Ukraine 19% Yields Narrow Options in Clashes: East Europe Credit

As Ukraine is besieged by the worst protests in almost a decade, President Viktor Yanukovych is running out of options to repay $15.3 billion of maturing debt.

Yields on Ukraine’s dollar-denominated notes due in June jumped above 19 percent for the first time yesterday after they were issued at 7.95 percent last year. They recovered ground today, with the yield falling four basis points to 19.78 percent at 4:08 p.m. in Kiev after earlier rising above 20 percent.

Yanukovych , who suspended trade pact talks with the European Union last month after spurning conditions attached to proposed financing from the International Monetary Fund, is also grappling with currency reserves that shrank by a quarter in the past year. Speculation the former Soviet republic would turn to Russia as a last resort is waning after Ukrainians took to the streets to object to the breakdown of EU talks, according to Societe Generale SA.

“Ukraine isn’t able to cope without external funding,” Regis Chatellier, an emerging-market sovereign-credit strategist at Societe Generale, said by phone from London yesterday. Gaining aid from Russia amid the protests “isn’t an option. But I don’t see any other options either.”

Dwindling Reserves

Just seven months ago, Ukraine sold $1.25 billion of 10-year securities at a yield of 7.5 percent, taking advantage of investors’ search for higher returns amid near-zero interest rates from the U.S. to Japan. With more than $15 billion of debt maturing over the next two years, the country’s notes due in June have posted the biggest yield surge among emerging-market sovereign dollar bonds in 2013, data compiled by Bloomberg show.

Central bank reserves have dropped as policy makers propped up the hryvnia currency and dipped into the stash to help repay maturing debt. Their level, at $20.6 billion on Oct. 31, is equivalent to less than three months of imports, a level economists use to gauge financial stability.

The government has cracked down on street protests triggered by Yanukovych’s decision to favor closer cooperation with Russia, which held out the prospects of cheaper natural gas prices in return.

Yanukovych walked away from the EU deal after Russia, which supplies 60 percent of Ukraine’s natural gas and buys a quarter of its exports, threatened trade sanctions. He also failed to pass legislation authorizing the release of his jailed political opponent, ex-Premier Yulia Tymoshenko, for medical care abroad, a prerequisite for signing the EU accord.

Orange Revolution

Yanukovych’s funding options are being exhausted after his opponents took to the streets to block government buildings and organize nationwide strikes in the biggest demonstrations since the 2004 Orange Revolution, according to Michael Ganske, the head of emerging markets at Rogge Global Partners Plc in London.

The cost to insure Ukraine’s bonds through credit-default swaps jumped 87 basis points, or 0.87 percentage point, in the past two days to 1,074, surpassing Cyprus as the costliest in Europe, data compiled by Bloomberg show. Only default swaps protecting Argentine and Venezuelan notes are more expensive.

“It’s politically impossible” for Yanukovych to gain a deal with Russia during the protests, Ganske said by phone yesterday. “If they got a loan or better terms for energy imported from Russia, credit risk would diminish.”

Rogge Global Partners, which oversees $8.5 billion of developing-nation currency and fixed-income assets, holds fewer Ukrainian bonds than is recommended by benchmarks, he said.

Police Crackdown

A police crackdown on protesters in the capital two days ago left at least 109 people hospitalized, according to a statement by Kiev’s local government. Prime Minister Mykola Azarov said protests are spinning out of control, Interfax newswire reported yesterday. Opposition leaders failed to oust the government in a no-confidence vote today in parliament.

“These sorts of issues shouldn’t be blown out of proportion -- they are part of the democratization process,” Arjuna Mahendran, chief investment officer at the wealth management division of Emirates NBD PJSC, said by phone yesterday. “The issue of trading with Europe is at the heart of this. If Ukraine has trade with both Russia and the EU, that will be the optimal situation.”

Mahendran, a former head of Asia investment strategy at HSBC Private Bank, said his company owns Ukrainian bonds and “if there’s a dip in the market, we will definitely buy.”

Ukraine sold 811 million hryvnia ($99 million) bonds due in 2018 at an average yield of 14.25 percent at the weekly auction, the Finance Ministry said on its website today. The yields on the domestic bonds were the same as in the previous issuance, before the protests escalated, according to data compiled by Bloomberg.

Gas Supplies

Ukraine’s motivation for suspending preparations for the EU treaty was “purely economic,” Azarov told lawmakers in Kiev on Nov. 22. Russia will offer cheaper natural gas to Ukraine if it opts to join a Moscow-led customs union, First Deputy Prime Minister Igor Shuvalov said in an interview last month.

Ukraine will hold talks this month about prices it will pay for the fossil fuel next year, Azarov said in comments broadcast yesterday by the television channel Inter. Failure to reach such deals blocked a key transport route for Russian gas to EU countries twice since 2006.

Bond markets would recover in case of “a confirmation of a deal with Russia, lower gas prices or a loan,” Richard Segal, the head of international credit strategy at Jefferies Group Inc. in London, said by e-mail yesterday. A “handshake” with the opposition, such as a timetable for renewing EU talks, or a pledge from Yanukovych not to seek re-election in 2015 would also help investors, he said.

Dmitry Peskov, Russian President Vladimir Putin’s spokesman, said yesterday that his country wasn’t in loan or bailout talks with Ukraine and that it “respects” decisions made by the government in Kiev.

Putin’s Pockets

Putin’s “pockets are very deep but the problem is there’s no trust at all between Putin and Yanukovych,” Tim Ash, London-based chief emerging-markets economist at Standard Bank Group Ltd., said in an interview on Bloomberg Television today. “Putin would provide the cash but Ukraine has to sign on the dotted line to join the customs union and that is impossible for any Ukrainian leader to deliver.”

Ukraine, which entered its third recession since 2008 in the second quarter as demand for its steel exports waned, sold notes due in 2023 in April, tapping into demand spurred by unprecedented monetary stimulus in developed economies.

The yield on the notes increased two basis points to a record of 10.60 percent today from as low as 7.29 percent in May. Four of the five worst-performing sovereign dollar bonds from developing markets this year are Ukraine’s, data compiled by Bloomberg show.

Junk Rated

Fitch Ratings Ltd. reduced Ukraine’s credit rating on Nov. 8 to B-, six levels below investment grade, citing its strained external finances. Standard & Poor’s cut its ranking to the same level on Nov. 1 while Moody’s Investors Service reduced its assessment of Ukraine to Caa1, or seven steps below investment grade, in September.

The government has suspended talks with the IMF on about $15 billion in financing, with Azarov saying on Nov. 22 that conditions attached to the offer were the “last straw” in pushing Ukraine away from the lender.

The central bank will “increase its presence” in the currency market to “keep balance and mitigate risks,” Governor Ihor Sorkin said in a video on the bank’s website yesterday.

“When you have this sort of tension, you might have a problem for the local currency that might be devalued,” Gianni Franco Papa, the head of UniCredit SpA’s east Europe division, told journalists in Vienna yesterday. “This is clearly a situation that cannot last for weeks.”

The hryvnia strengthened 0.2 percent to 8.22 against the dollar today and weakened 0.1 percent per euro to 11.1650.

“A prolonged period of political instability is the last thing Ukraine’s struggling economy needs,” Liza Ermolenko, an analyst at Capital Economics in London, wrote in an e-mail yesterday. “With the economy already in recession and suffering from strains in the balance of payments, prolonged political instability could tip Ukraine into a crisis.”

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