A revolution in the Ukrainian bond market is about to take place this month that should provide ample financing, raised on the domestic, not international, capital market to deal with a debt mountain Ukraine is facing this year.
In the next five years bond repayments will rise significantly and it was not clear whether the government could make its payments. A restructuring deal cut by former finance minister Natalie Jaresko kept debt repayments down to under $10bn a year for the last five years, as Ukraine emerged from an almost total collapse of its economy in 2015. Now those payments go up considerably to $16.1bn this year, according to JP Morgan, followed by $12.8bn in 2020, $13.8bn in 2021, $14.7bn in 2022 and $15.2bn in 2023.
It’s going to be tight, but assuming a receptive international capital market and a moderate expansion of the domestic capital market Ukraine should be able to cope with the increase. Indeed, Ukraine seems to be in luck, as after the US Federal Reserve bank made it clear it was not going to continue its tightening of monetary policy a window has opened for emerging markets bond issuers into which issuers have rushed: emerging European companies and governments have already issued a total of $27.3bn of debt in the first quarter and bond traders' appetite is not yet sated.
In April Ukraine is due to be hooked up to the Clearstream international payment and settlement system that will plug its financial market directly into the global capital market system. That means bond traders can buy and sell Ukraine’s local sovereign bonds from the comfort of their dealing desks in London and New York, without having to go through expensive local brokers.
When Russia made the same reform in 2012 it transformed the local capital market as some $20bn of foreign money flooded the market, providing an essential source of fresh capital to finance the Russian budget. Even with last year’s sell off foreign investors still hold some 30% of all the outstanding ruble denominated OFZ treasury bonds, and those have been selling like hot cakes in the last two months thanks to a return of “risk-on” sentiment amongst international investors following the signals from the Fed.
Yield hungry foreign investors have already been getting into the Ukrainian debt market, buying up the locally issued dollar-denominated sovereign Eurobonds that has allowed Kyiv to meet last year’s obligations as well as the UAH debt.
The finance ministry issued UAH8.2bn, UAH7.7bn, $13.5mn and €2.6mn worth of bonds of various maturities at its weekly auction in the second week of April. And the amount raised on the domestic market has already doubled from UAH32,755mn ($1.2bn) in 2017 to UAH65,128mn in 2018, with as much raised in the first quarter of this year, UAH33,695mn, as was raised in all of 2017. Following this trend, Ukraine’s finance ministry can raise at least $2bn a year from the domestic market and probably more.
But meeting this year’s obligations is going to be tough. The debt numbers only just add up and that assumes there are no more shocks or surprises – a risky bet in Ukraine.
Currently most of Ukraine’s debt is held by its banks and the central bank and over half is denominated in foreign exchange: $22.5bn is outstanding Eurobonds (33% of the total). Another $15.1bn is debt to international financial institutions (IFIs), which is 23% of the total, domestic UAH debt is $22.4bn (33%), domestic FX debt is $5bn (8%), and another $2.1bn (3%) is external debt.
With $16.1bn to pay this year (and $613mn and €70mn is already due in April) Ukraine is expecting a total of $3.8bn from the new International Monetary Fund (IMF) deal signed in December, perhaps another $2bn from other international donors including the World Bank and the European Union (EU). And assume $2bn of issues on the domestic market. Add all that up and it comes to $7.8bn -- well short of the $16.1bn needed so a lot will depend on the Ministry of Finance borrowing programme.
The Ministry of Finance tellsbne IntelliNews that in 2019 its borrowing plan is $11.6bn, which includes $6.9bn of domestic debt issuances, $4.2bn of external borrowings, both commercial and concessional, and $0.6bn of privatization proceeds.
From $4.2bn of external borrowings Ukraine has already received €529mn loan arranged and provided by Deutsche Bank under the Policy Based Guarantee from the World bank and a $350m tap from the outstanding $1.25bn 9.75% notes maturing in 2028. There is another €500mn of EU MFA program money anticipated in the first half of this year and there are ongoing negotiations on providing concessional financing from the other official lenders. On domestic market $4bn out of $6.9bn planned borrowing has already been taken in.
“During this year, the Ministry is focused on maximizing funding from official lenders. The decision on the placement of government Eurobonds will be based on the market conditions and the residual amount of required financing,” Alla Danylchuk, head of investor relations at the ministry said.
Taken all together then Ukraine could raise over $19bn this year (if you include the $6.9bn of UAH domestic borrowing in the total) and just the donor and Eurobond issues in foreign exchange will just about cover the $16.1bn needed to refinance Ukraine's obligations this year.
Closing the gap
The Clearstream deal could make life even easier and the Ministry of Finance is getting ready to entice more investors into the local market with a revamped website, slick presentations and a “how to access UAH domestic government bonds market?” guide on the ministry website.
In the current borrowing plan 67% is in foreign currency but the state wants to expand the amount it borrows in local currency to reduce the FX risks and diversify the investor base.
Today 48.5% of the total domestic bond portfolio is held by domestic banks, followed by the National Bank of Ukraine (NBU) with 44.5%. Foreign investors account for a tiny 3.3% of the total, but that is already up from nothing two years ago. Last year the share of foreign investors' holdings went up 600% to the current total of $512mn in the first quarter and UAH19.5bn as of April 1, 2019.
And with the advent of Clearstream it will grow more. In the first two years after Russia opened its bond market to the outside world foreign investors sunk over $20bn into Russian fixed income instruments. If Ukraine follows a similar trajectory then foreigners could invest up to $4bn into Ukraine’s domestic market in the next two years, which will allow it to comfortably meet all its obligations over the next five years.