In Background, Ukraine

Ambrose-Evans-Pritchard, The Telegraph (UK), 14 Nov 2014

The International Monetary Fund faces a fresh debacle as Ukraine burns through an $17bn rescue package agreed in April and spirals into a full-blown currency crisis, with credit markets already bracing for likely default. The country’s foreign reserves have dropped to $12.6bn, barely enough to cover six weeks worth of imports. Its currency has been in freefall since it became clear that the Minsk ceasefire deal with rebels in the Donbass region was breaking down.

The Hyvrnia has crashed 20 per cent against the dollar over the past week and has lost almost half its value this year, making it much harder for Ukrainian companies, banks and the state to service $60bn of foreign debt, mostly in dollars.

The economy is expected to contract by 10 per cent this year, twice what the IMF expected when it first approved the bailout. Ukraine still has another $10bn of IMF aid to come but the pace of disbursements is too slow to keep the country afloat. Ukraine is in such dire straits that officials are holding back on pre-payments to Russia for gas imports, keeping their fingers crossed that the warm weather will last long enough for Ukraine to make it through the winter, relying on gas stocks and limited flows from Slovakia and Poland through “reverse pipelines”. This is a risky strategy since climate experts are predicting the coldest winter in more than 30 years.

It is unclear whether Ukraine will ever agree to pay a further $1.6bn of arrears to Russia’s Gazprom still left from an EU-brokered deal, given the fresh violence on the ground. NATO officials and international peace monitors (OSCE) say Russian tanks, artillery and troops have been streaming across the border into eastern Ukraine. The United Nations Security Council said the country is at risk of “total war”.

“Ukraine desperately needs support and foreign exchange to defend the currency but there isn’t enough money left from the IMF. A sovereign default looks increasingly likely,” said Tim Ash, from Standard Bank.

Yields on three-year Ukrainian bonds spiked to 17.7 per cent on Thursday. Credit default swaps measuring bankruptcy risk soared to 1,485 basis points, a level that typically precedes a debt-restructuring.

The central bank raised interest rates to 14 per cent this week to stem capital flight, but this is pushing the country into a deeper depression. The economy is already reeling from the loss of its industrial core in the coal and steel regions of the Donbass and from drastic austerity measures imposed by the IMF itself, including a 50 per cent rise in fuel bills.

A string of companies are trying to restructure their debts, including the steel group Metinvest, First Ukrainian International Bank and Mriya Agro, one of the world’s biggest food producers. “The country is bankrupt,” said Oleksander Cherniavskiy, Mriya’s chief financial officer.

Analysts say the IMF has repeated the errors made in Argentina and Greece, lending large sums of money to a country charging headlong towards insolvency. The alternative – more in keeping with IMF rules – would have been to impose a haircut on creditors and offer Ukraine a fresh start with debt relief. “The IMF massively under-estimated the damage done to the economy by the conflict,” said Neil Shearing from Capital Economics.

The IMF has unwittingly bailed out creditors – including Russian state banks, Austrian lenders, as well as protecting Western investors accused by critics of propping up the previous regime – at the expense of taxpayers. The global asset group Franklin Templeton held $7.3bn of Ukrainian bonds at the end of 2013.

The IMF also rewarded “vulture funds” that bought Ukrainian debt cheaply for quick gain, betting that the country was too important in geopolitical terms to fail, and would always be rescued in the end by either Russia or the West.

Mr Ash said there are serious issues of moral hazard involved. “A lot of people feel that these bondholders were part of the problem, and should therefore be part of the solution. In the end, Ukraine must decide whether it wants to pay off creditors or buy weapons to defend itself,” he said.

Ashoka Mody, a former top bailout official for the IMF in Europe, said it was clear from the start that Ukraine would need “very deep debt relief” to return to viability, given the collapse in exports and external debt of 75pc of GDP.

It is unclear why the IMF has once again put itself in a position where it is seen to be coddling creditors. Ukraine’s economy is too small to pose any systemic risk to the global finance, an argument that at least had some validity in the case of Greece at the outset of the eurozone debt crisis, when there was no backstop machinery to prevent EMU-wide contagion.

The Fund has published lengthy mea culpas analyzing its own errors with great candour in Argentina and Greece. Top officials vowed that the IMF would never again kick the can down the road by lending to an insolvent state. The lessons appear not to have been heeded.

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