Ukraine Bond Repayment Belies Economy Gutted by Conflict

As Ukraine repays its $1 billion dollar bond, sentiment for the nation’s notes is souring with the economy withering amid fighting between government forces and pro-Russia separatists.

The yield on the July 2017 note fell seven basis points to 9.62 percent 11:28 a.m. in Kiev, paring the increase to 10 basis points in the past week amid a government crackdown on rebels in Donetsk and Luhansk in Ukraine’s industrial heartland in the east. Optimism that the country would avoid war with Russia spurred an 8.7 percent return in its dollar-based securities in May, the most among 56 emerging markets tracked by Bloomberg.

While an International Monetary Fund bailout is helping the country repay the dollar note maturing today, the European Bank for Reconstruction and Development forecasts the economy will shrink 7 percent this year after the government pledged to lower its budget deficit to win the aid. Russia, which annexed Ukraine’s Crimea peninsula in March, has given the country until June 9 to prepay for natural-gas supplies or face a cutoff.

“I am very skeptical about Ukraine in the medium term as growth prospects are dim and popular support for the very tough IMF-imposed measures may evaporate soon,” Ivan Tchakarov, an economist at Citigroup Inc., said by phone from Moscow two days ago. “While default risks have been averted, I can see no reason to remain bullish on Ukrainian bonds.”

‘Cautious’ View

Goldman Sachs Group Inc. is maintaining a “relatively cautious” longer-run view on Ukraine because of the difficulty of implementing “deep structural economic and institutional reforms,” while also integrating and reviving the economy of conflict-hit eastern regions, Andrew Matheny, a Moscow-based analyst at the bank, wrote in an e-mailed report dated yesterday.

The IMF on May 1 approved $17 billion of loans to keep the country afloat for the next two years and help revive growth. The funds won’t be enough if the government loses control of eastern lands, as the predominantly Russian-speaking Donetsk, Luhansk and Kharkiv regions account for 30 percent of the nation’s industrial output, the Washington-based lender said.

Government troops killed “a large number of terrorists” yesterday as fighting continued, parliament Speaker Oleksandr Turchynov told lawmakers in Kiev. President-elect Petro Poroshenko has vowed to wipe out the insurgents and re-establish order after winning the vote in a May 25 election.

‘No Return’

“Fighting seems to have intensified,” Timothy Ash, head of emerging-markets research at Standard Bank Plc in London, said by e-mail yesterday. “The market seems oblivious to the risks, but the longer this conflict on the ground drags on, with yet more casualties, the closer we get to a former Yugoslav point of no return.”

Moody’s Investors Service downgraded Ukrainian bonds three times in the past nine months, with the last cut in April taking the credit rating to Caa3, nine steps below investment grade and on par with Greece. The country has $20.8 billion of principal and interest payments coming due this year and next, including the note maturing today, data compiled by Bloomberg shows.

Ukraine’s government ordered the repayment of the notes due and is preparing to repay $1.6 billion of notes from state utility NAK Naftogaz Ukrainy maturing in September, according to Halyna Pakhachuk, head of the Finance Ministry’s debt department in Kiev. The country seeks to offer international bonds when violence in the east subsides, she said by e-mail yesterday.

“I strongly hope that the civil conflict in Ukraine will be stabilized and markets will allow us to borrow internationally on reasonable terms,” Pakhachuk said. “But at this moment, Ukraine’s credit ratings are like a millstone around our neck.”

Border Movements

Societe Generale SA raised Ukrainian sovereign debt to overweight on May 28 from a previous neutral stance, according to a research note from Regis Chatellier, a London-based director of emerging-markets credit strategy.

“Ukrainian Eurobonds may not rally further but the yield remains attractive given the substantially reduced geopolitical risks,” Chatellier said by phone June 3.

Russian President Vladimir Putin, who faces sanctions from the U.S. and Europe, has withdrawn most of his forces massed on Ukraine’s border, U.S. Defense Department said on May 30.

“Investors may finally understand that Putin is likely not sending troops to Ukraine, so all that fat risk premium has disappeared,” Citigroup’s Tchakarov said. “We’re back to using macroeconomics to make the case for buying or selling Ukrainian” bonds, which “argues for a sell,” he said.

To contact the reporters on this story: Krystof Chamonikolas in Prague at kchamonikola@bloomberg.net; Daria Marchak in Kiev at dmarchak@bloomberg.net

To contact the editors responsible for this story: Wojciech Moskwa at wmoskwa@bloomberg.net; Daniel Tilles at dtilles@bloomberg.net Stephen Kirkland

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