Explainer-Ukraine Pushes For Debt Freeze To Dodge Hard Default

Ukraine has asked its creditors for a two year payment freeze on its international bonds in a bid to focus its dwindling financial resources on repelling Russia.

Creditors have until Aug. 9 to vote on the proposal. Ukraine has called its plan a liability management exercise, indicating Kyiv's efforts to spare bondholders a writedown on the bonds.

Official creditors have already said they would suspend payments owed to them and urged bondholders to accept the country's request for the freeze.

The group, including Canada, France, Germany, Japan, the United Kingdom and the United States, said they would provide a coordinated suspension of debt servicing from Aug. 1 to the end of 2023 and potentially for an additional year.

HOW MUCH DEBT DOES UKRAINE HAVE?

At the end of 2020, Ukraine had $130 billion in external debt outstanding, according to World Bank data.

Ukraine has earmarked nearly $20 billion in international bonds to be subject to the debt freeze - eleven dollar-denominated securities and two euro-denominated ones - maturing 2022 to 2030. Ukraine also has a warrant linked to GDP growth in the mix for an overhaul. This was created during its 2015 debt restructuring as a sweetener to creditors.

WHO ARE ITS EUROBOND CREDITORS?

Ukraine's sovereign bonds are held by major fund managers.

Filings gathered by EMAXX show that the world's largest asset manager BlackRock held $1.2 billion across various funds in the United States and the UK while Alliance Bernstein has exposure of $580 million with Eaton Vance and PIMCO each holding over $300 million of the bonds.

BlackRock declined to comment. PIMCO, Eaton Vance and Alliance Bernstein did not immediately reply to a request for comment.

WHAT IS THE STATE OF UKRAINE'S PUBLIC FINANCES?

Ukraine's economy has taken a massive hit from Russia's invasion on Feb. 24 with predictions for an economic contraction ranging from 35-45% for 2022.

Ukraine has estimated a fiscal shortfall of $5 billion - or 2.5% of pre-war GDP - a month, which economists calculate pushes its fiscal deficit to 25% of GDP, compared with just 3.5% before the conflict.

Since the start of the war and up until July 12, Ukraine has received $12.7 billion in external funding from international finance institutions as well as other governments, according to the finance ministry. Kyiv also raised nearly the same amount through central bank financing and domestic government bond issuance, chiefly through sales of its so-called "war bonds".

Rating agency Moody's calculated in a recent note that tax revenue is down over a third since the start of the invasion while government expenditure has risen some 36% over the same period, chiefly due to a 319% jump in defence spending.

The recent opening of an account at the International Monetary Fund (IMF) to channel donor resources for balance of payment and budget needs as well as SDR donations to the country had helped ease some of the strains.

WHAT CONSEQUENCES WILL A DEBT FREEZE HAVE?

A moratorium will instantly free up money for war expenditures. The finance ministry said it will help "mitigate the current $5 billion monthly fiscal gap," as the country won't have to tap its international reserves to pay hard currency bond maturities in a pressing financial situation.

"Most people have been expecting Ukraine to default since the invasion, so crystallising that in terms of a standstill makes sense," said Stuart Culverhouse, chief economist at London-based Tellimer.

Ukraine's proposal is a suspension of debt servicing but the question remains about how Kyiv will pay back those sovereign notes further down the line. A debt restructuring might be the next phase.

The government and overseas creditors would negotiate and eventually agree on new conditions for the bonds, which could include maturity extensions, haircuts or a combination of both.

"This won't be a permanent scar for Ukraine in order to regain market access," Culverhouse added. "Everyone can accept this is a consequence of Russia's aggression, and creditors will be prepared to look at Ukraine more favourably."

Ukraine last restructured its sovereign bonds in 2015.

WHAT WILL HAPPEN NEXT?

Bondholders have received a formal consent solicitation - an offer from the issuer to change some of the terms of the bonds' contracts.

Ukraine's finance ministry held a conference call with creditors to explain details of the proposal and wider points on Wednesday.

Creditors have until Aug. 9 to vote on the proposal, with results due to be published the day after.

There is some precedence for what is happening on the sovereign side. Last week, Ukraine's state-owned energy company Naftogaz requested a two-year debt payment freeze from its creditors.

That proposal raised some hackles with creditors who felt the timeframe of the freeze was too long.

"Why two years? It's not clear, but it doesn't seem the war is going to end soon, and it is very hard to do a debt sustainability analysis in this situation," said one creditor, who asked not to be named as the talks are private.

"It is not clear if this (sovereign) proposal is going to be widely accepted by creditors, there might be some push back from creditors to cut down the payment freeze."