Trying to find a fast, profitable investment?
Maybe it’s time to look into hryvnia bonds.
The National Bank of Ukraine is trying to convince the population to invest more in hryvnia-denominated bonds issued by the Finance Ministry.
Available at high yields – up to 18.5 percent for a six-month bond – the instruments could allow Ukrainians to store their wealth in a high-return product while helping the government finance itself.
But the trend is ripe for arbitrage as well. As a case that stretched from January 2018 to this past August shows, foreign investors can combine the products with Ukraine’s high interest rate to effectively game hryvnia trading into massive payouts.
“They blew $400 million on this,” said Oleksandr Savchenko, a former National Bank of Ukraine deputy governor and rector of the Kyiv International Institute of Business.
In the backdrop lies Kyiv’s frozen International Monetary Fund assistance program. With $8.7 billion disbursed on the $17.5 billion emergency lending plan, many analysts predict further falls in the hryvnia’s performance before the March 2019 presidential election, barring any agreement with the fund.
The program has stalled out on budgeting issues and whether Ukraine will raise household gas prices to import parity – both key IMF demands before delivering the next $2 billion tranche.
But the government may have found itself in a trickier spot with respect to its foreign exchange reserves thanks to the hryvnia bond issue.
The bonds
During the first half of 2018, the Finance Ministry issued a number of short-term hryvnia-denominated bonds with a 17 percent yield – pegged to the country’s interest rate.
The bonds have become a still-rare but increasingly popular place for Ukrainians to store their wealth.
Government figures show that over the course of 2017, investments among Ukrainians in government-backed bonds grew from Hr 104 million ($3.6 million) to Hr 2.4 billion ($84 million).
The trend comes from an often-overlooked consequence of the country’s banking collapse has been a precipitous drop in annual deposit growth rates.
After decades of rates as high as 60 percent turned nearly every Ukrainian bank into ponzi schemes of various intensities, the NBU, backed by foreign lenders, has attempted to clean up the situation by taking bad banks off the market and by incentivized banks to lower their growth rates.
That, in turn, has put pressure on Ukrainians, accustomed to the high growth rates, to find other profitable places to store their wealth.
In April 2018, for example, news website Censor.net published an article explaining how average Ukrainians could buy their government bonds.
Titled “how to buy state bonds and earn money off of them,” the story advises readers that “bankers don’t see potential in the growth of deposit interest rates. But those who have foreign currency income and buy hryvnia government bonds can receive extra income.”
It’s a profitable opportunity – the government offered them at a 17 percent growth rate, a potential killing for those with enough money to put down.
The trade
But non-residents of Ukraine take a far greater interest in the instruments.
Hryvnia-denominated bonds are profitable to foreign investors thanks to an operation called a “carry trade.”
The trade works like this: an investor sees that the Ukrainian interest rate is 17 percent – 15 percent higher than the U.S. rate of 2 percent.
The trader will then borrow dollars and use the cash to buy hryvnia, using it to purchase Ukrainian government bonds that pay out the 17 percent rate.
Once the bonds mature, traders can sell them off and repurchase the dollars to pay off the debt they incurred by borrowing them. Since the dollars were borrowed at the 2 percent U.S. interest rate – 15 percent lower than the Ukrainian one – traders can pay off their debt with a 15 percent profit.
The reality
Careful timing of seasonal changes in the exchange rate can spark even higher yields.
“The problem is that non-residents are very sensitive to different issues, political and economic, and they are very fast in bringing in and withdrawing money,” said Concorde Capital Analyst Oleksandr Paraschiy. “And this is why the Central Bank and Finance Ministry want the population to get involved, because the population is not that fast.”
Government officials and bankers say that Ukraine has seen a big example of this kind of trading over the past year.
In the winter, the hryvnia regularly reaches a peak of strength thanks to export payments. n January, the currency dropped to Hr 25.8 to the dollar.
Foreign investors began to buy hryvnia bonds en masse at the time, purchasing around Hr 14 billion ($504 million) in the first three months of the year, according to NBU statistics.
The inflow stoked anxiety in the NBU over concerns that traders could withdraw hundreds of millions of dollars en masse, weakening the currency.
“We are concerned about the influx of short-term capital because we remember the experience… of other countries that faced the outflow of ‘hot’ capital,” said NBU Monetary Policy Chief Serhiy Nikolaychuk in March 2018 remarks.
Paraschiy said that most of the traders intended to sell “in half a year when the hryvnia is traditionally seasonally strong, you can redeem your bonds and buy the dollars back.”
But according to Savchenko, the government essentially repeated the mistakes of dozens of collapsed banks in the bond issuance – offering too high a rate of return and stretching itself too thin to pay off its clients.
“The NBU, absolutely stupidly, began to support the devaluation of the hryvnia, wasted around 400 million, so that Western and Ukrainian investors received 17 percent interest,” he said, calling it “fantastical income.”
Paraschiy had a more conservative assessment of the situation, saying that since the Finance Ministry issued the bonds, “there is no other way” than to pay them off. The government had to pay out 17 percent in dollars that were neither brought into Ukraine or withdrawn, but it doesn’t constitute a material loss.
The larger issue is expanding the government bond market to average Ukrainians.
“The total share of residents in bonds is less than five percent – in neighboring countries its 25 to 30 percent,” Paraschiy said.
