Big debts and dwindling cash: Ukraine tests creditors' nerves


By Sujata Rao

LONDON, Oct 17 (Reuters) - It will be a jittery 18 monthsfor Ukraine's international creditors, who are weighing up its$60 billion-plus debt repayment schedule against itsfast-diminishing hard currency reserves.

Ukraine's presidential election in early 2015 is the focusfor investors, who reckon the government will then be willing tosign up to a desperately needed loan from the InternationalMonetary Fund. Before that, though, it would prefer to scrape byrather than accede to the IMF's politically difficult demands.

The country's debt problems shot into the spotlight thismonth when its state oil firm Naftogaz narrowly escaped default-- not through lack of cash but because of action by aU.S.-based creditor which successfully petitioned a UK court toseize a bond coupon payment in lieu of an old $22 million debt.

Ukraine paid the $22 million again to avoid default. But itcould ill-afford the extra payment, given central bank reservesare barely above $20 billion -- less than enough for threemonths of imports.

And many more payments loom. Over $60 billion, or a third ofthe country's GDP, is due in the coming year, central bank datashowed at the end of July. Of this the state owes $7 billion.

Add to this a $10 billion hole in the balance of payments,an economy stuck in recession and a government that plans toissue promissory notes in lieu of budget arrears, and it's easyto see why investors are worried.

With the exception of hedge funds and opportunists keen onthe high yields, most have ducked out, an exodus that gatheredspeed last month as Moody's cut Ukraine's credit rating to Caa1-- seven notches in junk territory.

"It's very simple. They are supposed to have $60 billion inmaturing debt and $20 billion in reserves," said Okan Akin, anemerging markets analyst at asset manager Alliance Bernstein.

"Even the healthiest Ukrainian company will find itextremely hard to refinance external debt before the sovereignsorts out its situation."

Swap markets currently rate Ukraine's default probabilityover the next five years at 50 percent, next only to Argentina,while a jump in short-dated bond yields and debt insurance costsreflect fears of an impending default

For its part, the central bank says Ukraine will meet itsforeign debt repayment obligations on time despite the decreasein its foreign exchange reserves.

What are Ukraine's options?

An International Monetary Fund loan would at a strokeresolve many of the problems, putting cash in the bank andreassuring global investors. But the IMF's loan conditions --currency flexibility and cutting energy subsidies -- will beunpalatable to a government facing elections in 2015.

Russia, Ukraine's main source of energy and bank loans, hasbeen angered by Kiev's efforts to cosy up to the European Union.

Export revenues are down, along with prices for steel, which comprises a quarter of Ukraine's exports. And if C-ratedUkraine were to issue Eurobonds, it would have to pay 10percent-plus yields to induce investors to buy.

The IMF starts a 10-day visit to Kiev this week but analystsare pessimistic about a loan deal before the 2015 election.

"The only thing which could force an early programme is ifthe hryvnia cracks, and Ukraine ends up going into a full blownbalance of payments crisis, pre-election," Standard Bank analystTim Ash said, referring to the tightly controlled currency.

"Given Ukraine's fundamentals that's not a low probability."


Without an IMF deal, what stands between Ukraine and defaultis the central bank's reserve chest.

While reserves have fallen by a third in the past year andare well under total maturing debt obligations across the stateand the private sectors, analysts reckon the government can atleast muddle through until 2015.

"Our base case is there will be enough cash to service nextyear's obligations but ... there is going to be a significantdrain on FX reserves," Barclays strategist Andreas Kolbe said.

Reserves could fall to $11-$12 billion by the end of 2014,Kolbe reckons, while Unicredit analysts are more pessimistic,predicting they could even crash below $5 billion.

The reserve depletion shows Ukraine is "increasingly runningout of ammunition to maintain even a sub-optimal status quo,"they said in a recent note.

On the plus side, Ukrainians have $23 billion in hardcurrency bank savings that the state can tap via domestic dollarbonds. Such issuance has raised over $3 billion this year.

Much will depend on the global bond market too, Kolbe says.

"Can they maintain status quo for 15 months until theelection? It depends on ... whether there will be a window ofopportunity to issue Eurobonds," he said


Ukraine's high yields may well persuade bond buyers tooverlook its troubles. Max Wolman, a fund manager at AberdeenAsset Management, says Ukraine makes up over 3 percent of theEMBI Global, the main emerging debt index and excluding it froma portfolio is not easy.

Wolman predicts, first, that creditors, including the IMFcould grow kinder to Ukraine after the expected Nov 28 signingof political and trade deals with the EU. Second, he expectsthat billions of dollars in outstanding loans and trade linkswill dissuade Russia from pushing Ukraine into bankruptcy.

Also, a third of the short-term debt burden is comprised oftrade credits which tend to be rolled forward, he notes.

"I am not saying Ukraine is a great credit but they have the ability to kick the can down the road and avoid default,whether they get money from Europe, from markets or Russia," hesaid.

And, if faced with the worst, there is always -- the IMF.

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