Why investors who bet big on Ukraine should shoulder their own losses

June 3, 2015
Elderly woman begs for money near a currency exchange office in Kiev

An elderly woman begs for money near a currency exchange office in Kiev July 20, 2012. REUTERS/Gleb Garanich

Ukraine is flat broke. Kiev is running out of hard currency reserves to pay its foreign debts. Inflation is at 60 percent due to huge increases in gas prices. The country’s economy collapsed at an annualized rate of 17 percent last quarter. A full-scale economic depression is unfolding.

There may be only one way out of this mess for Ukraine: to default on its international debts and tell its foreign creditors to take a hike. While some argue that government debt restructurings are akin to theft from “powerless” creditors, Ukraine’s foreign bondholders are sophisticated investors — including one of America’s biggest investment firms — who knew the risks of investing there. No money from the International Monetary Fund (IMF), which is injecting cash into the Ukrainian economy, should go toward repaying Ukraine’s debts to foreign creditors.

To assist Ukraine, the IMF and other Western donors recently agreed to lend Kiev $40 billion to stabilize its economy. This number, while huge, is deceiving. A good chunk of the $40 billion was already promised to Ukraine in an earlier IMF loan. More importantly, the IMF requires $15 billion of this assistance to come from the restructuring of Ukraine’s international bonds — in essence, demanding that Ukraine’s foreign creditors accept a loss on their investments.

Kiev and its creditors, however, disagree on how to achieve this savings. Ukraine is demanding that its creditors accept a “haircut” — or loss in the face value of the bonds. Creditors such as Franklin Templeton — the country’s largest creditor, which reportedly owns almost half of the government’s foreign debt — assert a “haircut” is not necessary, and that reducing interest payments and extending the maturities of the bonds yields the necessary savings that the IMF demands.

If Ukraine cannot negotiate a debt reduction plan with its investors by June 15, when the next IMF review of Ukraine’s bailout program occurs, its IMF loan could collapse — sending Ukraine’s economy into an even deeper tailspin. In response, Ukraine’s parliament just passed a law authorizing the government to impose a moratorium on bond payments to its foreign investors if negotiations fail.

Some of Ukraine’s foreign creditors buy assets in struggling countries at low prices, hoping to sell at a big profit when prices recover later. They seem to be savvy at finding one-way bets. For example, as the value of Templeton’s Ukrainian bonds dropped from 80 cents on the dollar to 50 cents when the war in Ukraine’s east began, the head of the firm’s Global Bond Fund spoke publicly about Ukraine’s merits as an investment destination, explaining to nervous investors that billions in IMF cash backstopped his Ukrainian bond holdings.

Counting on the IMF has worked so far. Ukraine received almost $10 billion from the IMF in the last 12 months, some of which went right back out to pay foreign bondholders. While it’s natural that foreign creditors want to limit their losses, Ukraine’s collapsing economy and massive defense expenditures makes it likely that Kiev’s $40 billion aid program will not be sufficient.

Kiev should therefore stick to its guns and insist that foreign creditors share in the pain of its citizens and take a loss on the principal of their investments. If foreign creditors continue to refuse this “haircut,” then the government should stop paying interest on these bonds until its creditors agree to accept one. The aim is not to forgo repaying its creditors indefinitely, but to push its investors to accept better terms than they are offering. Citigroup argues that prices of Ukrainian bonds indicate markets already expect a 20 percent haircut — and Kiev has an obligation to its citizens to secure the best deal it can.

Indeed, Ukraine’s citizens are already suffering. The average monthly salary in Ukraine is only $186, and skyrocketing inflation is decimating the purchasing power of ordinary citizens. Kiev is also implementing a painful IMF-mandated economic austerity program involving massive cuts in social spending programs of nearly $30 billion. While Ukraine’s current unemployment rate is just shy of 10 percent, if the results of the Greek economic crisis are any guide, both the unemployment and poverty rates could easily double. The Ukrainian government’s first responsibility is to its people, and if Kiev implements the painful social spending cuts mandated by the IMF, then at a minimum Ukraine’s IMF money should not be used to protect sophisticated foreign bondholders from the consequences of their poor investment decisions at the expense of ordinary Ukrainians.

While Ukraine’s central bank governor worries that Ukraine risks becoming a “pariah country” if it does not meet its obligations, she needn’t be concerned. There have been 187 sovereign debt restructurings between 1970 and 2013, and recent IMF research found that emerging market governments almost always come to terms with their creditors eventually and return to international markets with a clean bill of health. Moreover, once a country’s debt load becomes manageable, inflation drops substantially while economic growth rates at least double — exactly what Ukraine desperately needs after years of economic crisis.

Ukraine does not control its own destiny on the battlefront. On the financial front, however, Kiev holds a strong hand — and should not hesitate to play it.







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The bias and hypocrisy in this article reaches a point of absurdity.

Written by a US AID worker, whose agency financed the violent overthrow of a legitimately-elected government.

Glosses over the atrocities committed by the totalitarian regime in Kiev.

Ignores the criminalization of dissent through this US-backed regime’s “lustration” process.

Suggests stiffing the creditors, while purposely omitting the fact that Russia is one of the main creditors.

What is to be gained by a deadbeat nation refusing to pay its debts? Forcing taxpayers of other countries to replace the $20-$40 billion/year welfare subsidy formerly contributed by Russia may work for a while, but no private investors or banks will be willing to throw more money into a financial black hole.

Posted by fairbro_plus | Report as abusive

Investors who bet big on ANYTHING should shoulder their own losses. They shoulder their own wins.

Posted by Solidar | Report as abusive

the problem in ukraine is government corruption. reduce that and the big investors will support. as a small investor, the problem is no way to invest in ukraine. and the time to invest is now.

Posted by harrykrishna | Report as abusive

Actually, the parallel with Greece is not a good one.

Despite the horrible sound of 60% inflation and 17% drop in GDP this is just a consequence of a loss of export-oriented territory, and dramatic devaluation of national currency. This all happened several months ago, and by new econnomy has adjusted itself to new conditions.

Namely: the country has a budget surplus (a rare case in Europe or elsewhere these days), the chronic current account deficit had vanished, central bank stopped loosing its reserves, The debt is manageable and not growing. It stands at 70 bln $. Pre-crisis nominal GDP is 180 bn$, this year GDP will be about 100 bn $.

There is a strong case for restructuring to give Ukraine a breathing space, but not for a haircut. If the current policies stay in place AND the war situation stays under control, we will see a very strong rebound as soon as 2016-17.

The conditions and set of reforms in Ukraine are very similar to what Baltic states implemented in 2008/09. Much to dismay of My. Krugman and other Keynesian economists, that strategy totally worked.

Posted by Ulyssis | Report as abusive

Are we back to the not-posting-comments policy again ?

Posted by Laster | Report as abusive

The first problem I see here is an assertion that if you are big and “sophisticated” its somehow OK to “take your money”. So if you are rich its OK to
steal from you? Somewhat false logic.

Sure Ukraine can go into default but that would imply no more loans. Can the country afford that?

IMF bailout is strongly co-related to the bonds. If Ukraine bails on the bonds then no IMF is coming. The author fails to see that IMF will not pay out a single $1 if the bonds are not satisfied.

The bottom line is Ukraine is the only country that can save itself.

Posted by TomK2 | Report as abusive

@ fairbro_plus:
Re: (quote) “…the violent overthrow of a legitimately-elected government” – this is one of the most commonly used false accusations by putin’s propaganda. Ukrainian government along with the supreme legislation body Rada were not overthrown and continued to function after the cowardly escape of the former russia-backed corrupted president Yanukovich who didn’t even have courage and decency to come to Rada next day to ratify the agreement with the opposition he personally signed the previous day at the presence of the 3rd party… Although clearly there was no thread to his safety, he just chickened out and nobody, including his own folks could figure for several days where he was hiding. Even his supporters in eastern Ukraine demanded him to go back to work but he refused (he must have known at that moment pretty damn well that what many of his deeds would easily qualify as a criminal offense).
By all definitions, overthrow or coup is a forced removal from power. While there was an attempt to make him resign, including mass protests, clashes with police etc, eventually he peed his pants and ran away when, once again, the agreement was achieved to stop violence by both sides and have early president elections.

Posted by andp | Report as abusive

A clever-by-half attempt at using Russia’s Scorched Earth policy against her.
Here’s the question: If the legal venue for bondholders was a court in Lower Manhatten, would you have still penned this article ?

Posted by Laster | Report as abusive

Ukraine can chose to default if they wish… Just don’t come crying to the rest of the world when no one want’s to invest in it’s state (criminal enterprise). They will be every bit the pariah’s as North Korea for private investors.

People generally take notice when you choose not to pay your bills – then rub creditors nose in it.

It will be a LONG, LONG time before any sane person (or corporation) invest hard money in such a state. Despite the pleadings of Obama and his neocon ilk.

They may be cheered on by the neocons to screw over investors – just like they were cheered on to screw over Russia.. and they may choose that course.

But, just be warned, a big western fire truck is not going to arrive when Kiev is in flames.

Posted by RoyTyrell | Report as abusive

“Bet Big” does that mean the same thing as invested lots? What Eukraine needs is an army of small investors?

Posted by Charlesequine | Report as abusive

“Why investors who bet big on Ukraine should shoulder their own losses”

And they will in ANY case…whether or not Ukraine defaults or makes their creditors take a massive ‘haircut’.

That said, why should not the deadbeats in Ukraine accept some sort of ‘sanction’, if you will…..for blowing off their creditors ?

I mean….even I…if I default and declare bankruptcy….the very LEAST I’m going to be punished for defaulting is that I’m going to lose access to other forms of financing for any reason whatsoever for X number of years.

The deadbeats squatting in Kiev think they are somehow ‘above’ that sort of punishment ?

Posted by NthrnNYker55 | Report as abusive

Josh Cohen says, “Kiev should therefore stick to its guns . . . “.
Isn’t that the problem? If Kiev would address the needs and desires of its citizens, instead of cutting their pensions and drafting them into a civil war, which they do not want, while spending a huge part of the aid provided by IMF, perhaps life would be better for all.
Instead, the top politicians steal money, the Kiev government sells off farm land to Monsanto and industries to rich individuals.
This is not democracy; it’s totalitarian rule by oligarchs and foreigners.

Posted by Cassssandra | Report as abusive