Putin Bailout Haunts Ukraine With Early Repayment Clause

By Krystof Chamonikolas, Natasha Doff and Volodymyr Verbyany  

Photographer: Vincent Mundy/Bloomberg

Residential housing blocks stand beside a highway on the city skyline in Kiev. Ukraine... Read More

The risk that Russia will seek early repayment of a $3 billion bond is adding to pressure on Ukraine as it races to secure more International Monetary Fund loans.
Russia has the right to call the Eurobond, bought a year ago to avert a default, if Ukraine’s public debt tops 60 percent of gross domestic product. The ratio may jump to 70 percent by Dec. 31, Moody’s Investors Service said Oct. 30.
While Russian President Vladimir Putin said last month he won’t use the redemption clause on the notes, part of a bailout package signed with deposed President Viktor Yanukovych, there’s no guarantee he won’t change his mind, said Paul McNamara at GAM UK Ltd. That could weigh on Ukrainian finances, strained by a war against pro-Russian separatists, political wrangling after October elections and uncertainty about further IMF aid.
“I wouldn’t rely on Russian officials’ statements about the
bail bond,” McNamara said Dec. 3 by phone from London. “There’s a real prospect of a standoff between Russia and the IMF, which will find it hard to justify to the western countries the covering of an early repayment.”
Ukraine’s bonds lost 9.3 percent this quarter through yesterday, the most after Venezuela among 58 nations in the Bloomberg USD Emerging Market Sovereign Bond Index. (BEMS) The benchmark note due July 2017 fell 13 cents on the dollar in the period, touching a record-low 73.5 cents on Dec. 3. It traded at 74.3 cents by 10:13 a.m. in Kiev, yielding 22.8 percent.

IMF Requirements

The new government of Premier Arseniy Yatsenyuk, approved by lawmakers this week, needs to adopt a 2015 budget and tax laws complying with IMF requirements to qualify for the next $2.8 billion disbursement. Ukraine needs the cash, part of a $17 billion loan program, to repay other debt, buy heating fuel for winter and stem the hryvnia’s 46 percent slump this year.
Russia, which annexed Ukraine’s Crimea peninsula in March, has repeatedly denied accusations by NATO and the European Union that it’s supporting the insurgency across the border, which has killed more than 4,300 people and displaced 500,000.
The government in Moscow will determine whether Ukraine has crossed the 60 percent debt threshold based on IMF estimates expected early next year, Russian Finance Ministry official Andrey Bokarev said Nov. 27. The ministry didn’t immediately reply to an e-mail seeking comment yesterday.

‘Whole Amount’

The earliest Russia can try to call the bonds is after the ministry publishes preliminary 2014 GDP data in March, Halyna Pakhachuk, head of the Ukrainian Finance Ministry’s debt department, said yesterday. The government in Kiev has the right to wait with the payment until December 2015, when final GDP data is to be released, she said in a phone interview.
“Our 2015 budget will envisage the whole amount needed for the repayment,” Pakhachuk said.
Russia probably won’t call the bond early, according to Regis Chatellier, a London-based director of emerging-market credit strategy at Societe Generale SA, and Lutz Roehmeyer, a money-manager at LBB Invest in Berlin.
“Putin does not want to be seen as the one who triggered a default,” Chatellier said Dec. 3 by e-mail. SocGen has an underweight stance on Ukrainian debt. “The pressure on Ukraine would come very soon anyway as the bond matures next December.”

Towel ‘Thrown’

While Ukraine will probably avoid default, it will seek to re-negotiate debt terms in 2016 or 2017 to prolong maturities by three to five years, LBB’s Roehmeyer said Dec. 1 by phone. Current bond prices are already reflecting such a scenario, according to the money manager, who oversees $1.1 billion of debt from emerging markets including Ukraine.
“Investors are really fed up and most have thrown in the towel,” he said. “Everyone is realizing how far away from each other both sides are and that Russia keeps sending troops.”
Without more IMF payouts, Ukraine can’t stop the hryvnia depreciation that’s stoking bad loans and boosting the future costs of rescuing ailing banks, according to Marco Ruijer, who helps oversee $7.5 billion of emerging-market debt at ING Investment Management in The Hague.
“If the government implements reforms then the IMF will be willing to give them the benefit of the doubt and save them,” he said Dec. 1 by phone. “Russia could move forward the payment. It is a risk, but not one of my main risks.”
Should Russia call the bond, and if Ukraine is unable or unwilling to repay early, this could trigger a restructuring affecting other debt, according to Timothy Ash, London-based chief emerging-markets economist at Standard Bank Group Ltd. Potential losses for Russia on the $3 billion bond may not be a concern for Putin, Ash said Dec. 2 by e-mail.
“This is small change for Russia in the bigger scheme of things, and given its ambitions in Ukraine,” Ash wrote. “You have to ask why it included the debt-to-GDP trigger in the documentation anyway.”