Ukraine’s Options Wane as Payment Time Nears Amid IMF Freeze

Ukraine’s government is running out of options to finance $4.3 billion of outstanding foreign- currency debt in the first half of next year.

The government, which raised $1.25 billion in a bond sale on Nov. 20, wants to extend a $15.4 billion IMF loan suspended in March 2011 that expires this year. To regain access to funds, the government needs to give up resistance to raising gas prices and adopting a more flexible exchange rate.

The economy, among the world’s worst-hit during the 2009 global recession, is slumping as the euro area’s crisis curbs demand for such export products as steel. President Viktor Yanukovych, who drew European Union criticism over the jailing of former Prime Minister Yulia Tymoshenko, has struggled to obtain alternative financing. It’s testing investors’ patience.

“We would like to see more positive movement on the IMF deal before we would consider increasing our exposure,” Ronald Schneider, who helps manage 700 million euros ($910 million) in emerging-market debt for Raiffeisen Kapitalanlage GmbH in Vienna, said by phone Nov. 19. “We would like to see more credible steps.”

Ukraine’s default risk is the sixth-highest among 93 countries tracked by Bloomberg. The benchmark Ukrainian Equities Index has lost 41 percent this year, the world’s second-worst performance after the Cyprus General Market Index. International reserves have plunged to $26.8 billion, the lowest since May 2010, as the central bank dipped into the stockpile to prop up the hryvnia. The hryvnia, which lost 1.4 percent versus the dollar this year, traded at 8.1540 as of 1:35 p.m. in Kiev from 8.1535 from yesterday.

Russian Gas

Ukraine has been trying to lower price for imported Russian natural gas, which widened the current-account deficit to $9.3 billion in the first nine months of the year from $5.9 billion in the same period of 2011.

Russia offered to cut gas price to $160 per thousand cubic meters of gas from $430 if Ukraine joins the customs union it formed with Belarus and Kazakhstan, Prime Minister Mykola Azarov said Oct. 9.

The economy, which shrank 14.8 percent in 2009, contracted 1.3 percent in the third quarter from a year earlier. To fight the shortage of foreign currency, the former Soviet republic’s exporters will be required to convert half of what they earn abroad to hryvnia.

Bond Yield

The government this week paid 7.8 percent yield, or 6.187 percentage points above similar-maturity U.S. Treasuries, to attract investors to its junk-rated debt.

Ukraine is the lowest-rated country to have sold debt abroad this year. The sale, along with other emerging market- offerings, benefited from stimulus by the U.S. Federal Reserve and the European Central Bank and investors’ hunt for higher- yielding assets amid near-zero rates in the developed world.

The yields make the Ukraine’s foreign-currency bonds attractive even at a time when the the “market is concerned about the country,” said Sergei Strigo, who helps manage about $750 million as head of emerging-market debt at Amundi Group in London, 3 percent of which is invested in the country.

“Ukraine has different means to improve the situation,” Strigo said by phone yesterday. “The best thing for them to do is to have an agreement with the IMF or with Russia on gas prices. Both of these scenarios are very feasible.”

‘This Trick’

The fact that the government was able to tap international markets this week doesn’t mean that it will succeed in plugging the financing hole, said Alexander Valchysen, an economist at Investment Capital Ukraine.

“This trick may work once, but it can’t be repeated all the time,” Valchysen said by phone. “They won’t be able to sell a Eurobond every time they face a sizable redemption of debt to the IMF. The bold solution for Ukraine is definitely the IMF because the IMF requires them to carry out the policies that would eliminate deficits. It’s a painful path.”

The Finance Ministry declined to comment on the government’s plan to finance its 2013 debt obligations.

Ukraine’s dollar Eurobond due 2017 fell this month, pushing the yield up 15 basis points to 7.29 percent yesterday. A basis point is 0.01 percentage point.

Credit-default swaps have widened 59 basis points since the beginning of November to 660 basis points, according to data provider CMA, which is owned by McGraw-Hill Cos. (MHP) and compiles prices quoted by dealers in the privately negotiated market. The increased spread reflects a worsening perception of risk.

Breathing Space

The bond sale gives Ukraine some breathing space as the government seeks to secure financing without giving in to the IMF’s conditions of cutting gas-price subsidies for households and allowing the hryvnia to trade more freely, according to Liza Ermolenko, an emerging-markets economist at Capital Economics Ltd. in London.

“They will probably be pushed into a deal by the market, but until something drastic happens it’s unlikely there will be an improvement at the talks,” Ermolenko said by phone.

The country will have to repay $5.7 billion to the IMF next year, according to the Washington-based lender’s website. The first payment of $404 million is due Jan. 30, with a further $2.4 billion scheduled by May 10.

Risk Appetite

Should global risk appetite abate as the developing world recovers and central banks end quantitative easing, Ukraine would be among the first to suffer and might as well be locked out of markets, said Valchysen. Without an IMF agreement, Ukraine’s options include turning to Russia or China for a loan, according to Olena Bilan, chief economist at Dragon Capital (VIETENI) in Kiev.

When Ukraine sought to lower prices for imported Russian natural gas to improve its external balance, Russia urged Ukraine to join its custom union

“Given Russia’s regional integration ambitions, a new gas deal can hardly be reached without significant concessions from Ukraine ranging to a commitment to join the customs union,” Bilan said.

Ukraine may seek to use the fact that it was able to tap international bond markets to negotiate better terms with the IMF, said Timothy Ash, head of emerging-market research at Standard Bank (SBK) Group Ltd. in London.

“At the moment I think they are playing for time,” Ash said in a Nov. 20 phone interview. “They are probably just keeping their options open and trying to improve their negotiating position. I doubt that they’ve got an option not to go to the fund.”

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net; 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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