Treasury’s Lew Uses Mideast Toolkit to Back Ukrainian Bonds
The U.S. Treasury Department is using experience gained over years of supporting Middle East countries in transition to deliver financial aid to the latest hot spot: Ukraine.
Among the lifelines Treasury Secretary Jacob J. Lew offered within days of Russia’s move into Crimea was a guarantee of debt sold by the new government in Kiev. Similar U.S. support has been used in recent years by Jordan, Tunisia and Egypt. For Ukraine, the $1 billion backing that the U.S. Congress may approve this week will cushion the impact of the economic policy changes the International Monetary Fund will require in exchange for a loan Ukraine is seeking.
The first foreign debt guarantee by the U.S. since Jordan sold $1.25 billion of seven-year bonds in October is part of a financial arsenal the Treasury uses to buttress American foreign policy. The U.S.-backed funds will have a “multiplier effect on Ukraine in a critical time,” said Robert Kahn, a senior fellow for international economics at the Council on Foreign Relations in Washington.
“Money is critically important here: it keeps this government together. It can provide basic services. It can keep the lights on,” said Kahn, a former IMF, Treasury and Federal Reserve official. “The U.S. money would bring other donors,” including European governments and regional lenders such as the European Bank for Reconstruction and Development.
Investor demand is likely to be high, given the bonds offer a higher return than U.S. Treasuries, with risk limited by the U.S. guarantee, said Rune Hejrskov, a senior portfolio manager of emerging-markets debt at Jyske Bank A/S in Silkeborg, Denmark.
“These will be attractive and fairly well bid,” said Hejrskov, who manages $1.5 billion in assets, including about 1.5 percent to 2 percent in Ukrainian debt. He said he will be interested in buying Ukraine’s U.S.-guaranteed securities. “They are likely to perform fairly well given that we do expect a certain amount of stability once the current events disappear.”
Hejrskov expects the U.S.-backed Ukrainian bonds to trade at 70 basis points to 80 basis points above Treasuries with comparable maturities.
The yield gap between Ukraine’s dollar debt and U.S. Treasury notes reached 1,214 basis points, or 12.1 percentage points, on Feb. 19, the widest since July 2009, according to JPMorgan Chase & Co.’s EMBI Global Diversified index. The country’s gap, which declined to 1,080 basis points yesterday, is the highest in emerging markets after Venezuela.
In July 2012, Tunisia sold seven-year dollar-denominated bonds with a 70 basis-point spread over comparable Treasury securities, while Jordan sold $1.25 billion of seven-year dollar-denominated bonds with a 60-point spread about five months ago.
The U.S.’s help for Ukraine is conditional on Congress passing the necessary legislation and may complement any Ukrainian government agreement on a longer-term assistance package with the IMF. The House passed a measure allowing the guarantee on March 6 and the Senate may do the same this week.
The proceeds “will be aimed at protecting the most vulnerable Ukrainian households from the impact of the needed economic adjustment,” Lew said in a March 4 statement.
Working in tandem with a U.S. debt guarantee proposal are financial sanctions on Russian officials and business people. “But these sanctions take time to work,” Kahn said. “It is important that at the same time that we are putting these sticks in place we also have carrots.”
While a U.S. guarantee has never been called as a result of a default by the issuing government, the support doesn’t come without a risk.
“The revenue base of Ukraine can be compromised by further actions in the east” because there is a risk of the eastern part of the country won’t comply with conditions in an IMF loan, said Peter Attard Montalto, an emerging-markets strategist at Nomura Holdings Inc. in London. The eastern areas of Ukraine maintain strong ties to Russia.
An IMF team is in Kiev on a 10-day trip scheduled to end March 14 to assess the economy and discuss policy changes that may become part of a loan. Among the changes that may be part of a deal are deficit-reduction measures and a phasing out of energy subsidies.
Ukraine says almost 19,000 Russian troops have moved into Crimea to take control of a peninsula that is the home to both countries’ Black Sea fleets. Russian President Vladimir Putin backs the region’s recently appointed administration, which plans to hold a March 16 referendum on joining Russia. Ukraine’s government and Western nations have called the vote illegal.
The Ukrainian government of Arseniy Yatsenyuk that replaced President Viktor Yanukovych following his ouster last month estimates it needs as much as $35 billion in foreign aid over the next two years. The nation’s international reserves dropped to an eight-year low of $15.5 billion in February as central bankers burned through dollars to prop up the currency amid deadly street protests that toppled Yanukovych’s government.
With about $10 billion in debt coming due by year end, junk-rated Ukraine needs access to capital markets and U.S.- backed debt will reassure investors, analysts said.
That was the case in Tunisia, where the prospect of a 2012 sale of $485 million U.S.-backed debt helped push yields on its euro-denominated bonds to the lowest levels in more than a year as investors ignored a junk rating by Standard & Poor’s.
The guarantee came as a part of the U.S. effort to help Tunisia’s economy recover after a 2011 revolt that toppled President Zine El Abidine Ben Ali and inspired similar uprisings across the Middle East and North Africa, leading to the ouster of rulers in Libya and Egypt and unrest in Syria, Bahrain and Yemen.
Among the holders of U.S.-backed Tunisian debt is Jeffrey Klingelhofer, an associate portfolio manager at Thornburg Investment Management Inc., which oversees $94 billion. He said he expects the Ukrainian bonds to be priced at “just under 100 basis points” above U.S. government securities and that he may be interested in purchasing some.
“They might have a little more of volatility associated with them and that makes them certainly trade wider than U.S. government paper, as well as liquidity concerns,” Klingelhofer said in a telephone interview from Santa Fe, New Mexico. “They don’t trade very often -- nothing like Treasuries.”
In Jordan last year, the $1.25 billion raised by the sale of U.S.-backed bonds helped the nation address challenges including the influx of refugees from civil war in neighboring Syria and disruptions in natural gas supplies from Egypt.
When the U.S. provides a loan guarantee, the goal is to maintain “a democratic and open society,” said Charles Collyns, managing director and chief economist at the Institute of International Finance in Washington.
If lawmakers approve the package, the guarantee would be subject to negotiations between Ukrainian officials and a U.S. team that would include officials from the Treasury, the State Department and the U.S. Agency for International Development.
With support of the Obama administration and swift approval by Congress, the sale of U.S.-backed Ukrainian bonds may take place as early as in June, said Collyns, who served as assistant secretary for international finance at the U.S. Treasury.
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