Ukraine Bulls Scatter as Death Toll Mounts: East Europe Credit

Investors tempted to Ukraine by the prospect of a foreign bailout are sounding the retreat as deadly clashes between government forces and separatists threaten to overwhelm efforts to prop up the nation’s finances.

JPMorgan Chase & Co., which advised clients earlier this year to increase Ukrainian bond holdings on expectations that a civil war was an “extreme” scenario, is now warning of the risk of “huge” economic fallout as the former Soviet Republic’s territorial integrity crumbles. Barclays Plc said it’s urging caution on anything but the shortest maturities in Ukraine’s debt, with Capital Economics Ltd. anticipating a deeper selloff.

The yield on Ukraine’s benchmark Eurobonds surged as much as two percentage points in the past month and headed toward the record 11.4 percent reached on Feb. 19 even as the International Monetary Fund’s board approved a $17 billion lifeline last week to avert default. Four government servicemen and 30 rebels died on May 5 as Ukrainian forces attempted to dislodge separatists who have seized more than 30 administrative buildings in the eastern Donetsk and Luhansk regions.

“We are now at a turning point where the economics part of the equation is the least of our worries,” Simon Quijano-Evans, head of emerging market research at Commerzbank AG in London, said by e-mail yesterday. “Markets are having to price in factors that are frankly outside anyone’s control.”

Default Probability

Ukrainian bondholders have a 56 percent chance of not getting all their money back over the next five years, according to credit-default swap prices yesterday, up from 43 percent at the beginning of the year. The nation’s debt lost 5.3 percent this year through yesterday, the worst performance in the Bloomberg USD Emerging Market Sovereign Bond Index, which returned 5.8 percent.

Surging casualties are threatening to undermine Ukraine’s campaign to regain ground from pro-Russian militants before a planned presidential election on May 25. French President Francois Hollande yesterday said Europe will press Russian President Vladimir Putin to let Ukraine hold the vote and if it is thwarted, “chaos and a risk of war” would follow.

“The approval of the IMF aid package is a positive for Ukraine’s short-term liquidity position,” Andreas Kolbe, a London-based strategist at Barclays, wrote by e-mail yesterday. “However, medium-term risks remain elevated, exacerbated by the recent events in the southern and eastern parts of the country.”

Franklin Buys

The hryvnia has depreciated 29 percent this year, the worst performance among more than 170 currencies tracked by Bloomberg. The currency gained 1.5 percent to 11.625 per dollar at 5:37 p.m. in Kiev after Putin said Russia pulled back troops from Ukraine’s border. The yield on Ukraine’s dollar bonds due in April 2023 has risen 2.7 percentage points in the last 12 months. It fell 48 basis points to 10.23 percent today.

Even as the risk of conflict escalated in the first quarter, Franklin Templeton Investments, whose $190 billion global bond group is the largest mutual fund investor in offshore Ukrainian debt, increased holdings by $62 million in the period to $7.6 billion, the company’s latest filings show.

Templeton was “encouraged” by the government’s crisis management, San Mateo, California-based executive vice president for global bonds Michael Hasenstab said in an April 5 video posted on Franklin Templeton’s website.

Ukrainian bonds advanced in the past two days as Ukraine received the first $3.2 billion tranche of the IMF aid and as Putin said his country pulled back troops from Ukraine’s border and he urged separatists to delay a referendum to ease tension.

Aid Program

The loss of the regions around Kharkiv, Donetsk and Luhansk, which together account for about 25 percent of gross domestic product, might force the IMF to “redesign” Ukraine’s aid program, Vadim Khramov, a London-based analyst at Bank of America Corp., said in an e-mailed report yesterday.

The IMF sees Ukraine’s economy shrinking by 5 percent this year, according to projections made before the latest surge in violence.

“We felt that Ukraine would get support either from west or east, but the situation changed with the escalation in the eastern part of the country,” Morten Groth, who helps manage about $1.5 billion in debt at Jyske Bank A/S in Silkeborg, Denmark, said by e-mail May 5.

The bank is “not ready yet to increase exposure” after cutting its outlook on Ukrainian debt to underweight from neutral March 28, he said.

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