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Samstag, 16. August 2014

Ukraine, war, and sovereign default

Ukraine, war, and sovereign default

Ukraine claimed at pixel time to have fired on a number of Russian tanks crossing its borders.
Being invaded by Russia is not very conducive to a country’s GDP. But also, bizarre as it seems if its armour really is aflame in the Donbas, Russia is also the owner of Ukrainian sovereign debt. This has some precarious terms (for the borrower) restricting growth in debt to GDP to below 60 per cent.
Which is why it is worth noting this chart on Friday from Gabriel Sterne of Oxford Economics…
Ukraine also has a $17bn two-year programme from the IMF, as of May. Back then the IMF staff judged that the sovereign debt-to-GDP ratio would go from 45 per cent this year to 60 per cent in four years’ time (that is, after Russia’s bond matures).
But as Sterne points out, these forecasts would have gone well out of date already. One thing which we’d note, for example, is that the hryvnia has fallen to 13 against the US dollar. That’s a danger level noted by the IMF’s staff in another report:
Staff analysis suggests that an exchange rate in the UAH 10–13/US$1 range is consistent with Ukraine’s fundamentals over the medium term, with the rapid economic shifts underway accounting for the uncertainty in these estimates. Should the hryvnia trade within the UAH 10–11/US$1 range, the impact would be manageable for banks, firms, and households;balance sheets would take a stronger hit if the exchange rate settled in the UAH 12–13/US$1 range…
In other words, one threat to Ukraine’s debt — that banks will have to be bailed out of FX exposures — is growing.
That’s before factoring in the economic destruction of conflict in the east, as Sterne attempts to do (though still without fully taking into account a potential Russian invasion). But in any case the IMF programme seems to be heading markedly off the reservation.
Of course, the IMF didn’t like it when this happened in Greece in 2010, when its loans were mostly used to make payments to private bondholders. They could thus cash out of a sinking sovereign while official lenders took the exposure instead, storing up greater losses for remaining bondholders in future (and risking financial contagion). Ultimately it took one of the biggest, and most overdue, sovereign debt restructurings in history to correct the official sector’s mistakes.
The IMF has since entertained restructuring-lite options to use on dodgy sovereigns, before they get as bad as Greece. These would in theory follow set rules, though they’d more likely be ad hoc.
We wonder if Ukraine is going to be an ad hoc case, in which bondholders are ‘invited’ to accept less than full repayment (or to maintain exposure through a maturity extension) while the IMF programme is still young.
Sterne also wonders this — although there’s a catch:
The main argument against default may be that there is no bond for which – on its own — default would appear worth the triggering the costs of default. There is a huge political economy aspect to this potential default. Default costs are big and there is not much point in defaulting unless there is a clearly unaffordable amortisation payment encroaching. So in spite of the arguments for default being strong in general; the IMF would need to take a view on a bond-by-bond basis, as and when they mature. In Greece, for example, it was the March 2012 €12bn Eurobond that proved too big to pay.
Relatively few bonds are maturing this year or next. One of them is Russia’s $3bn claim. As we’ve noted with the curious debt-to-GDP clause in that bond, Russia effectively can accelerate and demand full payment any time — potentially triggering cross-default provisions in other bonds — rather than negotiate a restructuring.Update: However, this paper by Anna Gelpern for the Peterson Institute is worth reading for one way of removing the leverage Russia has here.
But if the IMF does decide not to recommend early debt restructuring (and/or to avoid antagonising Russia), the Greece syndrome may come back, as Sterne also notes:
Default-dodging is good for holders of those bonds but not for other holders of Ukrainian assets. If default is avoided in the short-term, it means holders of other assets are taking on more of the risk. The funds for paying out the maturing bonds are coming from IMF programme money. And since the IMF must always be paid back, longer term bondholders are ultimately taking on a greater share of the risk. This is because to achieve a given level of debt reduction, the proportionate haircut will eventually need to be bigger, the more the non haircuttable IMF debt is used to bail out haircuttable…
Whatever the IMF decides — Ukraine is going to be a test of whether anything has changed in sovereign debt restructuring.

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