Ukraine Pushed to Mend Fences With Russia to Keep IMF Rescue

  • Creditors need to engage in `substantive dialogue': IMF
  • Showing will to do deal not hard for Ukraine: Oxford Economics

Ukraine may need to step up efforts to resolve a standoff with Russia over a $3 billion bond due this month to keep receiving aid from the International Monetary Fund.

While the IMF loosened its policy this week to allow lending to countries that default on money owed to sovereign creditors, it said debtors need to engage in “substantive dialogue” with creditors and be willing to meet separately from private lenders. Ukraine, which is preparing to default on the bond due Dec. 20, has offered Russia the same restructuring terms including a 20 percent principal writedown that creditors led by Franklin Templeton accepted in October. Russia has insisted on payment in full.

The new guidelines may push the government in Kiev toward seeking a bilateral agreement to hold onto a $17.5 billion lifeline needed to pull the economy out of recession. Relations between the two countries have deteriorated after Russia, which bought the debt to bail out Ukraine’s former president two months before his ouster, annexed Crimea and a separatist insurgency in Ukraine’s east killed 9,000 people.

"The IMF is indicating to Ukraine that they need to make an effort to find a solution with Russia," said Dmitri Petrov, an analyst at Nomura International Plc in London. "The fund wants a golden balance between Russia not being able to control the program and Ukraine not being able to just sit around and benefit from IMF protection."

The rift over the debt deepened this week as Russian Prime Minister Dmitry Medvedev, angered by the IMF’s decision to change its lending policy, called government officials in Kiev "swindlers" for planning not to pay back the debt and reiterated a threat to pursue legal action if Ukraine defaults. His Ukrainian counterpart Arseniy Yatsenyuk said his country is “fully armed” and ready to go to court.

Under the IMF’s new rules, a debtor country is expected to make "good-faith efforts" in restructuring, according to a policy paper released Thursday. The fund’s executive board, which represents a 188 member nations, will decide whether those attempts to negotiate better terms on the bond have been adequate, it said.

"It must be a core principle of IMF lending that a borrower may receive funding only if it negotiates in good faith with official creditors,” Russian Finance Minister Anton Siluanov wrote in a letter to the Financial Times Thursday. “Ukraine has not."

The Finance Ministry in Kiev said in a statement Thursday that Ukraine has been committed to engaging in good faith with all of its creditors.

Restructuring terms

“Ukraine will definitely have to show it is still trying to negotiate with Russia,” said Gabriel Sterne, head of macro research at Oxford Economics in London. “But that could be done by Ukraine sending letters through the lawyers. I don’t think it’s very hard for Ukraine to do that."

Ukraine has offered Russia the same terms it gave creditors in October, treating the security as commercial debt because it has the same legal structure as the country’s other Eurobonds. Russia rejected the deal, saying that it should be offered more favorable terms since it lent to Ukraine when it was on the brink of economic collapse at an interest rate of 5 percent, less than half the yield on the country’s bonds at the time. 

In the first sign that Russia may be willing to negotiate new terms, President Vladimir Putin last month proposed allowing Ukraine to pay back $1 billion annually from 2016 to 2018. The deal appeared to fall through this week after Russia said the U.S. declined to meet a condition to guarantee repayment. 

Legally Bound

Ukraine is legally bound by the terms of the debt restructuring with private creditors not to give favorable treatment to holdouts such as Russia. So if the countries agreed to a deal, Ukraine would need other creditors to approve.

The issue "needs to be sorted out between Ukraine, Russia and probably the IMF," Michael Hasenstab, the Franklin Templeton investor who owns about half of Ukraine’s restructured debt, said in an interview last month.

The yield on Ukraine’s dollar-denominated bond maturing 2025 climbed nine basis points to 9.26 percent on Friday, taking an advance since the bonds began trading last month to 36 basis points. Investors holding the country’s debt have lost 2.9 percent this month, according to the Bloomberg USD Sovereign Emerging-Market Bond Index .

“The IMF are pushing for the two to find a solution but they understand this may take a very long time,” said Nomura’s Petrov.

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