Ukraine's Debt Restructuring: Playing on the Edge (June 19, 2015)

While the negotiations on quasi-sovereigns debts and notes have been much acclaimed by market players, the negotiations on the sovereign bonds have virtually stalled. Finalizing a restructuring deal is a condition for the disbursement of the next tranche of IMF loan, scheduled for July 2015. Nevertheless there are no signs that the parties will find any viable and mutually suitable deal toward that timetable. We see any default of the country in the current condition to be mostly preemptive and technical, aimed at prompting all parties to start negotiating a mutually acceptable solution and find a quicker way out of the stalemate. 

We believe that the most plausible scenario is for a mild debt reduction of up to 20% on the sovereign bond principal, together with a maturity extension of over 7 years and a coupon rate reduction of 1-2 pp. From this perspective, most sovereign issues would have an IRR of 12-16% if bought at current prices and held till maturity.

In our view, Ukraine's negotiating position is strong since its key international lenders (IMF, EBRD, US) will continue supporting the country even in case of a default on its public debt, which is supported by the recent statements of the IMF. This indicates a strong "political will" of the US and the EU towards helping Ukraine.

Nevertheless, we do not see any success in the restructuring negotiation to be a warrant against recurring default beyond the seven-year horizon, given the ambiguities of the economic assumptions under the EFF program and the volatility of the environment in the country. 

IMF program requires revision as underlying assumptions are overoptimistic and already out of box. The IMF has outlined the major expectations as to the country’s economic and financial development in the next 10 years. Nevertheless, the current program, in our view, has already came off track, due to a heavier impact of the conflict in Eastern Ukraine on the country’s political and economic environment. This demands a correction of the program and incentivizes the government to propose tougher restructuring terms to sovereign bondholders. 

The first target stipulated by the IMF (savings of USD 15 bn over 2015-2018) should be easily reached through an extension of maturity of sovereign Eurobonds and the Eurobonds of state-owned Ukreximbank and Oschadbank, which have already secured a preliminary agreement of their bondholders.

The second target (achieving a public debt to GDP ratio of 71% by 2020), however, imposes rather harsh restrictions on the Ukrainian government, and implies the need of haircuts applied to sovereign debt. Although this does not come directly from the IMF program, if we are to take a conservative view on the UAH exchange rate and the GDP growth, this need becomes fairly evident. As was stated in the presentation of the Ministry of Finance dated March 13, 2015, debt operations will need to account for possible shocks in the short to medium term and enable the country to meet IMF targets. 

We assume that the target of keeping budget financing needs under 10% of GDP for the period beyond the year 2019 is mostly a matter of government fiscal discipline, and thus it will mostly depend on budget planning.

 

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