Ukraine’s $58 billion problem

April 24, 2012

Ukrainian officials were at pains to reassure investors last week that no debt default was in the offing. But people familiar with the numbers will find it hard to believe them.

The government must find over $5.3 billion this year to repay maturing external debt, including $3 billion to the IMF and $2 billion to Russian state bank VTB. Bad enough but there is worse:  Ukrainian companies and banks too have hefty debt maturities this year. Total external financing needs– corporate and sovereign – amount to $58 billion, analysts at Capital Economics calculate. That’s a third of Ukraine’s GDP and makes a default of some kind very likely. The following graphic is from Capital Economics.

In normal circumstances Ukraine — and Ukrainian companies — could have gone to market and borrowed the money. Quite a few developing countries such as Lithuania recently tapped markets, others including Jamaica plan to do so. Ukraine’s problem is its refusal to toe the IMF line.  Agreeing to the IMF’s main demand to lift crippling gas subsidies would unlock a $15 billion loan programme, giving  access to the loan cash as well as to global bond markets. But removing subsidies would be political suicide ahead of elections in October.  And with the sovereign frozen out of bond markets, Ukrainian companies too will find it hard to raise cash.

So what options does Ukraine have? It could yet sell bonds on global markets. Or it could, as the finance minister sugggested last week, borrow at home in hard currency. But its tiny, illiquid  local debt markets are unlikely to attract too many foreign investors. And yields will be ruinous. Ukraine’s 2015 dollar bond is trading with a yield of 9 percent and Ukrainian sovereign dollar debt carries a hefty 870 basis-point premium to U.S.  Treasuries, among the highest in emerging markets. Analysts at Capital Economics write:

Issuing debt at interest rates of 8-10% is unsustainable for a country that even on the IMF’s optimistic projections is likely to record average nominal GDP growth (in US$) of only 4.5% a year over the next three years.

The government could also dip into the central bank’s $30 billion reserves. But this would be a temporary fix. Also, reserves are already down $7 billion since last August and spending more of this could leave the hryvnia seriously exposed in coming months.

Max Wolman a fund manager at Aberdeen Asset Management says there are still some good stories in Ukraine. He owns bonds issued by steelmaker Metinvest and chicken farmer MHP. Both firms have low debt and strong profits but being Ukrainian firms, their bonds yield over 10 percent, he says. But Wolman is bearish on the country’s prospects and reckons Kiev will struggle to issue Eurobonds as long as it is at loggerheads with the IMF. While he does not expect a default just yet, he thinks bond investors will take Ukraine’s assurances with a pinch of salt.

The market is pretty underweight Ukraine as no one is willing to give them the benefit of doubt (Wolman says)

His advice is to wait until October. Because once elections are past, the goverment might suddenly become more amenable to the IMF’s demands.

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