How Ukraine’s $40 Billion Bailout Depends on Bondholders, Putin

Ukraine’s preliminary $40 billion financing package rests on President Petro Poroshenko’s ability to drive through overhauls from tackling corruption to restructuring banks. It also depends on a debt-relief agreement with bondholders that include Russia’s government.

Here’s a breakdown of the proposed funding, based on analysis of official statements:

1. The IMF component

The International Monetary Fund has agreed to provide $17.5 billion in the next four years. The funding replaces a two-year $17 billion plan from April, of which about $4.5 billion has already been disbursed to Ukraine.

The first payment may be about the level the IMF had previously intended for March, at $4.8 billion, according to a JPMorgan Chase & Co. report Thursday from Nicolaie Alexandru-Chidesciuc, a London-based economist.

Ukraine will push to receive $10.5 billion, or 60 percent of the new loan, in 2015, Simon Quijano-Evans, the head of emerging-market research at Commerzbank AG in London, wrote in a report Thursday.

“It appears that the amounts the IMF will disburse this year are broadly comparable to what they were before,” Robert Kahn, an economist at the Council on Foreign Relations in Washington, wrote in a Feb. 12 blog.

The IMF said disbursements will be contingent on Ukraine reducing gas subsidies, tackling corruption and revamping banks, state-owned enterprises and the judiciary.

2. Government pledges

The $40 billion package cited Thursday by IMF Managing Director Christine Lagarde includes about $5.2 billion of loans previously pledged by governments. It comprises $2.2 billion from the European Union, $2 billion from the U.S. and a total of $1 billion from countries including Germany, Japan, Canada, Poland and Norway.

3. Agencies aid

The European Bank for Reconstruction & Development, the World Bank and the European Investment Bank are among institutions that will contribute a total $4 billion.

4. Bondholder haircuts

The aid package depends on a $13.5 billion contribution by holders of the government’s bonds. The amount gained from “debt operations” may reach $15 billion, Ukraine’s Finance Minister Natalie Jaresko said by e-mail on Friday.

Ukraine will probably seek to achieve this by extending the maturity of its debt due between now and 2019 by five years and cutting interest payments, or coupons, on its Eurobonds by 20 percent, according to a Goldman Sachs Group Inc. report by Andrew Matheny and Clemens Grafe in Moscow.

In order to make its debt more sustainable, the government may also push for bondholders to write down the principal owed. All told, that could mean a reduction, or haircut, of about 70 percent in the net present value of the bonds, the Goldman analysts wrote Thursday.

JPMorgan predicts coupons to be lowered by $1.9 billion, which is 45 percent of the interest due in the next four years, or the principal will be reduced, Alexandru-Chidesciuc wrote.

The IMF’s reliance on private-sector involvement for the biggest chunk of additional funding may set an international precedent, according to Robert Kahn at CFR. Agreement with bondholders will be a condition for future disbursements.

5. Putin’s help

Debt restructuring is complicated by Russia owning $3 billion of Ukraine’s $16 billion of international bonds. Legally, the government must treat all holders of its Eurobonds equally, giving President Vladimir Putin a role in any debt restructuring talks.

Attempting to resolve the issue by buying back its bonds from Russia would be “political suicide in Kiev” and make the other bondholders “very unhappy,” Timothy Ash, the chief emerging-markets economist at Standard Bank Group Ltd. in London, said by e-mail on Friday.

Ukraine asked Russia last month to restructure its bond, a request the government in Moscow isn’t ready to meet, Finance Minister Anton Siluanov said in an interview on Feb. 10. Ukraine denied it has approached Russia. The Minsk cease-fire agreement increases the chances of Russia cooperating in restructuring talks, according to Goldman’s report.

Bottom line:

“The total program falls short of what is needed to make the market confident that financing issues of the Ukrainian economy are behind us,” wrote Alexandru-Chidesciuc at JPMorgan.

“Ukraine looks like it is now demanding too much from bondholders,” wrote Quijano-Evans at Commerzbank.

“While I remain highly critical of the West’s stinginess in providing bilateral economic assistance as part of its overall strategy of support for Ukraine, the fund has done what it could do, and it is an important bit of breathing space for the Ukrainian government,” wrote Kahn at CFR.

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