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Friday, 15 December 2017

Ukraine bailout imminent

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Restructuring

Full rescue favoured over re-profiling

Investors holding Ukraine’s sovereign bonds face a nervous wait to see if the International Monetary Fund will back an emergency programme that will see all bondholders paid in full or else recommend a package requiring investors to contribute by re-profiling their bonds.

The latter would most obviously effect a US$1bn Eurobond issue maturing on June 4. However, the price of these notes rallied last week by two points to 95.5 as the market interpreted the worsening situation in Ukraine after Crimea voted to secede as more likely to provoke a full Western bailout.

The IMF mission to Ukraine, which started at the beginning of this month, has been extended twice but is now scheduled to conclude this Tuesday. The stand-off between Russia, which has backed Crimea’s secession, and the interim Ukraine government and its allies has aggravated the IMF’s task.

“In the last six weeks the situation has changed dramatically,” said one sovereign debt restructuring adviser. “Ukraine has lost Crimea. Sanctions have been imposed that could affect the supply of gas. Putting in an austere IMF programme could also hit GDP.”

Foreign currency reserves have fallen to US$15bn, enough to meet state liabilities only until the end of July, according to fresh estimates from the Institute of International Finance. The IIF also said that Crimea’s secession would contribute to a fall in GDP this year of up to 9%.

That would worsen the ratio of Ukraine’s total debts to GDP and in theory make a debt restructuring more likely.

However, a combination of factors – alongside the need to preserve political stability in Kiev – may make a softer bailout more likely, said the adviser, adding: “There is a strong sense that the G7 would prefer to repay bonds rather than enflame a debt crisis on top of all this.”

But there are still strong advocates of the alternative approach, adopting a recent IMF staff proposal that bailout funds should be deployed more effectively if bonds maturing in the short term are extended rather than repaid with bailout cash.

“Ukraine needs a lot of money but the official sector liabilities can be restructured and there is only one Eurobond maturing this year. So it could be a good time for the IMF to try the new approach,” said another adviser.

Choosing this alternative would also prevent the estimated money from the IMF, US and European Union (which could total as much as US$20bn) in effect going to repay bonds, many of which are owned by Russian banks, which might face sanctions, or Russia itself. “The IMF is truly conflicted on what it might do,” said the first adviser.

Crimea compensation?

Ukraine itself also faces a dilemma about how to seek compensation for the loss of Crimea and the port of Sevastopol, which had been leased to Russia until 2042 in return for discounted gas and relief from Paris Club liabilities owed to its Eastern neighbour, amounting in all to US$3.75bn annually.

Suggestions have ranged from deeming a US$3bn Eurobond issued to Russia last December “odious” – as happened a decade ago with regards to Iraq’s bonds issued by Saddam Hussein – to transferring a portion of Kiev’s debt to Crimea, or calling a moratorium on debts owed by Ukraine to Gazprom.

“The Ukrainians can do anything they want but this is not a legal argument. If they sue or stop paying on a debt then the Russians can simply stop supplying gas,” said the second adviser. A Ukrainian government official in any case ruled out defaulting on selective bonds earlier in the week.

“If no payment is made on these bonds, then Ukraine is in default. That might trigger cross-default clauses and other bonds could accelerate. Also the bonds issued to Russia are not bilateral loans and could be traded,” said Carter Brod, partner at law firm Morgan Lewis.

The improving weather gives Ukraine some leverage, though, as Russian threats to disrupt energy supplies during the summer carry less weight, said Tim Ash, an analyst at Standard Bank. “Any impact of this on Ukraine will likely be limited by the close proximity of the end of the heating season.”

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