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?

The Ukrainian Week - - CONTENTS - Lyubomyr Shava­lyuk

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.

IN­NER RE­SOURCES

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.

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