Ukraine's Debt Deal Is a Draw
The debt restructuring that Ukraine has agreed with its private creditors has all the hallmarks of a win-win: The government can boast of persuading investors to accept a haircut, while the creditors can congratulate themselves on losing practically nothing in reality.
Yet the five-month negotiations -- the equivalent of a hard night out clubbing that ends with a chaste kiss -- will do little for Ukraine. Indeed, the outcome doesn't even meet the International Monetary Fund's demand that Ukraine should save $15.3 billion on its debt costs.
The deal reached on Thursday shaves 20 percent, or $3.6 billion, off the face value of $18 billion in government debt. If the same terms are agreed for some government guarantees and for Kiev municipal bonds, the write-off amount will rise to $3.8 billion. All principal repayments are deferred by four years, from 2015-2023 to 2019-2027, and the coupon rates on all bonds will be reset to 7.75 percent from the current average of 7.22 percent. Ukraine's creditors will also get growth-linked warrants that will reward them if the Ukrainian economy expands at least as fast as the IMF projects.
For the creditors, that's more or less a wash. In present value terms, the new deal guarantees them roughly the same payback as the original. For example, using a 5 percent discount rate (essentially, the opportunity cost of not investing money elsewhere), the future cash flows on $1 billion of the $2.6 billion bond maturing in July 2017 are currently worth $1.085 billion; after the deal they will be worth $1.007 billion. That's an insignificant reduction. It's similar with longer-term bonds. If all the creditors' present-value losses are added up, they will amount to about half a billion dollars.
That's a pretty good outcome for a bet on Ukrainian bonds that the creditors got badly wrong.
Ukraine is asking Russia to accept the same terms on the $3 billion bond it holds, which comes due for repayment in December. From a financial point of view, Russia would lose nothing if it accepted: The cash flow through 2019 would be worth a little more than the expected principal repayment. Russian Finance Minister Anton Siluanov, however, has already refused to restructure, showing yet again that for Russia, the matter is political. Siluanov's attitude might also signal disbelief that Ukraine would actually pay in 2019; the debt agreement does little to help Ukraine fulfill the IMF program on which its financial solvency depends.
The deal will, however, give Ukraine some short-term relief. Principal repayments due on Ukraine's international bonds from this year through 2017 amount to $6.7 billion, and will now be deferred. Still, even though some other forms of debt will also be deferred, Ukraine will not get to the $15.3 billion savings the IMF factored into Ukraine's program. In fact, because of the maturity extensions, Ukraine's debt service payments will actually rise, since it will be paying coupons on bonds that would otherwise already have been paid off.
Other parts of the IMF plan also look improbable now. I wrote previously about the overly optimistic growth forecasts that underpin the fund's math. The government's readiness to offer big payouts to the creditors if the economy does indeed grow as fast as the IMF thinks suggests that it doesn't believe in the forecasts, either.
The government offers no payments if the economy grows at a rate of 3 percent or less, but pays out on a rising gradient at higher growth rates. These terms don't become valid until 2021, and only if Ukrainian gross domestic product has by then reached $125.4 billion. If the government really believed all these conditions were feasible, or that it would still be around to witness them, it wouldn't be offering to give the creditors billions of dollars in potential bonuses.
So far, it appears the IMF plan is coming apart at the seams -- with some help from the fund itself. It is now pushing tax changes that close an important tax loophole used by the country's lucrative software development industry and other white-collar businesses, but without lowering tax rates. That will create no incentive for companies and their employees to report income, which means that Ukraine's huge shadow sector is unlikely to start feeding growth.
At the same time, corruption remains widespread, despite ostensible efforts to combat it. Tomas Fiala, a Czech investment banker who has made a home in Ukraine, recently accused President Petro Poroshenko and Prime Minister Arseniy Yatsenyuk of selling spots on their party lists before last year's parliamentary elections (an ugly staple of Ukrainian politics that a new and supposedly different government should have ended). And if that wasn't enough, the conflict in eastern Ukraine is flaring up again.
The government in Kiev has much more serious problems to deal with than a smaller-than-expected debt write-off. If it makes progress in solving these in the next few months, the debt deal's significance will pale in comparison. If it fails, a future Ukrainian government will be seeing more of the creditor committee members, headed by U.S. asset manager Franklin Templeton.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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