Ukraine could be forced to restructure or reissue its debt if further devolution of its provinces takes place, according to a new report.
Bank of America Merrill Lynch analyst Vadim Khramov on Tuesday outlined a range of separation scenarios and their likely impact on the Ukrainian economy and its bonds.
In his base case, Ukraine is pressured into deep constitutional reform which leads to a more federal and decentralised Ukraine without formal separation. But he said full separation would pose a risk to IMF financing and — in the worst case — a default requiring “external and local debt restructuring with sizable haircuts to bond values”.
On Sunday the Donetsk and Luhansk regions of eastern Ukraine held referenda and voted overwhelmingly for independence. Although neither is likely to be recognised internationally, Russia is likely to use the votes to pressure Ukraine into constitutional change. Luhansk, Crimea and Donetsk between them comprise about 20% of Ukrainian GDP, population and employment, 26% of exports and 9% of imports, Khramov said.
Khramov said that as long as decentralised regions continued to transfer fiscal revenues to the central government or arrange to cover external debt payments, there should be no threat to the IMF programme to assist Ukraine in meeting its debt repayments. Even if Donetsk and Luhansk eventually gain full autonomy, the IMF is likely to continue the programme, he said.
But if the Kharkiv region were to separate, bringing the total of Ukraine’s GDP affected to 25% as well as a large chunk of industrial production and exports, that would tip the balance.
The worst case would be the further separation of eight southeastern regions, which would lead to substantial GDP and revenue loss, devaluation, and increase government debt to almost 120% of GDP. The southeastern regions comprise 63% of industrial production and 54% of total exports, BAML said, and their loss would be debilitating to the current account and the coverage of external financing needs. “In this scenario, debt dynamics would become unsustainable,” Khramov said, and debt restructuring would be inevitable.
Other economists are looking at Ukraine with mixed feelings. “The bullish case is that you’ve got the IFIs committing upwards of $30bn, and that provides an enormous backstop in terms of the sovereign’s financing and reserves position,” said Stuart Culverhouse, chief economist at Exotix. “That should ensure the bonds that mature this year are paid. Ukraine is not heavily indebted, with public debt only 40% of GDP; the issue is more about liquidity where there is difficulty in rolling over debt.”
There are two caveats, though, he said. “Firstly, to the extent that we see further economic deterioration — and that’s possible given the political circumstances — the financing needs may increase.” Deeper recession brings problems at the corporate level or in the banking system, with exchange rate weakness that increases debt burdens. “If the debt burden increases, it may be the IFIs are happy to provide $30bn, but what if it becomes $50bn or $60bn?”