Payback time! Is Ukraine ready to pay back the bulk of its external debts?
What kind of situation is Ukraine facing as time comes to pay back the bulk of its external debts?
It must be some kind of national hangover. Sometimes Ukrainians call it “resolving problems as they emerge.” Sometimes we boast about our ability to live one day at a time, hiding behind the Biblical phrase, “Every day brings its own troubles.” But if we look carefully, this is nothing more than abstracted shortsightedness. Maybe it’s a normal trait that is often manifested in the life of an individual, but for a nation and its elite, it is clearly not. When the political class is unable to recognize large-scale problems and challenges in advance and to prepare to deal with them ahead of time, the country lives from emergency to emergency, from one crisis to the next. And it looks like that’s what’s happening in Ukraine.
One such issue is debt, especially the country’s foreign debt. Over 2014-2016, Ukraine needed enormous injections of cash to pay off its international bonds. Financing from international donors allowed the country to fill in the financial gaps. But the debt itself has not gone away: mostly Ukraine only got more credits that also have to be repaid. When they were issued, it seemed like paying them back was so many years away... But those years have passed very quickly and now barely two years remain to the peak of debt servicing that faces Ukraine. High time to recognize the challenge, otherwise, the same year that the country goes to the polls twice, 2019, this will threaten not just those in power, but the entire country’s further development.
CASH CRUNCH LOOMING
The first challenge: Will Ukraine have enough money to return most of its debts before 2019? This year, 2017, it has to start returning its IMF credits, which will not get in the way of receiving the next tranche, and in 2018 payments to the Fund will peak at US $1.5 billion—leaving out any other sums that the IMF might also give out. In 2019, Ukraine has to start paying out its eurobonds, which were issued as part of a restructuring of its debts two years ago. This will cost US $3.8bn (see Billions to pay out). This means that Ukraine needs in the neighborhood of US $8.9bn over 2017-2019 to pay off its foreign debts. If we add to this the “Yanukovych loan” that Ukraine is likely to also have to pay off sooner or later, given how the lawsuit is going right now, the total amount will be almost US $12bn.
Does Ukraine have this kind of money? Last year’s reserves grew by US $2.0bn, one billion of which came from the IMF, another from a eurobond issue that was guaranteed by the US, and US $2bn more came from other donors like the World Bank and the EBRD. Without these injections, either Ukraine’s reserves would have shrunk by US $1.8bn or the devaluation of the hryvnia would have been more noticeable. In 2015, the country’s reserves would have shrunk to almost nothing without external financing. So far, the country remains in the black this year, but trends are likely to change in the second half of 2017. This means that the NBU’s reserves are only growing thanks to the fact that Ukraine regularly gets injections of cash from its donors. If this support disappears, the reserves will begin to decline, and Ukrainians know very well from 2014-2015 what happens on the currency market when your country’s reserves begin to disappear. In short, Ukraine does not have enough of its own cash to quietly pay off its debts before the 2019 election season. The US $18bn in reserves that it had at the end of June 2017 are not enough for a payout of US $12bn not to be felt on domestic money markets and among foreign investors over 2017-2019, and not to have a negative overall impact.
Initially, plans were for the IMF to give Ukraine 12 tranches by the end of this year and the country would use US $15bn of the planned US $17.5bn. Unfortunately, the actual credit so far is about a third of this and state accounts should have had about US $6.5bn more. So Ukraine is considerably off the mark at this point. The reason is simple: the government’s inability to carry out reforms at the necessary pace, which would have enabled the country to reach the structural benchmarks in the IMF Extended Fund Facility (EFF), undergo the necessary number of revisions, and, as a result, receive the planned amount of credits in full. After all, every time the country needs to carry out some significant change, the media is suddenly full of scandalous announcements and opponents of reform drag things out and to set up impossible hurdles to implementing those changes. Judging by the number of tranches the IMF has released so far, Ukraine is taking three times longer than it should. In effect, although it’s not standing in place, which is already
good, but it’s moving at a snail’s pace. What’s bad is that the country’s leadership represents the biggest threat of a disruption in financing.
CAUSES AND CONSEQUENCES
If Ukraine fails to get further money from the IMF, the consequences will be an even worse cash shortfall. Firstly, other international financing will also to on hold. At the beginning of 2015, the IMF forecast was that other donors would provide Ukraine with US $12.6bn over 2015-2017. This money was indeed ready and waiting for the country, but in order for it to be released, Ukraine had to move ahead in the stages of the EFF program. In fact, the country received only US $5.0bn in the first two years, and at most another US $2.6bn this year: a shortfall of at least US $5.0bn that should have gone into Government and NBU accounts by the end of 2017. The reasons are the same: not implementing enough reforms and not properly meeting IMF conditions.
Secondly, more than two years ago, plans were for Ukraine to already enter the international lending market by 2017. The IMF had included in its forecasts that Ukraine would be in a position to borrow one billion dollars this year, and two each in 2018 and 2019. Had it undertaken reforms in a systematic way starting in 2015, this might have been the case, as most of the transformation processes would have already been set in motion and a few even completed. Investors would have no doubts then that the country was changing and had passed the point of no return, even if the war in Donbas was still going strong.
In fact, what does Ukraine have to show today? Economic recovery began too late and too slowly, the pace of reforms is painfully slow, with a significant proportion not even begun, and the obstacles placed in the way of the reformers so huge that there are doubts that Ukraine will be able to bring this process to its logical conclusion. Instead, the country could end up with a huge political reaction, a change of government and a 180-degree shift in its overall direction. Under such circumstances, investors will think twice about whether to lend Ukraine money if it looks like its economy will lack the resources to return it while those who come to power politically might decide they don’t want to return that money but will ask for any debts to be restructured substantially. In effect, Ukraine’s reputation as a borrower will remain questionable until at least the 2019 elections, when it becomes clear what direction the country will be going in for the next five years and how it will overcome the disruption in financing that is looming. Until that time, the chances of Ukraine attracting significant volumes of foreign capital on global lending markets will remain marginal.
And so it comes out that the country has already suffered from the shortsightedness of its government, which should have been conscientiously and methodically carrying out reforms and moving Ukraine well along the path of transformation prior to the next election cycle, getting money from donors, the support of voters and growing ratings. This was the best-cased scenario. Instead, those in power got mired in unnecessary media squabbles. The result has been the loss of nearly US $12bn in possible credits that would have been very useful prior to the next election cycle. Another US $10bn is at real risk over the next two years. Without this, the country’s financial state will be significantly worse and Ukrainians will likely face yet another economic crisis. What is most frustrating is how many politicians keep babbling that Ukraine will do just fine without IMF funds and so it needn’t worry about fulfilling the conditions of the EFF program. But when net reserves, that is reserves less the NBU’s external bonds, amount to only around US $5bn, this kind of attitude is either completely stupid or deliberately intended to undermine Ukraine. Neither one has ever led to a good outcome.
OPTIONS? WHAT OPTIONS?
The second challenge is whether other sources of financing can be found to cover this shortfall? Theoretically, yes. If the need is spread over three years, then Ukraine needs an average of about US $4bn a year. Earlier, it was easy enough to get that kind of money (see Dried up sources). Prior to the Euromaidan, FDI was bringing the country more than this much every year and so were foreign corporate credits. Significant sums were also coming in from eurobonds. But the situation is completely different now. Ukraine will have to spend US $8.9bn to service its external debt over 2017-2019. If the Yanukovych loan is added to this, based on the way the lawsuit is going in the courts, this amount will rise to nearly US $12bn.
At the time when the Revolution started, capital inflows from Cyprus at 33%, Holland at 17% and Russia at 6.6% dominated FDI. The first two are known legal offshore zones, through which capital earned in Ukraine and moved offshore, legally or otherwise, was returned. The crisis has put a serious cramp on the incomes of Ukrainian capitalists because of the crisis, the war, and a certain curtailing of opportunities for corrupt enrichment. As a consequence, the volume of FDI from Cyprus and Holland has fallen 45% and 36% in the last three years. The third country is hostile Russia. Investments during this period grew 23%, but only because Russians were forced to capitalize their banks further in order to meet NBU requirements and not lose their businesses altogether. If this factor is taken out, Russian investments in Ukraine also shrank substantially. In short, it turns out that the model that allowed the country to attract billions
in foreign investment prior to the crisis no longer works. It presupposed that homegrown oligarchs and Russians would invest in Ukraine because they had excess capital and saw the country as their own territory, protected from global competition and outside political influence. Now Ukraine has opened up, moreover on such conditions that Russian capital is tacitly a completely unwanted guest, while domestic oligarchic capital is suffering because the country is at war with its tycoons and many sources of easy enrichment have been cut off in an effort to make the playing field level for all businesses and remove the political factor and other non-market factors in competitiveness.
Since this model no longer works, the inflow of foreign investment that it drew will become marginal. The country will have to compete for global financial resources on the same basis as everyone else. To win in this competition, the business climate needs to be improved, which means reforms need to be carried out. But that does not seem to be going too well at this time, so it’s clear that Ukraine cannot expect to see much in the way of FDI in the next few years.
This is equally true for corporate borrowings. Prior to the 2008-2009 crisis, Ukrainian banks were able to borrow billions of dollars on global markets. Afterwards, most financial institutions paid off their accumulated loans by handing the baton of borrowing off to non-financial corporations. It seemed, at the time, that Ukraine’s big business was liquid and promising enough, and therefore capable of borrowing billions of dollars a year abroad. After the Euromaidan, however, these prospects vanished in the haze. For one thing, the war, the deep economic crisis and the decline in global commodity prices worsened the financial position of Ukrainian corporations, most of which were forced to restructure their debt portfolios.
What no one seems to have anticipated was that this would go on for so long: foreign lending markets have been closed to Ukrainian business for three years now. Only in 2017 were two heavyweights, Kernel and Myronivka Grain Products, able to issue eurobonds and draw US $500 million each. Today, there are few corporations in Ukraine in a good financial position, as well as public and transparent enough for foreign investors to want to trust them with a loan. And those companies that have all the necessary qualifications neither need capital nor intend to borrow it. In short, a few companies might place eurobonds in the next while, but there’s no reason to expect that they will bring in billions annually prior to 2019.
Ukraine could try to find the necessary resources internally. It’s not about the billions that Yanukovych & Co. Embezzled. The bulk of that money is far beyond the borders of Ukraine although once in a while there’s a pleasant surprise, such as the US $1.4bn confiscated in favor of the budget a few months ago, or the Odesa Petroleum Processing Plant, which the government took over not long ago. Such bonuses are too unpredictable and irregular for the state to build policy on that basis, no matter what the direction and they should also not be counted on.
What might work is to engage capital on the domestic financial market. Analysis suggests that its capacities are overly limited (see Foreshortened internal options). In the last few years, of all the government bonds issued, the financial market picked up only about 2% of GDP per year and the NBU was forced to buy up the rest. 2016 was the only exception, as most government bonds went to bail out PrivatBank, and went to its bottom line. Moreover, the majority of domestic government bonds are denominated in hryvnia, whereas foreign debts need to be paid off in hard currencies. Indeed, the country needs such currency to the tune of 4-5% of GDP. Theoretically, half of this sum could be found on the domestic market, and print money to cover the other half. But then Ukrainians have to be prepared for fairly steep, chronic devaluation and inflation, which, given the tendency for Ukrainians to panic, could take on a supersonic pace. As to serious investment, it will have to be forgotten for a few years and, along with it, so will economic growth. Is this what Ukraine needs? Probably not.
Some are also talking about real domestic resources such as state enterprises and land, especially state and community land, as a factor in attracting capital to Ukraine. Privatization needs to go forward, but now for the sake of money but to ensure that those companies are run properly. The land market is needed, but, again, not for the sake of money but to provide a solid foundation for agriculture to develop properly. And this means that the use of all these resources needs to be done on a monetized, market basis. However, the capital inflows from the sale of real property needs to be removed from current needs for financing or other tactical matters. Otherwise, the slogan “We sold the country for pennies” will be very close to the reality. So there is no point in expecting a specific sum from the sale of strategic assets to cover a specific financial gap, because this could prove to be against the national interest.
So what it comes down to is that today, Ukraine has no real or acceptable alternative for financing other than foreign donors. The country is in a situation where it must “go for broke.” Either Ukrainians carry out reforms and get both the money and a much better internal situation and prospects for the economy to grow, or they don’t do anything, they don’t get the money and they gird their loins for the next crisis, which will risk bringing radically different people to power and a radical shift in Ukraine’s direction. There are countries that have gone through this very kind of crisis, but their experience shows that, other than lost time—usually 5-20 years—nothing was gained.