Country risk: Why betting on Ukraine is for the fortuitous or foolhardy

By:
Jeremy Weltman
Published on:

Only time will tell if snapping up Ukrainian bonds before its creditor negotiations are complete is fortuitous or foolhardy, but what cannot be denied are the enormous risks involved.

Reports of some investors prepared to sink more funds into Ukrainian bonds is sure to raise eyebrows and set portfolio strategists thinking.

The country has plunged 43 places in Euromoney’s country risk global rankings since 2010, to 147th out of 186 countries and deep into tier five – the lowest ECR category signifying the highest risk of default.

The question now is whether its prospects are likely to radically improve from here on.

Ukraine’s relative ranking has certainly stabilized this year, but its total risk score is still edging downwards. Another half point lost during the first half of 2015 adds to the 13 points in total over the past five years, putting Ukraine lower than Greece, another tier-five sovereign in the global rankings:

 

Ukraine barely racks up three to four points out of 10 for any of its economic or political risk factors, while structural risks are also challenging despite scoring a little higher.

The government finances score is predictably low (just 2.7 points) and non-payment risk has increased since 2014 along with the growth and employment outlook.

Investors are banking on a favourable restructuring, stemming from the present negotiations with principal bondholders, to eventually bolster the price of debt.

Ukraine did manage to meet a July deadline for paying two-year Eurobonds, and is receiving IMF support, prompting one ECR expert to have some grounds for optimism.

"The government is pursuing some tough, but much-needed, reforms," says Olga Mrinska, an associate at the Institute of Local and Regional Initiatives, a think-tank, which when considering these other developments might well put Ukraine back on a positive trend.

Her optimism is qualified however on "a situation where military escalation is not on the horizon, or at least is not greater than the six months before".

Risky strategy

Other contributors recognize there is still quibbling over haircuts and that investors might be simply ignoring the overall picture.

The country is, after all, still embroiled in an unresolved war with Russia with more than a million of its people internally displaced. Trade sanctions and disrupted gas supplies are biting hard, and another winter is looming.

As the IMF recently noted, the economy is fragile and requires deep reform, even if some improvements are now emerging from the stabilizing currency, elimination of the current-account deficit, fiscal adjustment and rising deposits.

Real GDP shrank 6.8% last year and is forecast to contract again, more severely in 2015, and the 2% growth pencilled in for 2016 is conditional upon reforms and stability continuing.

Ukraine lost 4% of its GDP after the annexation of Crimea, around 10% more is affected by the loss of control in eastern oblasts, and Russia seems unlikely to untie the noose any time soon.

The devalued hryvnia has made restructuring of the $19 billion burden and inflation threats challenging. Indeed, the IMF’s worst-case scenario signals a possible 5% contraction in real GDP for 2016 if everything unravels.

To put the country’s problems further into perspective, the public and publicly guaranteed debt burden is expected to top 94% of GDP this year – that’s assuming there are no hidden liabilities.

In that light, ECR experts are hoping for the best, but remain cautious.

Pascaline della Faille, country and sector risk coordinator for Delcredere | Ducroire, part of the Credendo Group specializing in risk insurance, says: "Even if the recent IMF disbursement is welcome for external financial support, we remain off cover on Ukraine for the time being."

Head of research at Bank of Finland’s Institute for Economies in Transition Iikka Korhonen believes the IMF tranche and progress in debt talks has increased optimism, alongside the reforms, but also cautions "the macroeconomic situation is still bad".

Ukraine has a maturing Eurobond due in September and a creditor agreement to settle. Its country risk score remains very low. Investors thus have reason to remain cautious. 

This article was originally published by ECR. To find out more, register for a free trial at  Euromoney Country Risk.