Sovereign credit risk soars in Ukraine

The country is likely to avoid a default on existing obligations, but only if it keeps the IMF on board through continued commitment to reform.

After a long recovery from the crisis of 2014-15, Ukraine’s macroeconomic stability has taken another large blow. Fiscal rollout in response to the coronavirus crisis, as well as a contraction in GDP that could come to anything between 5 and 10% in 2020, mean that the budget deficit will rise to at least 7% this year.

This will be financed through borrowing, but a sharp rise in bond yields earlier this year means that doing so on the market would have a prohibitive cost. If Ukraine is to repay its existing obligations, its only viable option is to access a US$ 5.5bn extended fund facility agreed with the IMF in December 2019 and another US$ 2.5bn of no-strings-attached coronavirus financing. 

The disbursement of the IMF loan hinges on the approval of a law prohibiting the return of PrivatBank, Ukraine’s largest lender, to its former owner, Ihor Kolomoisky. The bank was nationalised in 2016 after an audit revealed that some US$ 5.5bn had gone missing from its ledger due to insider lending – a case a UK justice called “fraud on an epic scale.” Kolomoisky’s proxies in parliament, however, have introduced 16,000 amendments to the law in a bid to block it. If they succeed, the IMF will probably refuse to disburse the loan, resulting in a need to restructure existing obligations by year-end.

However, we believe that parliament’s leadership will find a way to ensure the bill’s adoption within the next month, perhaps by changing procedural rules to allow voting on amendments in batches. That should ensure that the IMF loan is disbursed, and that scheduled repayments are made. 

Nonetheless, with a measured rebound likely in 2021, bond yields are likely to remain high, meaning that Ukraine may need further IMF financing to service its accrued debt. Any future IMF loans will require a continued commitment to structural reforms, producing new conflicts with lingering vested interests at the higher echelons of power. Since the outcome of these conflicts is uncertain, overall sovereign credit risk is unlikely to recede in the medium term.