Putin Scores Victory Over Ukraine Allies in Bond Market Collapse
As a separatist insurgency in eastern Ukraine pits Russia against its Cold War-era foes, the conflict is also playing out in the trading rooms of Wall Street banks and hedge funds. Investors trying to anticipate the next move of rebels backed by Russian President Vladimir Putin are also weighing the ability of the Kiev government’s allies to counter the Kremlin’s economic maneuvers as Ukraine seeks to restructure its $16 billion of foreign-currency debt.
Ukraine has $5.4 billion in Eurobond principal and interest payments due this year and $6.4 billion in foreign reserves, a record low and down 64 percent from a year earlier.
The nation’s $2.6 billion of benchmark notes maturing in July 2017 dropped to a record 41.3 cents on the dollar this week from almost 57 cents on Feb. 12, when the IMF loan was announced, and above par in July. The bond traded at 41.80 cents on Wednesday. The hryvnia weakened to a record 33.5 per dollar on Feb. 24 from 9.725 a year ago.
“We see increased risk of substantial haircuts” reducing the bonds’ coupons or their face value, Vadim Khramov, a London-based economist at Bank of America, said in an e-mailed report on Tuesday. Even such a restructuring may not be enough “if the hryvnia’s devaluation is not managed, leaving debt dynamics unsustainable,” he said.
The plunge prompted the central bank to tighten capital controls twice this week, with the second spate of measures effectively freezing the country’s trade on Wednesday.
With much of Ukraine’s industrial base ravaged by the fighting in the Donetsk and Luhansk regions, gross domestic product shrank as much as 7.5 percent last year, the Washington-based IMF estimates. The economy will probably contract 5.5 percent in 2015, Finance Minister Natalie Jaresko said Feb. 16. GDP fell 15.2 percent in the fourth quarter from the same period of 2013, the most in five years.
While policy makers in Kiev share some of the blame, Ukraine’s allies have also been too slow to react to Putin’s moves, according to Otilia Dhand, an analyst at political-risk advisory Teneo Intelligence in Brussels. The process has suffered delays because of the need to coordinate policy between the U.S. and Europe as well as gaining consensus within the 28 EU nations, she said.
“The speed of making and implementing decisions is much faster on the Russian side and that obviously puts Russia at an advantage,” she said by phone Feb. 24. “The pain can be inflicted faster than the remedy can be administered.”
Getting the lender’s consent will become more challenging if pro-Russia rebels continue their advance and seize territory such as the strategic port city of Mariupol, one of the people said. A second person said that while a worsening conflict would complicate approval, IMF country representatives are likely to maintain their support unless an open conflict with Russia breaks out affecting the majority of Ukraine. Both people asked not to be identified because the matter is confidential.
While the holders of Ukraine’s foreign-currency debt lost 25 percent this year, the most among 58 nations in Bloomberg’s USD Emerging Market Sovereign Bond Index, investors don’t expect the country to be abandoned by its financial backers.
The hryvnia’s free-fall is adding to the financial distress by driving up prices of imports, including oil and gas, as well as boosting the cost of repaying foreign bonds.
The government seeks to negotiate a debt-reorganization agreement with bondholders by June. A deal may be delayed by continued fighting with separatists and Russia’s opposition to restructuring, Andrew Matheny, a Moscow-based economist at Goldman, said in a research note last week.
Trying to stem the outflow of capital, the central bank restricted importers’ purchases of foreign currencies on Feb. 23. and two days later banned commercial lenders from buying currencies for their clients, freezing the hryvnia market.
“The Ukrainian economy is in serious liquidity crisis with its external financing needs rising,” Lilit Gevorgyan, senior analyst at IHS Global Insight Inc. research company in London, said by e-mail on Monday. “Even with the help of donors, Ukraine’s currency can only start stabilizing when the armed conflict freezes.”