What will happen if Ukraine defaults?

By bne IntelliNews June 12, 2015

Graham Stack in Berlin -


With Ukraine edging closer to the world's first unilateral sovereign default since Argentina's in 2001, analysts are grappling with the question of how this might impact on the ex-Soviet republic as its strives for deeper integration with the EU and the West.

Ukrainian default on $23bn of sovereign debt to bondholders is now on the table,   Finance Minister Natalie Jaresko indicated to journalists during a visit to Washington on June 10. If bondholders failed to agree with Ukraine's terms, "I'd have to use other tools to reduce the pressure on the balance of payments. A moratorium [on payments to bondholders]," Jaresko said, adding, "I don't think we have that much time."

According to debt analyst Aleksander Paraschiy of Concorde Capital in Kyiv, Ukraine could “use the moratorium during the next 10 days”. The first opportunity arises on June 17, when the country is due to pay a $39mn coupon on a $1.25bn Eurobond due in 2016, and then on June 20 when Ukraine has to pay $75mn on a $3.0bn Eurobond held by Russia.

What will happen if Ukraine does what was until recently unthinkable, and becomes the first country since Argentina in 2001 to declare a unilateral moratorium on payments?

Jaresko herself argues that Ukrainians have nothing to fear. In a long interview in Zerkalo Nedeli on June 6, the US-born minister seemed to be preparing the ground for a default. “To be honest, it [default] will not effect Ukrainians…The law we passed on the moratorium on payments will have one effect: forex will stay in the country, helping to reduce pressure on the balance of payments,” Jaresko said. “We own no property abroad [that could be confiscated].”

In Argentina's footsteps

Some analysts fear that despite these assurances, a default will unleash mayhem on Ukraine's already comatose financial system.

“The truth is that a unilateral moratorium on foreign debt payments will undoubtedly have both immediate and long-term effects on all Ukraine’s residents, companies and households alike,” argues Oleksiy Andriychenko, an analyst at the Art Capital brokerage.

“Right after the default, the understanding that Ukraine’s access to capital markets can be closed for a long period of time will lower expectations of Ukraine’s economic growth among investors, local banks and companies and even lay people, who still remember the economic hardship at the end of 1990’s after Russia’s default,” he explains. “Ukraine will sink into a period of low economic growth that can last for more than a decade, as evidenced by Argentina’s case.”

“The population will try save the remainders of its savings by taking them out of banks and buying foreign currency if possible. A true banking crisis might emerge unless the National Bank of Ukraine reacts quickly, allowing the banks to limit access to deposits. Ukrainians will be forced to cut consumption, some will lose jobs,” Andriychenko continues.

“Since Ukraine will be shunned from foreign capital markets, financing the rising needs of state and local budgets will be done through hryvnia emission with direct consequences for inflation and real economic growth. Not only will the state be shunned from the capital markets, but also Ukrainian corporates, which will undoubtedly hurt their ability to invest, pay high salaries, and carry out any expansion plans,” he says.

'Internal default'

Andriychenko's gloomy analysis echoes that of billionaire philanthropist George Soros, who warned in January in an international plea for financial help for Ukraine that, “a default would have disastrous consequences.”

But Nick Piazza, CEO of SP Advisors, argues that since then, Ukraine has in fact already gone through an “internal default”, in the form of steep devaluation in February only stemmed by the imposition of stringent capital controls.

“Default happened for most Ukrainians in February. Everyone is already used to it. Now some guys in New York will feel what the man on the street has for three to four months already,” he says.

“Everyone that can is already dollarised. Banks aren't lending, there is no [foreign direct investment]. What else can happen? I'm not saying [it would be] nothing, but it won't be colossal. A bigger event for forex would be a bad harvest, or attack on Mariupol – that would launch hording again,” Piazza adds.

Other analysts are closer to Jaresko's position. According to Aleksander Valchyshen, head of research at Investment Capital Ukraine, the brokerage founded and previously headed by current central bank head Valeriya Gontareva, Ukraine's tight capital controls have already "proved useful in having an impact on the local market by cooling down domestic demand for USD cash”.

According to Valchyshen, Ukraine has in recent months received enough foreign funding to create an airbag against the shock of default. “All these [international fundraising] efforts since March 2015 are producing a net FX inflow, while previously there was a net outflow of FX,” he says.

Valchyshen argues that whatever the outcome, default will be a better deal for Ukraine than ploughing on with unsustainable levels of debt. “Jaresko and the IMF's call to reduce debt nominal has its logic – to produce a sustainable public debt for an economy that very badly needs growth not burdened by debt of 100% of GDP,” he says.

“Without that nominal reduction, Ukraine's economy risks entering an untested period when the public debt level is projected to be in the 95-105% range,” he adds.

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