The Political Perils of a Ukraine Default
For the last 10 days, Ukrainian Finance Minister Natalie Jaresko has been visiting private creditors in Europe and the U.S. to explain why they should help her create a "new Ukraine," by agreeing to write off some of its debt. Back home, meanwhile, an oligarch with a private army was busy occupying two state energy companies in a style decidedly reminiscent of the old Ukraine.
The contrast is no criticism of Jaresko, an American-Ukrainian from Chicago who seems committed to the economic reform Ukraine needs. Indeed, the attempt by Igor Kolomoisky, a billionaire businessman and regional governor, to keep control of two state energy companies is grist for the pitch she’s been making to private holders of Ukraine’s sovereign debt.
Jaresko says they'll never get a better price for their bonds than now, because there’s a calm amid the Ukrainian storm. There's something resembling a cease-fire in eastern Ukraine; the currency is stable(ish); there’s a government committed to reform under the International Monetary Fund’s $40 billion loan program; and that government has support for that in parliament.
Her list of shocks that could end this lull is longer and all too plausible -- especially if the country's creditors don't help out before May, potentially forcing the IMF to withdraw its program and force a disorderly default.
Jaresko says she assumes that Russian President Vladimir Putin's game plan in Ukraine is to turn it into a failed state -- so it's likely the war in the east will reignite. Next, the five-party coalition in parliament could easily fall apart. The banking system is weak and riddled with fraud and corruption, a recipe for financial meltdown. And although Ukrainians have so far quietly endured plunging living standards since last year, an eruption of social unrest is all too possible.
"If, God forbid, there is another revolution, it won't be of the same kind," says Jaresko.
The problem for Jaresko is that bondholders have an alternative: They can wait and see what happens in this unpredictable situation. Maybe Western governments will pressure the IMF to alter the loan terms. Maybe they'll come up with extra cash to keep Ukraine solvent. And even if Ukraine defaults, it might honor its debts in full at a later date.
Jaresko is trying to persuade creditors to look at Ukraine's case as so extreme that the interests of the government and its creditors are in reality the same: for the state to just survive. And for that to happen, it needs debt relief.
"People outside Ukraine see what's happening very differently, as though it's something normal," said Vitaly Lisovenko, Ukraine's envoy for state debt, when presented with the wait and see argument by a representative from the creditors' side of the negotiation today. But it faces a combination of military and economic threats unique to previous IMF bailouts, he said. Without quick action, “you will end up with us, in a river full of crocodiles."
This is, of course, a negotiation. Each side will paint its case in stark colors for leverage. Markets seem to agree that some kind of default or debt forgiveness is probable, with Ukrainian bonds trading at just under 40 cents on the dollar.
Still, the brinksmanship over a potential default feels like it's ignoring the real stakes. As with Greece, this debt standoff is about more than just the losses creditors might incur. If Ukraine becomes a country with no IMF program to force reform or shape policy, and without the funds to respond to Russia militarily or pay officials, there's a real risk that Putin will succeed in creating a failed state of 45 million people in Europe. Jaresko didn't put it that way, but perhaps she should.
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