Ukraine has at least $1bn of debt to repay this autumn but only $17.7bn as gross international reserves (GIR), equivalent to three months import cover, the safe minimum countries need to keep their currencies stable.

The Ministry of Finance has been trying to raise money with euro- and dollar-denominated bonds issued on the domestic market, but demand for these bonds is running out. On August 23 the government surprised bankers by placing a $750mn Eurobond via a private placement, which means enough cash has probably been raised to meet this autumn’s redemption needs. But with debt payments ballooning next year, doing a new IMF deal is key.

bne IntelliNews editor-in-chief Ben Aris talked to Mykhaylo Demkiv, a financial analyst with ICU, Ukraine’s leading investment bank, about the problems the government is facing.

BA: Can Ukraine survive without another IMF tranche?

MD: Without the IMF, Ukraine would find itself in a very problematic situation. Its reserves are close to three months of future import. So, after the next payments on August 31 and then in September of more than half a billion dollars, the reserve would fall below this level. Without the IMF, the government is going to struggle to keep reserves above this threshold.

BA: The government has already made some debt repayments and spent more than half a billion this summer to meet domestic demand for currency, dipping into the reserves to meet this demand. The result was the hryvnia has started to slip, but what happens next?

MD: The hryvnia is subject to seasonal factors. It appreciated a lot in spring, by as much as 10%. Now, we expect the reserve in the autumn. The fall was anticipated but came sooner than expected due to the negative sentiment on emerging markets. Without the IMF, there is less confidence in the hryvnia and we risk devaluation.

BA: The government surprised by getting a $750mn Eurobond away, it said on August 23, which will close most of the funding gap for this year.

DM: This was an unexpected issue. A year ago, the Ministry of Finance successfully issued a 15-year Eurobond worth $3bn. It was partially used to roll over maturing debt and half used to bolster reserves. Now, we saw a very short six-month issue that you do not see every day and there was almost no road show. The yield was high – around 9% – higher than bonds on the domestic market.

BA: Yes, the low demand means there is pressure on the Ministry of Finance to increase the yield on bonds that are currently yielding 5% or so.

MD: The Ministry of Finance has been placing internal bonds and paying 5.5% on dollar bonds and 4.5% on euro bonds. But there is some arbitrage as they are borrowing on the international market by offering higher yields on the domestic bond issues; however, the local banks cannot buy or borrow externally due to the capital controls.

BA: With the latest Eurobond, it looks like the government can scrap through this year. But with $7bn to pay next year, doesn't it have to have the IMF’s help?

MD: There is a low demand for the bonds [on the domestic market]. We are talking about the rollover for many of the bonds. The banks are the main holder of local debt in foreign currency and are rolling over their debt. They have to make large repayments. In September alone, they attracted $70-80mn more than they have to repay. But the government can’t rely on the local market to make sure it meets the next repayments of external debt. The liquidity of Ukraine’s banks in FX is about $3-4bn. Obviously, only part of those funds can be used to buy local bonds as they need some cash for daily operations to meet depositor demand. The Ministry of Finance can probably attract $100-200mn more from the local market but not more. So, it has to rely on IMF and other International Financial Institutions (IFIs).

2018 and 2019 are the peak years for repayment. Our base case scenario is the government does an IMF deal. It gets the next $1.9bn tranche as well as $800mn from the World Bank [that is tied to doing an IMF deal] as well as $1bn from the EU. Then the government negotiates a new IMF deal, which is due to expire in March.

The government could go to the external markets and pay huge yields to raise money, but it is not the best idea. The government has few options other than to agree with the IMF terms. And the prime minister has said he will raise gas tariffs.

BA: Hiking domestic gas tariffs was a core IMF demand. The other issue was to contain the budget spending to a 2.5% GDP deficit – and next year is an election year. With President Petro Poroshenko’s popularity in the toilet, the government will be tempted to launch a big social spending spree. That means promises now to get the cash and reneging later to get the votes. Can the IMF enforce any deals it does?

MD: The IMF deal helps the government deal with external debt repayment. But it is unable to simply print money as we have built successfully an independent National Bank of Ukraine (NBU) that is in a cycle of increasing rates – from 12.5% in 2017 to 17.5% in September – to control inflation, which is increasing the cost of bonds, too. So, the government has no option to increase the minimum wage or pensions simply to please the voters.

BA: Thank you.

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