Ukraine Fans Default Risk in Russia Bet as Vote Molds Policy

Ukraine’s efforts to seek cheaper natural gas from Russia rather than comply with the terms of a bailout have alarmed investors, propelling the former Soviet republic’s credit risk above Argentina’s for the first time in two years.

The government is shunning the International Monetary Fund as it struggles to agree on discounted fuel imports from Russia, with whom clashes halted European gas transit twice since 2006. That’s fanned concern over its ability to meet $11.9 billion in debt costs this year, with default risk rising more than any country Bloomberg tracks except Greece in the last six months.

While Ukraine faces a widening current-account gap, slowing economic growth and limited access to global capital markets, President Viktor Yanukovych has refused to raise household gas tariffs to restart a $15.6 billion IMF aid package as support for his ruling party ebbs before October elections.

“It’s a question of willingness to pay a political price,” Ronald Schneider, who helps manage about $1 billion in emerging-market debt at Raiffeisen Kapitalanlage GmbH in Vienna, said Jan. 31 by phone. “Skepticism for Ukraine will increase” without a resumption in IMF disbursements.

Swaps, Global Appetite

The cost of insuring Ukrainian state debt against non- payment for five years using credit-default swaps rose 254 basis points in the last six months to 780 today, according to CMA, which is owned by CME Group Inc. and compiles prices from dealers in the privately-negotiated market. That compares with 768 yesterday for Argentina, which the gauge surpassed Jan. 13.

Ukraine’s CDS price fell this month after peaking at 930 basis points on Jan. 17. A basis point is 0.01 percentage point.

“The improvement in Ukrainian debt spreads is a mere consequence of the risk rally we’re now seeing in the markets,” Luis Costa, an emerging-market strategist at Citigroup Inc. in London, said today by e-mail. “The macro story in Ukraine still points to very dangerous imbalances in the local economy.”

Economic growth may slow to 3.9 percent this year from about 5 percent in 2011, the government estimates, as the euro- region turmoil threatens its steel exports and cold weather curbs the grain harvest.

IMF Warning

Pressure on the hryvnia has intensified in recent months while dwindling trust in the authorities has halted capital inflows and investment, the IMF’s Ukraine representative, Max Alier, warned former First Deputy Prime Minister Andriy Klyuev in a Jan. 31 letter, the Kommersant-Ukraine newspaper reported Feb. 13.

The hryvnia has declined to 8.0138 per U.S. dollar from 7.9550 a year ago. Ukraine’s gold and foreign-currency reserves fell $3.3 billion to $31.8 billion in 2011 as the hryvnia weakened and its current-account deficit widened to 5.5 percent of gross domestic product from 2.2 percent.

The former Soviet state’s credit-rating outlook was cut to stable from positive at Fitch Ratings in October, while Moody’s Investors Service lowered it to negative in December, citing risks to funding, liquidity and political stability. They both rate Ukraine five levels below investment grade.

The yield on the government’s Eurobond due 2016 has jumped to 8.587 percent from 6.265 percent when it was issued last June. Foreign investors have cut hryvnia-debt holdings to 4.26 billion hryvnia ($532 million) as of yesterday from 11.26 billion hryvnia last January, central bank data show.

Bailout Frozen

Ukraine’s IMF loan, obtained in 2010, has been frozen since last March because the government won’t approve a one-third increase in consumer energy costs, a move the Washington-based fund has demanded to trim losses at state energy company NAK Naftogaz Ukrainy.

“We can’t burden the citizens,” Yanukovych, whose ruling Party of Regions has 14 percent backing before this year’s parliamentary vote, said Feb. 16 in comments published on his website.

Instead, he wants to wipe a third off his country’s gas bill by seeking a discount on its Russian imports to $250 per 1,000 cubic meters from the $416 average price assumed in this year’s budget. The bill came to about $12 billion last year.

While the two neighbors have been negotiating for months, no agreement has been reached. Ukrainian officials say Russia wants control of the transit pipelines OAO Gazprom (GAZP) uses to ship gas to Europe, a similar deal to one Belarus accepted last year.

‘Very High Price’

Ukraine is unwilling to sanction the sale and Prime Minister Mykola Azarov reiterated Feb. 11 that there are no plans to join a Russia-led customs union of which Belarus is also a member.

“Russia will demand a very high price in terms of sovereignty and getting control of key economic assets,” Ariel Cohen, a senior fellow at the Heritage Foundation in Washington, said Feb. 8 by phone.

Gazprom’s press service declined to comment yesterday when asked about the negotiations with Ukraine and what the company is seeking in return for potential price discounts.

Russia, which supplies Ukraine with more than 70 percent of its gas needs, agreed to cut prices in April 2010 in exchange for a 25-year extension on its lease of the Black Sea port of Sevastopol, where it has a naval base.

Cheese Ban

The two countries have fallen out over Ukrainian cheese imports, with Russia banning products from three plants on quality grounds. Russia halted Ukrainian dairy imports in 2006 after it cut gas supplies during a price dispute.

Ukraine doesn’t appear ready to make concessions, according to Alex Brideau, an analyst at Eurasia Group in Tokyo.

“At the same time, it wants a deal quickly, so as to minimize the economic damage from high prices,” he said in a Feb. 10 note. “The combination of these factors makes it probable that tension will escalate between the two sides in the coming weeks.”

Gazprom’s Chief Executive Officer, Alexey Miller, accused Ukraine of taking as much as 40 million cubic meters of gas a day from EU-bound energy shipments during freezing temperatures this month, the Interfax news agency reported today.

Ukraine’s gas-transit system may be rendered obsolete after the Russian export monopoly completes construction of pipelines along alternative routes, Sergey Kupriyanov, a company spokesman, said later in an e-mailed statement.

Naftogaz denied taking “a single cubic meter of gas” in an e-mailed statement.

Eurobond Sale

With Russian gas talks dragging on and no sign of a compromise with the IMF, Ukraine has said it may seek to raise funds on international markets next month.

The government plans to borrow 12.15 billion hryvnia abroad in March, almost a third of its full-year target for foreign borrowing, the Finance Ministry said Feb. 9. It picked JP Morgan Chase & Co., Morgan Stanley and Russia’s VTB Capital and Troika Dialog, which is controlled by OAO Sberbank, to lead manage a potential Eurobond sale, the ministry said Feb. 3.

Whether Ukraine can successfully sell debt abroad depends on foreign-investor appetite and the government’s readiness to accept higher borrowing costs, Olena Bilan, chief economist at Dragon Capital in Kiev, wrote in a Feb. 10 note.

“Unless the Ukrainian authorities succeed in reducing fiscal and external pressures -- the main Ukrainian macro risk at the moment -- we don’t think investors will be prepared to accept a single-digit yield on new Ukrainian debt,” she said.

‘Enough Resources’

Even if cooperation with the IMF isn’t resumed, Ukraine doesn’t see any problems with foreign-debt repayments, Finance Minister Valery Khoroshkovsky said today, the Ligabiznesinform news agency reported. “We have enough resources to repay all debts,” he said, according to the agency.

The budget deficit reached 4.3 percent of GDP last year, with Naftogaz’s shortfall widening to 20.6 billion hryvnia, according to the Finance Ministry.

Ukraine’s currency may fall further without measures to bolster public finances, according to Sergei Strigo, who helps manage about $750 million as head of emerging-market debt at Amundi Group in London. Amundi cut its holdings of hryvnia- denominated bonds at the end of last year after the chances of a “substantial” devaluation in the currency in 2012 rose.

“The market is waiting for a resolution to either the IMF or some agreement on gas prices with Russia,” Strigo said Feb. 2. “The current path isn’t sustainable.”

To contact the reporter on this story: Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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