Handshake or arm twist?

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The IMF Bows to Putin in 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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Notions of justice and morality rarely apply to debt restructuring negotiations. Most parties want to get the best result that everyone can accept and move on. Nonetheless, what's going on with Ukraine's debt is disturbing.

The country's protracted battle with Russia, mismanagement under previous president Viktor Yanukovych, and a painful 2014 currency devaluation have wreaked havoc on its finances, impairing its ability to pay its sovereign debt. The government is thus insisting that private investors such as Franklin Templeton accept a "last chance" deal involving a 40 percent haircut and the possibility of receiving new bonds if the economy performs better than expected. The government is threatening a moratorium on debt repayments if the creditors don't agree.

At the same time, the government is acting very differently toward another major creditor: Russia, the country that helped get it into this mess. On Monday, Ukraine announced that it had paid a $75 million coupon on a $3 billion bond it issued to Russia last December. The debt, structured as a Eurobond registered in Ireland, is legally the same as that held by the private creditors -- a feature intended to protect Russia, because failure to pay would trigger early repayment on all the rest of Ukraine's Eurobonds. But last year, after Ukraine's "revolution of dignity," Russia sought to modify the bond's status: Finance Minister Anton Siluanov declared it the official debt of one country to another to avoid being part of any restructuring negotiations.

Now, Russia appears to have found an unlikely ally in the International Monetary Fund. Bloomberg reports today that fund staffers have decided to treat the Russian bond as official rather than private debt. At the same time, the IMF has been helping Ukraine put pressure on the private investors: A top fund official has suggested that Ukraine can stop paying them and still be eligible to receive IMF loans. IMF rules allow it to lend to countries that are in arrears to private creditors but not necessarily to official ones.

By taking Russia's side, the IMF is helping to destroy the private creditors' argument, backed by Moody's on Monday, that Ukraine doesn't need a reduction in the principal value of its debt. They say rescheduling payments would be enough to save $15.3 billion over four years -- the goal set out in the IMF's bailout program. The math doesn't work, however, if Ukraine has to pay $3 billion to Russia this year.

The IMF appears to be taking a pragmatic stance. Russia, after all, has shown that it has unconventional means of enforcing repayment. Its armed proxies control a sizable part of Ukraine's industrial east. If needed, regular Russian troops can inflict lasting damage on what remains of the country's export potential by shelling a few steel mills. If the IMF said it would keep lending to Kiev after a default on the Russian bond, there could be unpredictable consequences.

From the point of view of commonsense justice, though, Ukraine shouldn't owe Russia anything. It should be the other way around. The state-owned Ukrainian assets Russia expropriated in Crimea are alone worth much more than $3 billion. Even if Ukraine doesn't recognize the annexation of Crimea, Russia will be using the land, buildings, ships, equipment and natural resources for years without paying anything. 

The IMF, however, seems poised to push Ukraine to pay the Russian bond in full. This is the same as telling the rest of the world that might makes right. You there at Templeton: Got tanks? No? All right, we want you to accept a principal reduction. The bear gets fed, while the herbivores get fleeced.

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:
Mark Whitehouse at mwhitehouse1@bloomberg.net