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Circling bondholders: the debt treatment of Ukraine
The starting gun has been fired on negotiations concerning the debt treatment of Ukrainian sovereign debt.
Bondholders are circling around forming various creditor groups. From what we can see, the Ukrainian-side bilateral creditors and donors are ‘going with the flow’. But the issue of frozen Russian assets makes Ukraine an unusual case.
In fact, debt treatment was required by the International Monetary Fund (IMF) as a condition of its US$15 billion+ Extended Fund Facility (EFF) for Ukraine, and as its modus operandi, this was expected from the IMF. Yet, as per the IMF programme, the contribution from debt treatment to cover Ukraine’s US$122-140 billion gross financing gap is around US$14.8 billion.
We believe the problems with this are numerous
First, the IMF presents its macro framework for the period 2023-27 as the basis for the Debt Sustainability Analyses (DSA). But how credible is any macro framework in a war? How can the IMF make any credible longer term macro forecasts when outcomes are so war and security related, areas that lie outside of its expertise? Moreover, how can one conduct any DSA when the macro framework is so uncertain? This is in the realm of ‘finger in the air’ analysis.
Second, why rush with debt treatment? Why not wait for the end of the war when the macro-outlook and DSA will be much clearer? Surely it would make more sense to simply extend the 24-month debt service suspension agreed in August 2024.
The answer to that is the enormity of Ukraine’s financing needs for recovery and reconstruction. The appetite of the Western taxpayer to fund Ukraine’s recovery and reconstruction needs (over US$400 billion1) are limited and, as per the Ukraine Recovery Conference in London, the message is that the private sector will need to do the heavy lifting and, likewise, early market access for Ukraine will be key. Therefore, moving ahead with a debt restructuring to clear the decks will put Ukraine on the starting line as soon as the war ends.
We would counter though that even with an early debt treatment, given all the other issues around Ukraine (security risks, governance and issues with rule of law etc) the private sector cannot be expected to do the heavy lifting on what is, in reality, an important matter of public interest in the West. Furthermore, Western private sector investment into Ukraine in the immediate post-war period simply won’t touch the sides compared to the true financing needs.
Third, even on the financing assurances front, the IMF programme lacks credibility. The US pledge of US$22 billion for the period 2023-2027 must be in doubt given the difficulties getting the US$61 billion Ukraine financing bill through the House of Representatives, not to mention that if Trump wins presidency, US funding will likely drop off a cliff.
In reality, Ukraine’s gross financing needs are greater than US$122-140 billion. The total cost - military and fiscal - of keeping Ukraine afloat is closer to US$100 billion per annum in war, and likely US$50 billion per annum in peace. Around half of the current cost is being covered by the US – so, one must ask, is Europe likely then to fill the gap left by the US pulling support under Trump? We believe this is unlikely.
The military costs should not be ignored in this discussion - if this gap is not filled, Ukraine loses on the battlefield and then the macro framework and financing gaps deteriorate significantly.
Finally, the moral and equity issue of utilising immobilised Russian assets. The IMF makes zero reference to immobilised Russian assets in its latest staff report, why?
Russia is responsible for the war in Ukraine, economic losses, war crimes and human atrocities. There are over US$300 billion in immobilised Russian assets in Western jurisdictions potentially available to fund Ukraine through the war and then in a post-war recovery. However, arguments such as rule of law, reserve currency risk, and fear of Russian retaliation, appear to be holding back momentum here.
On the equity issue, current Western policy of avoiding seizing and allocating frozen Russian assets for Ukraine means that Western taxpayers are footing the bill for Russia. The case could be made that the interests of Russian taxpayers are being put above those of Western taxpayers.
Looking ahead
One take is that by holding out against any debt treatment at present, private bondholders are revealing the reality of the unsustainable financing picture, as presented by the IMF and Western governments.
In supporting the current debt treatment framework, bondholders risk ensuring Ukraine never secures the US$300 billion+ in immobilised Russian assets. Indeed, by supporting any debt relief deal they effectively help extend an unsustainable Western financing model, which increases the risk of eventual Ukrainian defeat.
When it comes to achieving a credible and sustainable financing plan for Ukraine, private creditors could be in a position to provide the cold water, if not the bucket.
1 World Bank/Kyiv School
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