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Ukraine’s Debt Is ‘Unsustainable’: Invesco

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Globally, government debt is at elevated levels and likely to grow – and Ukraine is no exception.

Two of Invesco’s emerging market debt experts discussed their views on Ukraine and its biggests economic challenges in the asset manager’s Global Fixed Income Strategy report for March.

“The biggest economic problem facing Ukraine at the moment is the deep recession,” said Banu Elizondo, emerging markets senior portfolio manager at Invesco. “We expect GDP to contract by around 7% this year. The severity of the slowdown makes the current debt burden unsustainable, in our view.”

Elizondo expects the Ministry of Finance to reach out to debt holders to restructure the country’s debt.

The government has already taken a big step toward addressing these challenges by approving the reform bills suggested by the International Monetary Fund in early March.

The IMF arrangement enables the immediate disbursement of about $5 billion, with about $2.7 billion being allocated to budget support and further disbursements based on standard quarterly reviews and performance criteria.

“While the IMF plans to provide several billion dollars in funding over the next four years, we estimate that there is also a roughly $13 billion debt restructuring implied in this package,” Elizondo said. “In addition to financing, the IMF deal provides impetus for the current administration to push for long-due structural reforms.

She says the agreement may also provide the Ukrainian military time to regroup in the event of further military escalation.

In addition to the IMF agreement, the National Bank of Ukraine also raised interest rates to 30%, which Elizondo said was able to “successfully stop the free fall of the Ukrainian currency, whose stability is critical to ensuring that the new budget and the IMF program are sustainable.”

The country’s economic situation has caused many business leaders’ outlook on Ukraine to deteriorate over the last six months, according to Elizondo’s colleague Jason Trujillo, an emerging markets senior analyst at Invesco.

“I think six months ago many business leaders were expecting or at least hoping that the country would be emerging from the other side of the recent turmoil and starting to show improvement,” he said. “Instead, while there appear to have been some hopeful developments in the East, the economy is now basically in free fall, in our opinion. The key assumption back then — that has turned out to be incorrect — was that Western countries would step in and provide adequate economic support to Ukraine, thereby lessening Russia’s influence.”

Some of this shifting opinion may also have to do with the economy’s effect on the operating environment for corporates in Ukraine over the last 12-18 months. “With the Ukraine economy under significant pressure, the operating environment has gotten very challenging for even the strongest companies, in our view,” Trujillo said.  “Perhaps one of the biggest problems, is that, across sectors, foreign suppliers of key input materials, such as fertilizer, are demanding upfront payments before sending goods.”

This is a “significant departure” from the previous standard of the average 60-day payment terms, Trujillo said. This change in payment terms has now caused companies to tie up a large amount of cash in working capital, which Trujillo said couldn’t come at a worse possible time because it’s happening right as “incremental financing is becoming more or less nonexistent.”

“This, coupled with the sharp drop in local demand, has put significant pressure on liquidity within the corporate space, in our view,” he said.

This liquidity pressure has also caused several corporates to enter into voluntary restructurings with bond holders, according to the Invesco report.

“The challenging operating environment and limited availability of financing that Ukrainian companies are facing has created a severe liquidity crunch across the business sector,” Trujillo said. “So, it is not surprising that we have begun to see companies attempt to restructure their debt.”

And with a sovereign restructuring now a certainty, Trujillo believes that it only makes it more likely that more companies will restructure their debt because “the sovereign restructuring makes international banks increasingly reluctant to lend in the Ukraine.”

That along with Ukraine’s weak economic outlook will most likely drive companies to make every effort to preserve liquidity, Trujillo added.

“That said, I don’t think we will see every corporate entity restructure — perhaps many, but not all,” he said. “The very top tier of Ukrainian corporates has so far shown its ability to access international capital markets. However, this is a very small club.”

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