Advocates of debt reduction for Ukraine are right
T
he economic front
When the International Monetary Fund revived its financial aid for war-torn Ukraine in February, the fund made unusually clear how much it expects Kiev's creditors to contribute to the country's rescue. About $15bn is pencilled in to be freed up in "debt operations" on some $23bn worth of sovereign bonds by the first review of the IMF programme in June. While private bondholders have formed a negotiating committee, the negotiations are not going well, according to the latest FT reports. The government accuses bondholders of not negotiating in good faith - Kiev objects in particular to some bondholders' refusal to say who they are. One, of course, is well-known: Franklin Templeton holds one-third of the debt being considered for restructuring. It and its partners resist debt reductions and have so far only accepted pushing back the dates by which the debts have to be repaid. In response, Kiev implicitly threatens unilateral default.
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Leonid Bershidsky at Bloomberg View has advised the Ukrainian finance minister to settle for an extension: "She needs breathing space more than she needs principal reduction," he writes. But in this morning's FT, Lawrence Summers writes powerfully in favour of outright haircuts. There is "a compelling case for debt reduction for Ukraine", he writes, citing both the war with Russia and the reform efforts of the Ukrainian government. His call for a debt reduction echoes one on FastFT earlier this year.
Summers is right to side with Kiev. Even on purely financial grounds, the economic collapse is enough to justify a significant restructuring: Ukraine's GDP fell by nearly 20 per cent in the year to the first quarter and inflation is soaring. The currency has plunged by more than half; the public debt-to-GDP ratio jumped from 41 to 73 per cent in 2014,according to the IMF (see page 47).
The path to a full-fledged debt restructuring is, however, extraordinarily thorny. The law professor Anna Gelpern forensically explains why: the fact that bondholders are unusually concentrated means they can easily block a deal they do not like. In particular, Russian banks have significant bond holdings and the Russian state, through its sovereign wealth fund, is the sole owner of a $3bn bond. This was issued in 2013 to tide over Viktor Yanukovich, the kleptocrat ruler ousted in the Euromaidan protests, and no doubt to keep him on a short leash: the bond matures this December. Russia could, through an unusual clause, demand accelerated payment given Kiev's high debt level.
To succeed, Ukraine's negotiators will need to use all the tricks in the book and obtain all the help they can get. For the tricks, FTAlphaville's "bonds of war" series is a required guide to the legal landscape including in particular the unusual clauses of the Russian bond and whether it counts as official or private debt. (Gelpern has also examined the Schroedinger's cat-like viewMoscow takes of its bond depending on which status looks more favourable). There is in fact quite a lot Kiev can do - if it is willing to stomach the possible lawsuits that, regardless of outcome, may be a lot costlier to it than to its creditors.
It is to minimise these costs that help is necessary. Gelpern herself made the most significant proposal in a paper last year which also gave a thorough explanation of the Russian bond. Since it is issued under UK law, Gelpern argues, the UK could through an Act of Parliament make this specific bond unenforceable in UK courts leaving Moscow (or any buyers of the bond) with a "right without a remedy". Interestingly, there are precedents in the cases of the Heavily Indebted Poor Countries Initiative and of Iraq.
Since the non-enforceability would clearly be an expression of UK policy towards Russia's aggression, and since it would be restricted to just this bond, such a "debt sanction" need not harm Kiev's reputation in private bond markets generally. It would leave Kiev in a stronger bargaining position vis-a-vis Moscow, but also vis-a-vis other creditors since the most immediate bond redemption would no longer be enforceable. It would also make it less costly to dispute any arrears on non-payment, which would give the IMF political cover to continue lending to Ukraine. All told it would help achieve what Gelpern argues for elsewhere: "Ukraine, its donors and the IMF should not allow generalised fear of lawsuits to drive restructuring strategy." The new UK government should listen and do the right thing.
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