16.2 billion at the end of September. No matter how great the political pressure, policymakers must stand their ground and pay bills as they come due in as far as they are able – and trust that when they can no longer do so the IMF and other western donors will step in.

If they fail to do so, then Ukraine has no hope of recovery anyway, given that the bills looming – for gas to heat the country over the winter, for recapitalizing the ailing banking sector and for rebuilding the infrastructure of the conflict regions – will make Russia’s $3 billion look like a flea bite.

Keeping the international investment community onside is vital. This may not seem like a good moment to invest in Ukraine, but as our story this month shows, there are plenty of big global fund managers sitting on the sidelines, looking to put their money to work.

As Ukraine’s deputy finance minister told Euromoney last month: "I met a fund manager from New York who holds our debt. He told me: 'I have a $1 billion cheque but I can’t sign it until I know whether the light at the end of the tunnel is an exit or a train’." 

Any hint of a default would ensure that overseas investors saw the light as the latter.

It is clear that the country’s future depends on an unemotional approach to public finances, even if that means apparently rewarding an aggressor.

Making the Naftogaz repayment was the right thing to do. Now Ukraine needs to do more of the same.