I think I am probably closer to the Ukrainian situation than most people out there and I am finding the endgame in terms of deal/debt moratorium hard to call.
We seem to be on a knife edge, and it could still go either way.
One big positive and really refreshing thing in my mind is that there does not appear to be any leaks of information out of the Ukrainian Ministry of Finance – I think there have been concerns over this in the past (pre-EuroMaidan Revolution).
This time around there is isn’t much in terms of the usual wink, wink and the whole thing is being undertaken in a pretty professional way. Some might dispute this, given market price action in recent weeks, as Ukraine 17s push up to 58 cents (pricing in a very favorable deal now for bondholders). That might just be a case of investors talking up their books.
This week seems to be decision day, either-way, so we will presumably find out, one way or another – guess there is a desire to make the decision before the Ukraine 21 coupon payment next week, and in time to manage scenarios relating to the Ukraine September 17s.
What seems clear now is that bondholders are negotiating very hard, and not being overly generous (from a Ukrainian perspective – I am sure they would say otherwise) – that’s reflected in price action over recent weeks, as optimism has built over a bondholder friendly deal, hence the 18 cent rally in Ukraine 17s from the year lows in July.
The question for the Ministry of Finance is is this deal the best they can get in the circumstances, or could they get something better by moving to a moratorium, and playing for time. I guess also they have to figure out just how damaging a moratorium would be – I tend to think not as damaging as some might suggest. I guess weighing up the pros and cons of cutting a deal now:
(Cons) How does this a deal on the terms currently being mooted change anything? The 10-15 cents hair cut currently mentioned in the media is hardly generous, and seemingly does not really address underlying debt sustainability concerns. If this is delivered, the question will be still how exactly is Ukraine going to meet IMF targets in terms of the public sector debt/gross domestic product ratio? Concerns over debt sustainability could linger, undermining confidence, and we have seen in the past both with the International Monetary Fund/Stand-By Arrangement in 2014, and also with the Greek support package, that unless you address underlying problems at the outset, the risks are that they come back to haunt you. I guess if a deal is done, the MOF/IMF will focus on the other aspects including coupon reduction, and maturity extension, hence addressing liquidity issues. IMF shareholders might be concerned that this deal still raises concern over the sustainability of the EFF, and whether they are going to get paid – official/private sector tensions could play out there.
(Cons) How is the politics of this going to play domestically? With the IMF, et al, seemingly calling for a greater reduction in the stock of debt, to ensure debt sustainability, questions will be asked as to why Ukraine cut a deal so easily? Is there really so much downside for Ukraine from a debt moratorium – but rather does it just improve the negotiating position with little collateral damage. This could still play very poorly back at home – and especially given that Ukraine 15s – the Russian bail bond – is being rolled into this deal. Russia is going to be offered the same terms, not that they are likely to accept in almost any reasonable scenario. There are hence likely to be significant holdouts anyway – Russia might try calling a default in any event. But in dimes and nickels, 40 cents off the Russia 15s is USD1.2bn in face value reduction, 15 cents off is just USD450m in face value reduction, in theory paying Russia an additional USD750m than might have been the case. That is a big number, given the challenges facing Ukraine. That said, Russia might never be paid anyway, if it ends up being a holdout.
(Pros) “We are the good guys” – I think the MOF and the Ukrainian government are minded to be investor friendly – this is not an Argentina, where bondholders are still viewed as the enemy. There is hence a desire to cut a deal which creates positive market sentiment/momentum – some have argued a larger haircut actually creates a better base for future investment, as it improves Ukraine’s ratios in a more meaningful way. This was evident in the Ukreximbank deals early in the year – many people argued that these actually undermined the sovereign’s negotiating position as somewhat perversely holders of a sovereign quasi entities’ debt got better terms than the sovereign. Perhaps the government wants to see some easy wins – to sell the line that they quickly cut a deal with bondholders (albeit the question still is is this a good deal for Ukraine) so as to move on and focus on other reform priorities. And therein there is lots to do.
(Pros) “A bird in the hand” – I guess there is probably a feeling that the deal now at least gives Ukraine some easing of the debt service burden, and taking this now, might be better than the prospect of perhaps something better in the future. In the interim, Ukraine could get into a long drawn out legal battle with bondholders, leaving a pall of uncertainty hanging over the credit.
(Pros) “The powers of persuasion” – no doubt large bondholders can be very persuasive on a MOF when one is locked in a room for an extended period of time. They can offer to support/or not future market access. Whether the sanction is meaningful at this point is debatable, given that Ukraine is not assumed to have market access until very late in the EFF. A lot can change there in terms of personnel on both sides of the negotiating table – a bird in the hand, the other way around.
As noted above, this could go either way now. It is binary. In terms of bond performance, a deal would see benchmark Ukraine 17s rally up through 60 (from 58) – a lot is already in the price, but there will be some temporary positive momentum associated with a deal. A moratorium would likely see prices drop back down to 40 cents, albeit this could still then create a new level for the sides to come back to the table later in the year, and to still cut a deal, but on terms more favourable to Ukraine. Looking at pricing it is pretty assymetrical at this point – if you bought at the lows, it might make sense to book profits. If you have firmer conviction as to how this will pan out – you’re probably belted in for the ride anyway.
Timothy Ash, a long-time analyst of Ukrainian political and economic life, works for Nomura International.
