Ukraine has struck a deal with bondholders that reduces its commercial debt, the country’s finance minister said Thursday, though the politically sensitive issue of whether $3 billion in Russian debt will be included in the haircut remains unresolved.
The debt deal is also vulnerable to a worsening of Ukraine’s already rapidly contracting economy and to any shocks caused by a resumption of war in the east of the country.
The agreement potentially reduces the $18 billion in outstanding commercial debt by 20 percent, cutting the cash-strapped country’s obligations by $3.6 billion, and keeping open its access to international credit markets. The government will not have to make interest or principal payments until 2019. Bondholders will be rewarded with warrants tied to GDP growth from 2021 to 2040.
Ukraine’s total outstanding debt comes to $72 billion.
“This agreement is a very important milestone for Ukraine,” Natalie Jaresko, Ukraine’s finance minister, said in a statement. “Ukraine gets a very immediate and a very significant debt reduction.”
The deal is also better than creditors, led by investment funds like Franklin Templeton and T. Rowe Price, and Brazil’s BTG Pactual, had initially faced. Kiev had been pushing for a 40 percent haircut.
“It’s a relatively soft landing for the bondholders,” said Otilia Dhand, vice president of Teneo Intelligence, an analysis firm.
Ukraine also preserves its relationship with the International Monetary Fund, which has already lent it $11 billion and has promised another $11 billion by 2018. As part of that lending agreement, Ukraine has to keep its debt-to-GDP ratio below 71 percent, the level it hit last year. However, Ukraine’s economy contracted by 17 percent year-on-year in the first quarter of this year and by another 14.7 percent in the second quarter.
“I am very pleased with today’s announcement,” Christine Lagarde, the IMF managing director, said in a statement. The Fund has pushed hard for a reduction in Ukraine’s debt.
If Ukraine’s economy does worse than the IMF is forecasting, or the frozen conflict in the east of the country heats up again, the country’s debt could spike higher than expected.
“The danger is that if Ukraine starts to succeed, then Russia could again intervene in the east,” said Timothy Ash, an analyst with Nomura, the investment bank.
Kiev will have to convince at least three quarters of its bondholders to agree to the deal.
Still unresolved is the fate of the $3 billion Russian loan, given to prop up the regime of former president Viktor Yanukovych before he was ousted last year. The sum is included in Jaresko’s calculations, but the Russian finance minister told Bloomberg Thursday he would not accept a debt reduction.
Moscow insists that the debt be treated as a sovereign obligation, while Kiev is treating it as a commercial debt. If the Fund agrees with the Russian view, then Ukraine would have to repay the money to retain access to IMF finance.
“For Russia, it is not about the money. It is about the political leverage it gives Russia over Ukraine,” said Dhand.
Repaying the Russians in December will cause a big political problem for Ukrainian President Petro Poroshenko at a time when his country is scrambling to scrape together enough money to buy the natural gas it needs to stay warm over the coming winter.