Ukraine Bonds Flag Default as Russia Has ‘Upper Hand’

Jan. 19 (Bloomberg) — Four years after Ukraine embraced the West with the election of President Viktor Yushchenko in the Orange Revolution, the former Soviet nation’s economy is collapsing and investors expect the country to default.

Even with the International Monetary Fund’s $16.5 billion bailout, Ukraine’s finances are deteriorating as the country battles with Russia over natural gas prices and the cost of steel, its biggest export, sinks.

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Yields on Ukraine’s $105 billion of government and company debt are the highest of any country with dollar-denominated bonds except Ecuador, which defaulted in December. The currency, the hryvnia, weakened 38 percent in the past 12 months against the dollar. The benchmark stock index lost 85 percent in 2008, the biggest drop in the world after Iceland, data compiled by Bloomberg show.

“The market is telling us there is a high probability of a default,” said Tom Fallon, head of emerging-markets at La Francaise des Placements in Paris, which manages $11 billion and sold its Ukrainian holdings six months ago. “It’s an advantage that the country is committed to policy measures that the IMF is prepared to back, but that is no guarantee it won’t default.”

The gap in yields between Ukraine’s bonds and Treasuries tripled in the past four months to 25.1 percentage points. The country’s bonds yield 9.6 percentage points more than debt sold by Argentina, which defaulted in 2001 and has yet to compensate all holders, according to JPMorgan Chase & Co. data.

Gas Dispute

Ukraine is getting battered after European steel prices plummeted 56 percent since August, according to data from Metal Bulletin. Industrial production fell 26.6 percent in December, the steepest decline in Europe, as the global economic slowdown cut international demand.

The country’s dispute with Russia over natural gas prices disrupted supplies across Europe and threatens to slow industry in Ukraine because of higher fuel costs, analysts led by Vienna- based Martin Blum at UniCredit SpA wrote in a research note this month.

Ukrainian Prime Minister Yulia Timoshenko returned to Moscow today after hammering out a deal during weekend talks with Russian counterpart Vladimir Putin. Ukraine will pay higher European prices for Russian gas from 2010, after a 20 percent discount this year. In return, 2009 transit fees for Russia will remain at last year’s level. Putin said gas transit to Europe will resume in full.

“Russia does have a bit of an upper hand, but an excessively weak Ukraine would not be a benefit to Moscow either,” said Ivailo Vesselinov, a senior economist at Dresdner Kleinwort in London. “The Kremlin has to balance keeping Ukraine stable so that does not spill over into a chaotic break- up, and preventing a move away from Russia politically.”

Divided Nation

The nation’s 46 million people are 45 percent Russian speakers and 55 percent Ukrainian, according to Dresdner. Ethnic Russians make up 17.3 percent of the population, compared with 77.8 percent ethnic Ukrainians, according to the Central Intelligence Agency Web Site.

While the U.S. is supporting membership to the North Atlantic Treaty Organization, Russia has warned the move would break the country into two states and prompt Moscow to aim missiles at Ukraine.

A feud between Yushchenko and Timoshenko has made matters worse as the collapse of their coalition government in September hampered policies to reassure investors. The central bank seized Prominvestbank, Ukraine’s sixth-biggest lender by assets, in October.

IMF Mission

The crisis led the IMF to provide $4.5 billion of emergency loans in November. Conditions for the credit include moving toward a flexible exchange rate, tackling inflation and running a balanced budget even though Ukraine’s parliament approved a 2009 deficit of 2.96 percent of gross national product. The government will partly cover the shortfall by selling bonds, according to the plan reached last month. Ukraine’s inflation rate is the highest in Europe at 22.3 percent.

An IMF mission is scheduled to visit Kiev this month before it provides a second payment in February.

“Without rapid correction, this could undermine the outlook for the second tranche,” said Ali Al-Eyd, an economist at Citigroup Inc. in London.

Ukraine’s economy, which expanded at an average annual rate of 7 percent since 2000, grew 2.1 percent last year. Gross domestic product may shrink 5 percent this year, Oleksandr Shlapak, the president’s deputy chief of staff said in November.

The slump coupled with the hryvnia’s decline increased concern that the government and companies will default after a fourfold jump in foreign debt since January 2004, according to data on the central bank’s Web site.

Maturing Debt

Citigroup, Credit Suisse Group AG and UBS AG arranged more than $8 billion of bond sales for the Ukrainian government since 2004, according to data compiled by Bloomberg. The country has to repay $1.4 billion of maturing foreign debt this year, according to Citigroup.

“I doubt Ukraine will default on the public debt, but at these sorts of high bond spreads the market doesn’t see it that way,” said Paul McNamara, who helps manage $1.2 billion of emerging-market debt at Augustus Asset Managers Ltd. in London, including Ukraine government and City of Kiev securities.

Investors demand higher yields from Ukraine than the average 18.1 percent yield on Argentina’s debt in October 2001, just before the Latin American nation defaulted. Ukraine’s yields are more than double the 10.8 percent Russian yields in the month before it defaulted in August 1998.

While a default by Ukraine is “not impossible,” it is not “imminent,” said Dmitry Sentchoukov, an emerging-market strategist at Dresdner in London.

Default Swaps

Ukraine’s yield spread narrowed to 25.18 percentage points from a record 27.38 percentage points on Dec. 30, JPMorgan data show. Ecuador, which stopped making payments in December on $3.9 billion of debt, has a yield spread of 37.46 percentage points.

AKIB UkrSibbank, the Ukrainian unit of BNP Paribas SA, sold $200 million of bonds in July 2007 at face value to yield 7.375 percent. The securities are now quoted at 57 cents on the dollar with a yield of 51 percent.

The cost to protect bonds sold by Ukraine against default jumped more than 12-fold in the past year to 3,489 basis points, the third-highest worldwide after Ecuador and Argentina, according to London-based CMA Datavision prices for credit- default swaps.

The contracts, conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point is worth $1,000 on a credit-default swap protecting $10 million of debt.

“Credit events are likely in the coming months,” said Dresdner’s Vesselinov. “At this stage we would expect the risks to be concentrated with the corporates.”

To contact the reporter on this story: Laura Cochrane in London at

Last Updated: January 19, 2009 11:16 EST
By Laura Cochrane

Source: Bloomberg

2 thoughts on “Ukraine Bonds Flag Default as Russia Has ‘Upper Hand’”

  1. I believe it is a complete nonsense about Ukraine’s default. First of all, Ukraine’s black economy exceeds by more than 50% its reported GDP. Secondly, the liquid reserves of the central bank are sufficient to repay the sovereign debts. Third. it is very likely that Ukraine will receive funding from the IMF. Forth, Ukraine is a large country and even though its exports (steel and chemicals) are now stumblimg, devaluation of UAH will bring a strong impetus for exports of other products (agricultural etc). Fifth, for those who have been to Ukraine and has seen the style of liviing in Kiev, it is rediculous to say that it is a poor country that can default.


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