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- Since April 2023, when the 4-year EFF program worth $15.6 billion started, Ukraine has received a total of $4.6 billion in three tranches in 2023 and $3.1 billion in two tranches this year.
- By the end of 2024, two more tranches of $1.1 billion each are expected.
- They are to be received after program reviews in September and December, provided Ukraine continues to meet all conditions. According to the memorandum, the IMF loan funds were and will be directed to the needs of the state budget.
Two new conditions from the IMF
Ukraine has effectively been demonstrating compliance with all the program conditions for the second year, despite the military situation. The IMF noted that all quantitative performance criteria and structural benchmarks have been met.
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Ukraine’s Debt Restructuring Negotiations
by Olena Hrazhdan | July 5, 2024, 8:35 am
Ukraine is a month away from its deadline to negotiate a new agreement with Eurobond holders. The standstill finishes during the first half of August, following two years of an agreed absence of payments.
Ukraine informed its creditors that it would be unable to pay following Russia’s full-scale invasion in February 2022, requesting new conditions of payments. For almost four months, Ukraine has been preparing for these negotiations, and for the last two years, the Ministry of Finance has been keeping in touch with its creditors.
The Ukrainian government took part in debt restructuring negotiations with Eurobond holders over a period of 12 days between June 3-14. News emanating from the first round of negotiations brought little hope, with the government failing to reach a compromise. Bondholders did not agree with a nominal cut of up to 60 percent, proposed by Ukraine's Ministry of Finance.
The government has little room to offer more to bondholders, otherwise International Monetary Fund (IMF) debt sustainability targets risk not being reached.
The Economist wrote an article that Ukraine might find itself in default if negotiations do not end with an agreement.
But even in the case of default, Ukraine will continue negotiating. It is pressed between agreements with the IMF on one side, and its own will to regain access to markets in the future.
Here are five important things to help explain Ukraine’s debt restructuring negotiations.
OTHER TOPICS OF INTEREST
No Intention of New Tariffs on Eggs And Sugar - Ukraine’s EU Integration Minister
Ukraine’s government did not confirm the EU’s intention to impose new tariffs on eggs and sugar imports to the European Union, stating the information spread by the Financial Times was false.Ukraine is not seeking restructuring because of ineffective policy – the country has spent all its pre-war budget due to Russia’s invasion.
A month ago, Ghana agreed a sovereign debt restructuring deal, emerging from a default declared in January 2023. Its economy was dealt a blow when inflation reached double digits and prices on oil – one of Ghana’s key exports – fell.
Before the COVID-19 pandemic, Ghana had a budget deficit of 7.5 percent of GDP. That doubled to 15.3 percent. The cause was high expenditure and low state incomes, Oleksandr Parashchii, head of research at Concorde Capital, told Kyiv Post.
“They have increased debt rapidly: 61 percent of GDP in 2019, 80 percent in 2021, 93 percent in 2022. The same is true for interest payments”, Parashchii said.
Between 2020 and 2021, Ghana spent half of the country’s revenues on interest payments. “They had a painful debt restructuring of both internal and external debt, the latter also undertaken with IMF assistance. Deal broken and no panic,” Parashchii added.
But Ukraine has different reasons for its increasing debt – Russia’s unprovoked full-scale invasion of the country.
Prior to that, Ukraine’s president signed a planned 2021 state budget expenditure of Hr. 1.3 trillion ($46 billion). Ukraine’s planned expenditure for 2024 more than doubled and reached Hr. 3.3 trillion ($914 billion).
Defense expenditure has increased from 5 percent of GDP to 22 percent of GDP. For 2024, Ukraine plans to spend more than the whole civilian 2021 budget – Hr. 1.7 trillion ($47 billion).
But that’s not the end of the story. The Ministry of Finance will now seek sources to pay an extra Hr. 500 billion ($12.5 billion) of war expenditure in 2024.
Due to a half-a-year delay of $60 billion in military and financial aid from the US, Ukraine had to purchase weapons the country expected to get for free.
This resulted in reallocating expenditure planned for the second half of 2024 to the beginning of the year. The West does not allow financial aid to be spent for military purposes, so Ukraine relies on its own wallet to buy weapons and ammunition.
Now the situation is such that money for the remainder of 2024 must be found – Ukraine is planning to raise a number of taxes this year, but specific estimates are not public at the time of writing.Ukraine is one or two steps away from a default rating, but the country has been there before and successfully bounced back.
Ukraine’s internal money is spent mostly on the war with Russia, meaning a standstill with creditors has been a necessary action to readdress financial resources. The war has turned out to be prolonged, exhausting, and costly.
Standard & Poor's Global Ratings downgraded Ukraine’s Foreign Currency LT credit rating to "CC" with a negative outlook in March 2024. In June 2024, Fitch Group affirmed Ukraine's Long-Term Foreign Currency Issuer Default Rating at 'CC', Moody’s – Ca with a negative outlook.
All three ratings are one or two steps below default credit rating scores.
One scenario that could lead to a default rating is that Ukraine’s borrowing position reaches a point that private creditors are not willing to provide the country with lending.
The lending deals Ukraine has been signing since 2022 have been with international financial institutions, since private lenders see no meaningful return from Ukraine during wartime.
“The Economist thinks we will get out of this state only after Russia’s full-scale invasion is over. But we may get out of it earlier when the war cools down. This already happened [between] 2014-2022”, Parashchii wrote in a Facebook post.
Indeed, after previous debt restructuring in 2015, Ukraine’s credit rating was upgraded to S&P’s “B” and Moody’s’ “Caa1”.
In 2017, Ukraine issued Eurobonds for the first time after 2015 debt restructuring negotiations ended. The country reached stability following the turmoil of Euromaidan and the start of Russia’s invasion of the Donbas region through its proxies.
Back then, Ukraine wanted to regain access to Western capital markets. And it did, issuing Eurobonds between 2018 and 2021. Now the Ministry of Finance is intending to repeat history.Ukraine is willing to repay the interest – it is crucial to leave room for return in the capital markets.
Ukraine understands its financial liabilities. “We remain fully committed to continuing our constructive engagements to resolve the outstanding differences,” Sergii Marchenko, Ukraine’s finance minister, said in a press release.
In the government’s proposal, Ukraine is still committed to paying interest of one percent in the second quarter of 2024 and throughout 2025; three percent during 2026-2027; and six percent from 2028 to maturity.
This did not coincide with what bondholders wanted – a 7.75 percent cash coupon and 0.5 percent as paid-in-kind (PIK) over the 2024-2027 period.
The final decision will come after a new round of negotiations.It is organic for creditors to want profit, but no one chose the full-scale invasion scenario.
Ukraine and the West wanted to win against Russia fast. But Russia learned how to evade EU sanctions through third countries, a shadow fleet, and cooperation with China, leaving enough cashflow for its war.
Ukraine will not give up fighting since it has already witnessed the effects of being under Russia’s control, during the times of the Russian empire and the Soviet Union. Both eras ended with Ukraine’s economic stagnation, repression, banning of Ukrainian culture and language, as well as the death of the country’s aristocracy.
This is the reason why Ukrainians do not want to give in to Russia even after two and a half years of an exhausting war.Default in any country does not automatically mean an economic crisis.
A default rating will inevitably be imposed upon Ukraine since it happens every time Ukraine renegotiates new debt servicing terms with creditors. This is a judicial procedure.
Credit rating agencies usually downgrade debt securities to “restricted default” or “selective default” in this situation.
The word “default” might spark anxiety among Ukrainians. It wakes up an old trauma of a 1998 crisis in Russia. At the time, oil prices plunged to $10 per barrel, and Russian Eurobonds became extremely expensive – the country had to pay a 200 percent interest rate.
“The government did not want to borrow at 200 percent, so it decided to go into default. International creditors saw the situation but did not want to lend either. The ruble had to be depreciated. Their central bank reserves were less than $15 billion and the ruble plummeted.
As a point of comparison, Ukraine now has $39 billion central bank reserves”, Parashchii told Kyiv Post.
Ukraine now has the resources to keep the dollar-hryvnia rate at a decent level. It does not rely on private creditor financing since it is now financed directly from other countries and International financial institutions “on preferential terms”, Parashchii said.“Besides, Ukraine’s interest rates on government bonds are significantly lower than 200 percent so we do not have a government bond pyramid,” he added.
Ukraine reaches agreement with IMF on gas procurement, postal bank, customs reform
Photo: New conditions appeared in IMF-Ukraine memorandum (Getty Images)The IMF conducted the fourth review of the EFF program, allowing Ukraine to receive the fifth loan tranche. For the first time in the history of cooperation with the fund, the Ukrainian authorities have come this far. RBC-Ukraine investigated the conditions for Ukraine in the new edition of the memorandum of cooperation with the IMF.
Contents
Ukraine successfully passed the fourth review of the EFF loan program, which enabled it to receive the fifth tranche of financial support from the IMF worth $2.2 billion. The funds have already been received by Ukraine and will be directed to finance the state budget.
- Since April 2023, when the 4-year EFF program worth $15.6 billion started,
- Ukraine has received a total of $4.6 billion in three tranches in 2023 and $3.1 billion in two tranches this year.
- By the end of 2024, two more tranches of $1.1 billion each are expected.
- They are to be received after program reviews in September and December, provided Ukraine continues to meet all conditions.
- According to the memorandum, the IMF loan funds were and will be directed to the needs of the state budget.
Ukraine has effectively been demonstrating compliance with all the program conditions for the second year, despite the military situation. The IMF noted that all quantitative performance criteria and structural benchmarks have been met. The Ukrainian economy remains stable, but determining prospects is quite difficult.
- Given this uncertainty, the list of conditions for the continuation of the program is formed for a relatively short term.
- For example, currently, the conditions are defined only until the end of 2024.
- By the end of October, Ukraine will need to adopt changes to the Customs Code, specifically to establish new rules for selecting the head of the State Customs Service and to provide for the re-certification of personnel.
- Also by the end of October, the so-called "Lozovyi's amendments" (amendments to the Criminal Procedure Code of Ukraine regarding the terms for pre-trial investigation - Ed.) that allow closing criminal cases for corruption offenses after the expiration of the pre-trial investigation period must be repealed.
Not just benchmarks: What's new in the memorandum
- In the new edition of the memorandum, it is effectively confirmed that the situation with energy supply in winter may be difficult.
- It will take 12-15 months to establish additional generation through gas turbines, and this is considered a medium-term solution to the problem.
- An increase in generation through biofuel, solar, or wind energy is also planned in the medium term.
"If Naftogaz faces a liquidity shortfall, we will assess the amount of PSO compensation in 2024 based on actual documentary proven expenditures," the memorandum says.
The memorandum also eases the conditions for providing banking services to the population. While the March edition of the memorandum effectively prohibited the creation of a new bank for Ukrposhta (national postal operator - Ed.), it is now agreed to approach solving the problems of vulnerable categories of financial services consumers inclusively.
"The authorities have committed to encouraging financial institutions to do more to meet the needs of vulnerable clients and to reintegrate de-occupied territories, and preparing by end-July 2024 a legislative draft proposal for a new specialized and restricted banking license which aims to quickly tackle growing financial inclusion challenges by leveraging on existing infrastructure such as the postal network," the memorandum states.
Several sources in the banking sector confirmed that it is about Ukrposhta, which will be granted a limited banking license. "It is expected that Ukrposhta will be able to provide a certain list of banking services," one of the RBC-Ukraine's sources said.
It is not yet known what services and territories this license will cover. The head of Ukrposhta, Ihor Smilianskyi, and the National Bank (NBU) have so far refrained from comments. According to the memorandum, the new special bank will participate in the deposit insurance system but will be limited in credit and financing operations.
The memorandum also names the state banks that are planned to be privatized. "We are also preparing two systemic state-owned banks for sale, Sense Bank and Ukrgasbank. We are planning to appoint an internationally recognized financial advisor by end-September 2024 using a transparent procedure and in consultation with IFIs," the document says.
The Government of Ukraine promises the IMF that the issue of restructuring external commercial debt of almost $20 billion will be resolved in the coming months. "Our goal remains to reach agreement on a debt restructuring with our international bondholders and other participating commercial creditors by the time the current standstill ends in August 2024," the memorandum states. According to Ukraine's Finance Minister Serhii Marchenko, the agreement is planned to be reached by August 1.
Negative scenario
The risks of negative developments in Ukraine remain high, according to the IMF. They are associated with the intensity and duration of military actions. "Security risks could persist for longer than expected, putting pressures on our fiscal position, and leading to the emergence of additional budget needs," the document notes.
A prolonged and intense war will negatively impact business and household sentiments, as well as exchange and inflation expectations, slow down migrant return rates, and exacerbate labor market disparities.
"Export transit routes could be significantly interrupted, there could be further damage to energy infrastructure, or past supply chain disruptions (imports and transit cargo blockages - Ed.) could resurface, weighing on production costs and firm profitability," the document states.
- If these risks materialize, delays in external financing from the US and EU may reoccur.
- As a result, allocated funds may simply not be sufficient. "Moreover, in the event of such risks materializing, the needed higher domestic financing may become difficult to mobilize," the memorandum emphasizes.
A negative scenario could lead to a GDP decline of up to 4% this year, compared to expected growth of 3-4% in the basic scenario. The country's financial needs could increase by $19 billion. It may be necessary to return to a fixed exchange rate and increase revenues from personal income tax, as well as luxury goods or excise taxes.
However, for now, according to Oleksandr Paraschii, head of research at IC Concorde Capital, it is advisable to focus on the basic scenario. Moreover, some indicators suggest reality looks even better than forecasted. For instance, while the IMF has slightly worsened its economic growth expectations - from 3.2% in March to 2.5% now - Ukraine's GDP grew by 6.5% in the first quarter, whereas the IMF had forecasted 3.8%.
"I think the deterioration of the Ukrainian economic growth forecast is largely due to the IMF's desire to facilitate the completion of negotiations with creditors on the Ministry of Finance's terms regarding the restructuring of external commercial debt," Paraschii commented.
If the situation develops according to the basic scenario, there should be no particular concerns about budget financing shortages. The IMF's conditions by the end of the year appear quite achievable. This essentially guarantees the inflow of funds from the fund.
Additionally, the successful implementation of the IMF program reduces concerns among other donors, including the US, EU, and countries from other regions that provide financial support to Ukraine on a bilateral basis.
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