Ukraine secured only half the write-off it wanted and the amount involved doesn't seem enough to fill the hole in its IMF programme.
This post first appeared on Russia Insider
An announcement on 27th August 2015 has confirmed that Ukraine has reached a restructuring deal with its private creditors.
However, as the article from the Financial Times attached below makes clear, it is far from certain that the deal comes anywhere close to meeting Ukraine's needs.
On the face of it the agreement looks like a bad deal for Ukraine.
Ukraine was demanding a 40% haircut. It got only 20%.
Ukraine's creditors have also agreed to delay bond (ie capital) payments on the remaining debt for four years, though Ukraine will have to continue to make coupon (interest) payments at a slightly higher rate during this period.
In return Ukraine has agreed to a GDP linked security that will pay its creditors a percentage of its economic growth after the debt repayment holiday ends in 2019. It seems 40% of any economic growth over 4% will have to be used to pay off debt. This will be on top of any regular capital and interest payments that fall due.
That suggests a very heavy period of debt repayments after 2019, after the four year bond payment holiday ends, and when the IMF programme also ends.
Not surprisingly the Financial Times reports worries amongst financial analysts that this may be too heavy a burder for Ukraine to bear.
Judging from the last paragraph of the Financial Times's article, Ukraine may be hoping to overcome this problem by further borrowing in the capital markets.
It remains to be seen whether lenders, once they have done the sums, will be prepared to lend it extra money.
The agreement still needs some creditors to agree. The pressure on them to do so will however be so great that it is a virtual certainty they will do so.
The agreement does not cover the $3 billion payment on the eurobond held by Russia, which matures in December.
What are the implications of this agreement?
Firstly, though the IMF is backing the agreement (it has no other choice), it is far from obvious that the sums add up.
The IMF’s latest programme assumes a reduction of Ukraine’s total debt repayments over the duration of the programme of $15 billion.
The Financial Times says the total amount of debt at issue in the negotiations is $18 billion, and says the value of the haircut is $3.6 billion (20% of $18 billion).
TASS says the total amount of debt at issue in the negotiations is $19.2 billion, and says the value of the haircut is $3.8 billion (20% of $19.2 billion).
TASS may be giving the more accurate figure. The Financial Times also says the total value of the write off is "close to $4 billion" - which seems more consistent with TASS's $3.8 billion figure than the Financial Times's $3.6 billion.
There is no information on how much Ukraine will save as a result of the cancellation of the interest payments for the debt that is subject the haircut. Nor do we know how much relief it will get from the four year bond payment holiday.
However, on the face of it, whether the haircut is worth $3.6 billion or $3.8 billion, the sums look too small to come anywhere close to hitting the $15 billion debt reduction target the IMF was looking for.
Ukraine’s demand for a 40% haircut by contrast would have written off £7.2 billion if the debt is $18 billion, or $7.68 billion if it is $19.2 billion, which together with cancelled interest payments and the four year bond payment holiday might have brought the debt relief target of $15 billion within sight.
More clarity will be provided as more information becomes available. However the Financial’s Times’s pessimism about the sustainability of what has just been agreed tells its own story.
If the $15 billion debt reduction target is not being achieved, then unless the West provides more money or Ukraine's economy suddenly improves, the IMF programme will fail.
Why did this agreement take so long to agree - especially given the immense pressure from Western governments on the creditors to settle - and why is it so unfavourable to Ukraine?
Firstly, it is important to say that it was not because the creditors anticipated that in the absence of an agreement the IMF would pull the plug on Ukraine - forcing Ukraine to settle on their terms.
As we have previously reported the IMF - under political pressure - has said it will support Ukraine regardless of whether it comes to an agreement with its creditors or not.
Nor is it likely that the creditors thought that if Ukraine defaulted they would get all their money back through credit default swaps. These were unlikely to come anywhere close to compensating the creditors fully for the money they would have lost.
The creditors held out because what Ukraine was demanding was completely unreasonable.
Ukraine's debt is not unsustainable. The Financial Times says the total amount Ukraine must pay on its debt (public and private) is $72 billion.
This ought to be perfectly sustainable for a country that is the second biggest in Europe, has a well-educated population of more than 40 million people, and which is blessed with an abundance of natural resources, large industries, a lengthy coastline, and some of the most fertile agricultural land in the world.
By contrast Greece, with a total debt of $350 billion, is a small country, has a population of just 11 million people, has very few industries, and few natural resources.
Parallels people make between the situations of Greece and Ukraine are simply wrong. Greece’s debt is obviously unsustainable. Ukraine’s debt is not.
The reason Ukraine is failing to pay its debt is not because its debt is unsustainable. It is because Ukraine is chronically mismanaged and insists on waging war rather than restoring its economy by making peace.
The creditors therefore question why they should be asked to agree to huge haircuts when - provided Ukraine ends the war and sorts out its problems - it is perfectly capable of paying them the money it owes them.
The Financial Times explains the creditors’ position clearly:
“Bondholders had rejected Ukraine’s assertion that they must take a 40 per cent upfront loss, arguing that the country’s problems were mutable and that a temporary freeze in debt payments would be a better solution, delaying a final deal until political and economic problems calm.”
Ukraine did not help its case by acting as if the creditors were under some sort of moral duty to write off the debt; and by constantly complaining that it was spending more on debt payments than on defence - leading to the inevitable suspicion that it was intending to use any money saved on debt payments to fund the war.
The result is what looks like an unsatisfactory outcome both for Ukraine and the IMF. Given the political pressure they will doubtless press on with their programme, but the sums do not look like they add up.
Recent news of the deterioration of Ukraine’s economy anyway calls the IMF's whole programme into question. Even if a much bigger haircut had been agreed it seems unlikely the sums offered are anywhere near enough to turn Ukraine's economy round.
It seems only capital controls are preventing the Ukrainian currency’s complete crash, and without a political breakthrough leading to an end the war there must be a question over how long the situation can hold.
In the short term this unsatisfactory agreement must however increase the possibility that Ukraine will look for some way to default on the $3 billion eurobond it owes Russia, which matures in December.
The Russians have categorically ruled out any restructuring of this debt, a position they have just reiterated.
Given the financial pressure they are under following an agreement that fails to meet their needs, there must now be strong pressure on the Ukrainians to default on this debt, and certain comments made by Yatsenyuk suggest as much.
As I have discussed previously, if Ukraine defaults on this debt bitter legal disputes will follow, with the Russians insisting that it is public debt and the Ukrainians arguing - implausibly - that it is not. These disputes alone might suffice to derail the whole IMF programme.
Regardless of what happens to this particular debt, Ukraine’s position, following what looks like a deeply unsatisfactory agreement, looks grim.
From the Financial Times:
Ukraine has secured an agreement to avert default and restructure billions of dollars of government debt in a deal that could see international investors write off close to $4bn.
Creditors, including San-Francisco based Franklin Templeton and Brazilian investment bank BTG Pactual, have accepted the proposal for a 20 per cent haircut on $18bn of the embattled country’s bonds as well as delaying debt repayment by four years.
In return they will receive a GDP-linked security that will pay holders a percentage of Ukraine’s economic growth from 2021.
However, questions remain over whether the hard-won deal, which is supported by the International Monetary Fund, will result in solvency for the country, as conflict with pro-Russian separatists imposes a heavier than expected toll on the economy.
“Ukraine could face further liquidity issues when the IMF programme is over so the extension of debt repayments is crucial,” says Vadim Khramov, strategist at Bank of America Merrill Lynch.
Under the plans agreed by Ukraine and creditors, bond repayments will be extended by four years while coupon payments will be slightly higher than the current 7.2 per cent average at 7.75 per cent. A GDP-linked warrant will be provided from 2021 to 2040 that will pay out up to 40 per cent of the value of annual economic growth above 4 per cent, although total payments will be capped at 1 per cent for the first four years.
The haircut on government bonds could mean immediate debt relief of up to $3.6bn. However holdouts on some bonds are expected by analysts, including Russia’s $3bn bond due to mature in December.
Kiev’s deal to restructure its $72bn government debt burden follows months of negotiations with investors who hold close to $9bn of Ukrainian bonds.
Although the creditor committee of Franklin Templeton, T Rowe Price, BTG Pactual and TCW have agreed to the plans with the Kiev government, other bondholders will need to be persuaded of a deal in order for a majority to agree relief on each bond.
Once the plans are submitted to Ukraine’s parliament, a prospectus will be published in mid-September and bondholders will vote on the restructuring proposal. The timing means that repayment of a $500m bond due on September 23 will be suspended while creditors consider the plans.
In August officials from Kiev, including US-born minister of finance Natalie Jaresko, flew to San Francisco, home city of Franklin Templeton, for emergency meetings as an upsurge of fighting with Russian-backed separatists controlling breakaway eastern regions of Ukraine focused attention on the deal.
Bondholders had rejected Ukraine’s assertion that they must take a 40 per cent upfront loss, arguing that the country’s problems were mutable and that a temporary freeze in debt payments would be a better solution, delaying a final deal until political and economic problems calm.
Relations with private sector creditors had soured since spring as the two sides clashed over the question of whether investors must write down their holdings in order for Ukraine to meet the terms of the IMF’s four-year $17.5bn bailout, designed to take the country’s debt below 71 per cent of GDP by 2020.
Earlier this year Ukraine took the highly unusual step of passing a bill in parliament that allows the government to halt payments on some foreign debts by declaring a moratorium, a term described by one international credit lawyer as “a polite word for default”.
The IMF alluded to the uncertainty in early August when it reiterated that although it expected Ukraine’s debt operation to be completed, it was willing to support the country even if debt discussions failed and a moratorium was imposed.
However, the repercussions of Ukraine defaulting on its debt would have been severe.
Ukrainian bonds, issued under English law, contain cross-default clauses that mean missed payments on one can trigger default on all, allowing bondholders to demand repayment, drag a country into lengthy legal battles and exacerbating existing economic problems.
S&P, the credit rating agency, said that a sovereign default would also worsen already tight liquidity in Ukraine’s banking sector, triggering panic-driven deposit withdrawals.
If Ukraine succeeds in a debt restructuring it could plausibly return to international debt markets within a year, said Yerlan Syzdykov, head of emerging markets debt at Pioneer Investments. The country has said that it plans to come back to the market by 2017.
Market prices for Ukrainian bonds have recovered in recent weeks as hopes rose that the country would avoid default, with a Ukrainian $2.6bn bond due to mature in 2017 trading at 57.4 cents on the dollar ahead of talks, up from 39.5 cents in March.
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