Ukraine's debt deal is a draw

The Pak Banker - - OPINION - Leonid Ber­shid­sky

The debt restruc­tur­ing that Ukraine has agreed with its pri­vate cred­i­tors has all the hall­marks of a win­win: The gov­ern­ment can boast of per­suad­ing in­vestors to ac­cept a hair­cut, while the cred­i­tors can con­grat­u­late them­selves on los­ing prac­ti­cally noth­ing in re­al­ity.

Yet the five-month ne­go­ti­a­tions -- the equiv­a­lent of a hard night out clubbing that ends with a chaste kiss -- will do lit­tle for Ukraine. In­deed, the out­come doesn't even meet the In­ter­na­tional Mon­e­tary Fund's de­mand that Ukraine should save $15.3 bil­lion on its debt costs. The deal reached on Thurs­day shaves 20 per­cent, or $3.6 bil­lion, off the face value of $18 bil­lion in gov­ern­ment debt.

If the same terms are agreed for some gov­ern­ment guar­an­tees and for Kiev mu­nic­i­pal bonds, the write-off amount will rise to $3.8 bil­lion. All prin­ci­pal re­pay­ments are de­ferred by four years, from 2015-2023 to 2019-2027, and the coupon rates on all bonds will be re­set to 7.75 per­cent from the cur­rent av­er­age of 7.22 per­cent. Ukraine's cred­i­tors will also get growth-linked war­rants that will re­ward them if the Ukrainian econ­omy ex­pands at least as fast as the IMF projects.

For the cred­i­tors, that's more or less a wash. In present value terms, the new deal guar­an­tees them roughly the same pay­back as the orig­i­nal. For ex­am­ple, us­ing a 5 per­cent dis­count rate (es­sen­tially, the op­por­tu­nity cost of not in­vest­ing money else­where), the fu­ture cash flows on $1 bil­lion of the $2.6 bil­lion bond ma­tur­ing in July 2017 are cur­rently worth $1.085 bil­lion; af­ter the deal they will be worth $1.007 bil­lion. That's an in­signif­i­cant re­duc­tion. It's sim­i­lar with longer-term bonds. If all the cred­i­tors' present-value losses are added up, they will amount to about half a bil­lion dol­lars. That's a pretty good out­come for a bet on Ukrainian bonds that the cred­i­tors got badly wrong.

Ukraine is ask­ing Rus­sia to ac­cept the same terms on the $3 bil­lion bond it holds, which comes due for re­pay­ment in De­cem­ber. From a fi­nan­cial point of view, Rus­sia would lose noth­ing if it ac­cepted: The cash flow through 2019 would be worth a lit­tle more than the ex­pected prin­ci­pal re­pay­ment. Rus­sian Fi­nance Min­is­ter An­ton Silu­anov, how­ever, has al­ready re­fused to re­struc­ture, show­ing yet again that for Rus­sia, the mat­ter is po­lit­i­cal. Silu­anov's at­ti­tude might also sig­nal dis­be­lief that Ukraine would ac­tu­ally pay in 2019; the debt agree­ment does lit­tle to help Ukraine ful­fill the IMF pro­gram on which its fi­nan­cial sol­vency de­pends.

The deal will, how­ever, give Ukraine some short-term re­lief. Prin­ci­pal re­pay­ments due on Ukraine's in­ter­na­tional bonds from this year through 2017 amount to $6.7 bil­lion, and will now be de­ferred. Still, even though some other forms of debt will also be de­ferred, Ukraine will not get to the $15.3 bil­lion sav­ings the IMF fac­tored into Ukraine's pro­gram. In fact, be­cause of the ma­tu­rity ex­ten­sions, Ukraine's debt ser­vice pay­ments will ac­tu­ally rise, since it will be pay­ing coupons on bonds that would oth­er­wise al­ready have been paid off.

Other parts of the IMF plan also look im­prob­a­ble now. I wrote pre­vi­ously about the overly op­ti­mistic growth fore­casts that un­der­pin the fund's math. The gov­ern­ment's readi­ness to of­fer big pay­outs to the cred­i­tors if the econ­omy does in­deed grow as fast as the IMF thinks sug­gests that it doesn't be­lieve in the fore­casts, ei­ther.

The gov­ern­ment of­fers no pay­ments if the econ­omy grows at a rate of 3 per­cent or less, but pays out on a ris­ing gra­di­ent at higher growth rates. These terms don't be­come valid un­til 2021, and only if Ukrainian gross do­mes­tic prod­uct has by then reached $125.4 bil­lion. If the gov­ern­ment re­ally be­lieved all these con­di­tions were fea­si­ble, or that it would still be around to wit­ness them, it wouldn't be of­fer­ing to give the cred­i­tors bil­lions of dol­lars in po­ten­tial bonuses.

So far, it ap­pears the IMF plan is com­ing apart at the seams -- with some help from the fund it­self. It is now push­ing tax changes that close an im­por­tant tax loop­hole used by the coun­try's lu­cra­tive soft­ware de­vel­op­ment in­dus­try and other white-col­lar busi­nesses, but with­out low­er­ing tax rates. That will cre­ate no in­cen­tive for com­pa­nies and their em­ploy­ees to re­port in­come, which means that Ukraine's huge shadow sec­tor is un­likely to start feed­ing growth. At the same time, cor­rup­tion re­mains wide­spread, de­spite os­ten­si­ble ef­forts to com­bat it.

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