No default in Ukraine, vows Yatsenyuk, despite Russian 'jail bonds'

By bne IntelliNews September 25, 2014

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Ukraine's prime minister Arseny Yatsenyuk said the country will not default and has all the resources needed to service its debt, including eurobonds issued to the Russian Federation in December 2013 under controversial terms.

“We strongly believe and we are confident that Ukraine will not default," Yatsenyuk said at the the Council of Foreign Relations in New York on September 25, according to Interfax.

"The former government had a number of deals with the Russian Federation, and these deals are and were not fair,” Yatsenyuk said. “They were more political, but you know Russians, they are not idiots. They usually try to facilitate a number of hooks in every deal…”

The key deal Yatsenyuk was referring to is the $3bn eurobond Russia bought from  Ukraine in December 2014, as part of a support package provided  in return for Ukraine not signing an Association Agreement with the EU in November 2013.

Critics have named these bonds “jail bonds” because of  the strings attached, in the form of cross-default clauses in the eurobond covenant stipulating that Ukraine's total sovereign debt not exceed 60% of GDP. The bonds mature in December 2015.

"Total state debt and state-guaranteed debt should not at any time exceed an amount equal to 60% of the annual nominal gross domestic product (GDP) of Ukraine," the covenant reads.

Underscoring Ukraine's fury at the hidden strings attached to the bond, Ukraine's state security service SBU announced criminal charges against former finance minister Yury Kolobev. According to the SBU, Kolobov “illegally transferred” $450,000 to Russian state-owned investment bank VTB Capital as a fee for  selling the bonds, newswires report. The move could be a precursor to Ukraine moving in court against the terms of the covenant as so-called 'odious debt,' incurred by a previous regime against the interests of the state.

With Ukraine's GDP collapsing,  large new foreign loans from the International Monetary Fund, and a slide in the exchange rate causing foreign debt to soar, many believe it is inevitable that Ukraine will breach the 60% GDP limit.

Commerzbank analysts believe that limit was already breached when the currency hit UAH13 to the dollar. The IMF forsees Ukraine's debt-to-GDP reaching 67% by the end of 2014.

"There is little doubt the ratio will be crossed," said Standard Bank analyst Tim Ash in a research note. "Russia will likely use this issue to make life very difficult for Ukraine." According to Ash, the officially binding calculation of Ukraine's debt-to-GDP ratio can however only be made in March 2015 when national accounts for 2014 are published. 

According to Ash, Ukraine's Finance Minister Oleksander Shlapak told Ukraine's banking summit in Lviv that he expects Moscow to demand early repayment of the $3bn bond, causing Kyiv to draw it down from its IMF funds. 

Apart from the Russian-held eurobonds, however, 40% of Ukraine's foreign debt is believed to be held by US fund Franklin Templeton, according to Reuters, which could make debt restructuring nearer December 2015 easier for Ukraine – and increase Russia's incentive to demand early repayment sooner. 

Speaking in New York, Yatsenyuk called for a new IMF programme to take account of the impact of the war in East Ukraine – and possibly make it easier for Ukraine to pay back the Russian 'jail bonds'.

"Probably we do understand that we have to re-adjust the programme, because when we started the program with the IMF, it was a peace program,” Yatseynuk said, according to wires. “For today, this is the wartime government and wartime programme,” he added.

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