Ukraine: living on borrowed money

Next year Ukraine will have to incur a huge debt in order to make ends meet. However, there are fewer and fewer creditors willing to provide it with the necessary financing. In the draft budget for 2021 the Ukrainian government assumed a deficit of 6 per cent, which means that it has to borrow UAH 704 billion, or approximately USD 25 billion.
Ukraine: living on borrowed money


The above amount is much higher than this year’s borrowing (UAH 642 billion) and comes in spite of a projected reduction of the deficit from the current level of 7.5 per cent of GDP. The main reason for this is that next year Ukraine will have to pay back the enormous amount of UAH 599 billion on account of previously incurred loans. As a result, these expenditures will take up as much as 12 per cent of the state budget.

Meanwhile, according to reports of the Ukrainian central bank (NBU), by the end of the first half of this year Ukraine’s debt had already increased to the very high level of 78.8 per cent of GDP. In the second quarter the debt of the government sector had already reached USD 52.9 billion (33.9 per cent of GDP), with foreign debt amounting to USD 46 billion (29.5 per cent of the country’s gross domestic product).

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The foreign debt of the NBU adds an extra amount of USD 6.9 billion (4.5 per cent of GDP). The debt of the private sector reaches USD 69.9 billion dollars (44.8 per cent of Ukraine’s GDP). However, a major part of these liabilities, reaching as much as USD 21 billion (13.5 per cent of GDP) is already overdue. Ukraine’s debt is primarily denominated in the US dollar (64.5 per cent), the euro (19.1 per cent) and the SDR, that is, the International Monetary Fund’s Special Drawing Rights (10.4 per cent).

The deficit is dragging Ukraine down

The experts are worried about the current deficit of the Ukrainian budget. According to Viktor Koziuk, a member of the NBU Council, Ukraine’s foreign partners will not tolerate such a situation.

The Ukrainian Ministry of Finance would like to reduce next year’s deficit to 6 per cent of GDP but admits that this is a difficult task. “Many experts believe that we can immediately secure a deficit at the level of 2-3 per cent of GDP. Well, let me explain to those who know how to count: if 1 per cent of GDP is UAH 45 billion, then a reduction of the deficit by 1 percentage point from the level of 7.5 per cent would mean a cut of UAH 45 billion. This means that a reduction to the level of 2 per cent would require us to cut our expenses by UAH 200 billion. When I ask them to show me which instruments or resources should be used for that, they just tell me ‘Well, this is what should be done in theory’. Yes, in accordance with the fiscal stability and debt policy criteria we are supposed to target a deficit of 3 per cent. Thanks to the balanced policy of the previous years, we were on the right track (…) Now, in the conditions of a pandemic, downward economic growth trends that we are observing this year, in the conditions of uncertainty in terms of consumer demand and potential export opportunities, we cannot afford to quickly reduce the deficit,” said the Ukrainian Finance Minister Serhiy Marchenko.

The government is not considering the option of increasing the revenue side of the budget.

 Interestingly enough, these arguments seem to indicate that the government isn’t considering the option of increasing the revenue side of the budget as a result of the supposed economic recovery, which has been announced on a number of occasions. And after all, this was the main argument used by the government in order to explain the repurchase of GDP warrants, which was heavily criticised by many experts.

Derivatives – loss or gain?

In 2015, the Ukrainian government signed an agreement with an international committee of creditors (including the American investment funds Franklin Templeton, T. Rowe Price, and TCW Group, as well as the Brazilian investment bank BTG Pactual) concerning the restructuring of USD 18 billion worth of debt on account of Eurobonds issued in previous years. The creditors agreed, among others, to write off USD 3.8 billion in debt, and to defer the repayment of USD 11.5 billion for four years. In return for these concessions the Ukrainian government provided the creditors with special derivative instruments known as GDP warrants. These securities give their holders the right to collect a certain type of “fee for development”. To put it briefly, Ukraine has undertaken to pay the creditors a portion of its GDP, which would depend on the rate of growth of the domestic economy. During the summer, the Ukrainian government bought back some of these securities.

“In light of the expected GDP growth, the potential payments from these state-issued derivative instruments could reach over USD 22 billion until 2040. Therefore, the government adopted a decision whose details are classified and which set out the conditions for the execution of this operation,” informed Marchenko during a meeting of the Ukrainian parliament’s Committee on Finance. The decision was based on the government’s forecasts indicating that Ukraine’s GDP would grow by as much as 4.6 per cent next year.

The critics of the operation believe that the government chose the wrong moment for the buyback of the derivatives, and that this transaction actually hurt the state’s finances rather than help. The decision on the buyback was announced on 15 August 2020, when the warrants were being sold on the secondary market for 86 per cent of their face value. The repurchase process was concluded on 8 September, when their price had already reached 97 per cent of the face value. Thus, the government drove up the price of the outstanding securities.

“We purchased the warrants below their face value and at a favourable moment. We calculated that even with the slightest GDP growth we would have overpaid USD 22 billion until 2040. If GDP growth reaches 4.6 per cent, as we are planning in 2021, then we would have to pay an additional USD 600 million on account of the warrants in 2023. (…) We should be praised that we conducted such an operation in the conditions of a crisis,” argued Marchenko.

Taking out new loans in order to pay off old debts

Meanwhile, “life based on borrowed money” has become the default mode of operation in Ukraine. Marchenko said that the country had to look for alternative ways of financing the deficit. In his opinion, “this isn’t really a big problem”.

In Ukraine small is not beautiful

This year, the Ukrainian budget obtained proceeds of UAH 20 billion from the issuance of hryvnia-denominated bonds. Meanwhile, the draft budget for 2021 assumes that this amount will increase tenfold – the revenues from the issuance of new bonds are supposed to reach UAH 200 billion.

The Ukrainian government would like these bonds to be purchased by banks, which in its assessment “have excess liquidity”. However, the implementation of this plan would mean that banks would have to completely suspend lending to businesses and private customers, which has already been very weak. This, in turn, would further detach the financial sector from Ukraine’s real economic life.

Pursuant to a draft act submitted to the Ukrainian parliament in September, the government would issue bonds for the amount of UAH 19.6 billion, or approximately USD 700 million. The funds obtained in this way would be used to repay state-owned intermediaries’ debts towards the suppliers of “green energy”. The state-owned energy company Ukrenergo and the state enterprise Guaranteed Buyer, which was created specifically for the purposes of the “green energy” transition, had been legally obliged to purchase energy derived from solar and wind power plants at prices far exceeding the market rates.

The ATM has had enough

It seems that Ukraine’s approach to the issue of debt is becoming increasingly annoying to its Western partners. “As I’ve already told the Ukrainian President, the European Union is neither a charity foundation nor an ATM,” wrote Joseph Borell, the EU’s chief diplomat, in an article devoted to Ukraine, which was published on the website of the European External Action Service (the European Union’s diplomatic service). The controversial portion of his post was removed after extensive coverage in the Ukrainian media. The publication coincided with the announcement that the EU would suspend the disbursement of a EUR 600 million loan promised to Ukraine during the summer.

Additionally, Ukraine may also miss out on new financing from the International Monetary Fund. The new tranche of assistance in the amount of USD 700 million was supposed to be disbursed by the end of this year. According to the Interfax-Ukraine News Agency, the main reason for the suspension of financing is the Ukrainian government’s failure to comply with the obligations contained in the memorandum signed with the IMF in the spring. However, without cooperation with the IMF it will be impossible for Ukraine to finance next year’s budget deficit. The authorities in Kiev want to issue further bonds for this purpose, but analysts at the Morgan Stanley bank estimate that such plans are unlikely to succeed in this situation.

Moreover, the share of non-residents in the Ukrainian bond market is gradually declining, which further increases Ukraine’s dependence on loans from the International Monetary Fund. The analysts at Morgan Stanley note that the possible termination of the current assistance programme wouldn’t be anything out of the ordinary, as the completion rate of the five previousprogrammes has only reached 40 per cent.

In September, the World Bank announced that it had lowered the amount of a loan aimed at supporting reforms in Ukraine.

 The fate of new financing from the World Bank has also been called into question. In September, the World Bank announced that it had lowered the amount of a loan aimed at “supporting reforms” in Ukraine by USD 300 million. Additionally, the initial amount of USD 350 million, which was approved in June, still hasn’t been disbursed. And these amounts were already far lower than the requests of the Ukrainian authorities – the initial discussions concerned a loan in the amount of USD 1 billion. The loan amount was ultimately reduced to USD 700 million because of the World Bank’s tight budget and the large number of loan applications from other governments.

Minister Marchenko argues that Ukraine will be able to cope even without the discussed loans. “On 1 September we completed a large payment of USD 2 billion and we did this on our own, without the financial support of our international partners we were hoping for. We are prepared for various scenarios, but we are still counting on the support of our international partners,” said Marchenko in an interview with the Interfax-Ukraine News Agency.