Ukraine's finance minister is looking for more support.

Photographer: Alex Wong/Getty Images

IMF's Leash Is Too Short for Ukraine

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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As Ukrainian Finance Minister Natalie Jaresko travels to Washington, New York and London to try to persuade her country's creditors to take a haircut, she comes with a math problem. The restructuring that Ukraine and the International Monetary Fund have agreed to doesn't really add up. Ukraine can't save $15.3 billion over the next four years unless its creditors forgive some of the principal they're owed -- yet none of them may be ready to do that. 

The IMF has agreed to lend Ukraine $17.5 billion over the next four years. This "debt operation" (a euphemism for a soft default) is supposed to save Ukraine $5.2 billion in debt payments this year and $3.4 billion, $4.4 billion and $2.3 billion in the next three years. According to the Ukrainian investment firm ICU, the government wants to include $20 billion of debt in the restructuring, at least half of which is scheduled for repayment over the next four years. That means that, over those four years, Ukraine would pay investors nothing.

This was more or less expected. With its export potential destroyed in the military conflict in the east and its antiquated tax system unable to ensure steady revenues, Ukraine needs time and investment to become solvent -- even if the current government carries out needed reforms more successfully than any its predecessors did.

However, the IMF program has another ambitious goal: to reduce Ukraine's debt-to-output ratio to 71 percent in 2020, from 94 percent this year. In absolute terms, that means paring the debt to $56.1 billion from $74.9 billion. If the amount that Ukraine owes to international institutions such as the IMF and to friendly governments is to stay the same, then only two other parts of Ukraine's debt remain open to reductions: $17.3 billion in sovereign Eurobonds and $31.4 billion in domestic debt. Since it's impossible to extract $18.8 billion from  the servicing of these two types of debt (the average coupon income is 7.1 percent), principal reductions are a must.

The IMF program doesn't say this in so many words, but Ukraine's funding for the next four years depends on, among other things, the finance ministry's ability to impose a haircut on bondholders. Jaresko asked the IMF to disburse this year's entire $10 billion installment immediately after the program was approved, but she got only $5 billion -- so she should be motivated to conclude talks with creditors by June.

Getting them on board, however, will be like herding cats.

The biggest private bondholder, the asset management company Franklin Templeton, which holds $7 billion worth of Ukrainian debt, has hired Blackstone to help it with the negotiations, signaling it won't roll over easily. Templeton bond guru Michael Hasenstab, who's made a name for himself by investing in distressed sovereign bonds just ahead of international bailouts, is not accustomed to losing. 

While Hasenstab may eventually bow to the inevitable, Ukraine has another creditor even tougher to convince: Russia, which holds $3 billion of the $20 billion debt in ICU's estimate. Today, Sergei Storchak, Russia's deputy finance minister, said that the IMF program calls for only private-sector debt to be restructured. "We're official sector," Storchak said, somewhat disingenuously. After all, Russia's loan to the previous Ukrainian government was deliberately structured as a Eurobond to make it hard for Ukraine to avoid paying without triggering a default on its private debt. Given Moscow's bad relations with the current government, talks would seem to be a nonstarter. This only makes it harder for Jaresko to get the cuts she needs elsewhere.

"The funding volume that it is suggested [Ukraine] use for all the planned steps is almost certainly not enough," Storchak said. He should know: He was a key figure in Russia's exhausting talks with creditors after the 1998 default. 

Jaresko appears to agree with him. "The package that we have is going to stabilize the financial banking system, but it’s not enough to seriously restart growth and promote growth," Jaresko told the Wall Street Journal after meeting with U.S. Treasury Secretary Jack Lew. "I’m looking for more support." 

Her argument is that "no one is paying more to protect the world from a nuclear power that is an aggressor" than Ukraine, and if its allies won't help fight Russia, they should at least cough up more money. With that argument, however, Jaresko risks irritating Kiev's Western partners, who have already provided billions in aid and persuaded the IMF to put together its bailout package with no certainty of repayment.

If, on the other hand, Western governments, especially the U.S., remain sympathetic to Ukraine's cause, the IMF may have to accept that debt restructuring on its terms is impossible. Ukraine might not be able to persuade creditors to take a significant haircut, but maybe it can get them -- even Russia -- to wait a bit longer for their money. The IMF's current leash may just be too short to allow Ukraine to dig itself out of its economic mess.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Mary Duenwald at mduenwald@bloomberg.net