Both sides though still complain of major military troop buildups by the other side – Ukraine complained of 40,000 separatist troops in Donbas, plus another 50,000 Russian regular troops amassing the other side of the border in Russia.
The Berlin summit between President Petro Poroshenko, German Chancellor Angela Merkel and French President Francois Hollande, on Aug. 24 did not really yield that much, aside from some warm words from the Western leaders in support of Ukraine’s independence.
All urged compliance with the Minsk II ceasefire agreement, but nothing more specific in terms of how to ensure greater compliance.
Moscow has been calling for a return to the Normandy format peace talks (led by France, with Germany, Ukraine and Russia), but Merkel and Hollande played a strait bat, or “boule” perhaps being more appropriate.
As was the case, pre-Minsk II in February, there seems real reluctance from Merkel and Hollande to be dragged into a new set of negotiations with Putin – remembering the last Minsk II round went on long through the night.
Arguably, Merkel and Hollande are playing for time herein – which might have been the demand of Poroshenko, i.e. don’t get into a new round of talks with Putin over Minsk II implementation, as the status quo on the ground, likely benefits Ukraine most at this stage (allows efforts to rebuild defences and get on with implementation of key economic reforms).
Hence, the ball is arguably back in Putin’s court. That said, without renewed Western focus I see the risks as biased towards continued re-escalation on the ground.
Perhaps the prime focus for the market in Ukraine now is figuring the prospects and likely terms for the Ukraine restructuring deal.
Creditors’ “briefing” to the media yesterday, suggestive of a 20 percent haircut “on the table,” have likely complicated talks, and might have delayed an agreement somewhat – the two sides had previously agreed to limit/coordinate interaction with the media.
The 20 percent haircut is larger than had been mooted in the media only a few weeks back, but the quid pro quo might have been changes to the advantage of bondholders in other parts of the transaction – and this might still be difficult for the Ukrainian side, and International Monetary Fund to swallow.
Remember the three point “criteria” for the debt operation as per the IMF loan:
a) Generate US$15 billion in public sector financing during the program period;
b) Bring the public and publicly guaranteed debt/GDP ratio from a projected 80 percent of GDP to under 71 percent of GDP by 2020;
c) Keep the budget’s gross financing needs at an average of 10 percent of GDP (maximum of 12 percent of GDP annually) in 2019–2025.
As expected, the debt operation would also reduce, notably the gross financing needs during the program period (2015-18), from an average of 18 percent of GDP to 12 percent.
All three have to be broadly complied with, albeit there is likely to be some moderate give/take allowable by the IMF.
The two sides are seemingly not over the line yet – this is not just a question of preparing the paperwork, but the sides still have to finally agree to the fine detail. This could all still go wrong, but on balance – and given the payment of the coupon on the Ukraine 21s, the chances of a moratorium being called at this point have surely significantly receded. This is not to say that the deal cannot go square-shaped at the last minute, but on balance of probability a deal will likely be concluded this week.
The Ministry of Finance will surely hope that the step up in the haircut will make this deal easier to sell at home – a 20 percent haircut is surely better than the 5 percent, then 10-15 cents initially mooted.
Could they have got more – possibly, but then the risks would have been a debt moratorium and all the negative publicity around that. They will hence argue that through this deal a damaging debt moratorium was avoided, and Ukraine has again shown it wants to be investor and market friendly, so facilitating potentially its early re-entry to international capital markets (albeit unlikely before later in 2017).
Seemingly the fund – or at least mission staff – seems comfortable with the broad contours of the debt reduction being mentioned. That said, I still find the 20 percent haircut on the low side, at least from a DSA perspective – and reviewing the IMF EFF staff report this relies on very optimistic assumptions in terms of REER appreciation in later programme years. More credible debt reduction would surely come from fiscal adjustment, state asset sales, and debt restructuring (write downs), which are much more tangible in my mind. But seemingly, the IMF and the MOF are more mindful of the bigger picture herein – and the assumption that everything comes with a price, i.e. securing a larger haircut would be at the risk of a debt moratorium and a bigger break in relations with private sector creditors. The MOF might also be mindful that if this deal proves unsustainable from a DSA perspective, Ukraine can always come back to the table – albeit not sure that this would be optimal, a la Greece experience.
Pricing any potential deal is still fraught with difficulty, given the still lack of fine detail over the contours of that deal – aside from now the 20% haircut indicated by the WSJ yesterday.
One issue to debate is surely exit yield, and therein I tend to think that Ukraine, post restructuring, should price in the 9-10% range, or thereabouts. Comparables would likely be Iraq (28s yield 9.15%) and Belarus (18s yield 10.2%), Ivory Coast (32s yielding 7.5%), then Armenia (25s yielding 7.9%), and on the top end the likes of Ecuador (24s yielding 13.3%). My best sense herein is that it should sit someway between Iraq and Belarus. Like Iraq, Ukraine is still a conflict credit. Iraq has much lower debt and has the benefit of oil resources (albeit currently on a downward trend) but Ukraine has a much better reform story now, and strong IMF support, and as part of the debt deal being negotiated Ukraine will face little private sector debt service over the duration of the EFF. But arguably both face security threats to their territorial integrity and hence ability to pay, which will keep yields elevated – and well above the likes of Armenia in my view.
Pricing the value of GDP warrants will also be a pretty imprecise science also related to the call on the security situation. If like me, you expect further re-escalation, which will seriously impact on macro outcomes, GDP warrants will have limited value in effect.
And, also there remains the issue of the Russia bail-bonds. I think it is very unlikely that Russia will play ball with the current restructuring – albeit the Ukrainian side are trying to roll these into the pending private sector agreement. Moscow is (very) unlikely to participate, but instead attempt to call these London club liabilities, and then call Ukraine into arrears, further complicating relations with the IMF. I do not expect these bonds to be paid out in full in December, under almost any reasonable scenario. Rather come early next year, as these bonds inevitably move into arrears, IMF shareholders will have to make a call whether they are willing to continue to lend to Ukraine, with official arrears outstanding. That will likely be a further stress point for the market, and perhaps also something which needs to be priced into exit yield.
