Ukraine - debt et al
I have had a couple of calls with think tanks this week on issues related to Ukrainian debt - and, in particular, likely options for future debt relief/treatment.
The starting point here has to be guidelines set by the IMF in its $15.6bn EFF approved in March 2023. I attach the link therein to its latest review document under the programme.
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Specifically on future debt treatment I refer to point 62, page 36, where the IMF refers to:
“Official bilateral debt: As announced by the Group of Creditors for Ukraine on March 24, 2023, a debt service standstill is in effect during the period of the EFF (2023-2027) along with a commitment to a final debt treatment before the final review of the programme. They have committed to the level of relief necessary in the baseline and to provide additional relief as needed to restore sustainability if the downside scenario emerges.”
“External commercial debt: Staff judges that a credible process to restructure these claims is underway. Building off their March 24, 2023 announcement regarding debt restructuring, the authorities, with support from their advisers, are taking early steps to advance their strategy to implement a debt operation consistent with the parameters of the IMF’s debt sustainability analysis and embedding comparability of treatment with other creditors. To this end, they have continued discussions with bond holders, consistent with the DSA. They aim to finalise the debt operation at the latest by mid-2024.”
Numerous issues are raised herein.
First, and most obvious, it seems very difficult to undertake said debt treatment while the war is on-going. Any debt treatment requires the production of a credible macro framework which underpins a DSA. I struggle Though to see how a credible macro framework can be produced in a state of war. The IMF does produce a baseline forecast (war reduces in intensity by mid 2024) in the above document and then a downside scenario, which assumes an intensification of the war in 2023, resulting in the prior assumption of real GDP growth in 2023 of 1-3%, seeing a deeper recession of over 7%. Obviously it deteriorates forecasts for public finance, balance of payments et al. But the IMF might be in the business of producing macro forecasts and DSAs, but it is not in the business of geopolitics or predicting the course or outcomes of wars. There are credible scenarios (I am more inclined to these) where Russian forces in Ukraine do collapse, the Putin regime collapses, and Ukraine’s macro scenarios therein would likely see significant upside. Equally, there are much worse scenarios where Western support for Ukraine falters, Russia takes the initiative again in Ukraine, and Ukraine could suffer further and perhaps catastrophic losses - not my base case, or even a high probability but still a non zero probability, but not really fitting well into the IMF base or even downside scenario.
But actually a much more likely scenario seemingly not even considered by the IMF and which would have a very material impact on Ukraine’s defence, macro framework et al, is that of a political change in the West which threatens financing to Ukraine.
On pages 57-60 of the IMF presents risks to the macro framework, and the above risk is not even mentioned.
Events in recent weeks in the US Congress, with the dysfunction now in the GOP around the election of a speaker, and debate questioning the future of financing support for Ukraine must raise serious issues about the durability of the circa $30 billion annually of official Western financing support for Ukraine assumed in the programme thru to 2024, and then $15-20 billion pa thereafter. The US approximately accounts for half this sum. Even if the US Congress finally pulls its finger out and backs a new $100bn financing bill for Israel, Taiwan and Ukraine ($60bn plus, including military support for Ukraine) what happens to US support if Trump returns to the presidency in 2025? And if Trump pulls support for Ukraine, is Europe willing then to shoulder the full burden?
I just think given the political reality now of populism, it is heroic for the IMF to assume that Western governments will continue to commit tax payers dollars, long term, to Ukraine’s victory and recovery/reconstruction. And without those assured commitments, it’s very hard to build a credible macro framework/DSA.
So if a credible macro framework is required for DSA as the starting point for decisions around debt treatment than it might either require the ending of the war, or consideration of much stronger financing options - therein we again return to the issue of utiilising frozen Russian assets to support Ukraine through the war and then the peace.
I have long argued over this point but I don’t think Western politicians are being realistic in assuming a blank cheque book from their tax payers for the billions of dollars to support Ukraine. If tax payers dollars are in short supply, debt relief is unlikely to fill the void and the private sector will not do the heavy lifting which means that absolutely the only source of funds to support Ukraine is frozen Russian assets. Our politicians should be honest with us, how exactly are their going to fund Ukraine, if they don’t tap frozen Russian assets? And not for the small change taxed on Euroclear profits, but a move to access the underlying assets.
Second, the IMF statements above suggest a two stage treatment, or perhaps three stage in effect. There is the initial debt service suspension, for private creditors through to mid 24, and for the official sector through to 2027, but then agreement is reached on private sector treatment in the first half of 2024, and then the official sector during the period of the final review of the EFF, so later in 2027.
The above seems unusual in terms of EM debt treatments, in terms of first a private sector treatment followed by a second official treatment. Normally the official sector agrees to its treatment of debt and the private sector follows assuming comparable treatment. Is the official sector going to think ahead of what treatment it requires from 2027 but then backdate that to 2024? A lot can obviously change between 2024 and 2027. It’s quite possible that the situation deteriorates between the two dates, so will private sector liabilities then be subject to a second and further treatment in parallel with the official treatment in 2027? Why not conduct parallel debt treatment of the official and private sector in 2024 or, indeed, both then in 2027, or actually when the war ends. Why rush when there are just so many uncertainties that just cannot be modelled?
I can understand the desire to resolve the issue of the private sector default early, say in 2024, to begin the clock ticking to enable Ukraine’s early market access. Indeed, central to recent Ukraine recovery conferences has been the idea that the private sector will be central to Ukraine’s successful recovery and therein Ukraine’s market access will be key. Remember after the 2015 Ukraine debt restructuring, Ukraine was able to re-access markets two years later, in 2017. Looking at the IMF EFF above though it seems to pencil in a relatively conservative assumption of Ukraiine’s market re-access by 2029 for $1bn in portfolio investment (read Eurobonds) that year. I am not sure that an early private sector debt treatment, with the message/risk of further official treatment in 2027, which could drag in the private sector to further treatment at that point, will inspire particular confidence to ensure large sized market access to move the dial on recovery/reconstruction. I am just not sure I get the logic of agreeing a debt treatment for the private sector in 2024 and then a further official treatment in 2027. Can someone explain?
Perhaps the first treatment in 2024 could be relatively soft light/trying to create good news/music around the whole Ukrainian private debt spectrum, allowing for early market access, and then if the data turns out less positive by 2027, there could be a further treatment on the private sector debt, then in line with more aggressive official sector treatment.
Third, and related above, the issue of the use, or not, of frozen Russian assets could well complicate any future debt treatment, particularly with respect to the private sector. Private sector creditors, as is their fiduciary responsibility, will argue why are their end clients (pensioners) being asked to take any NPV reduction on Ukrainian holdings when Russian frozen assets are seemingly being ringfenced by Western governments? Russia is clearly responsible for the war and damage to Ukraine, not Western tax papers or creditors. Russia should be first made to pay before coming to Western tax payers or creditors (pensioners). This could suggest a very long drawn out restructuring process with private sector creditors, much more difficult than proved the case in agreement the debt service suspension in mid 2022. Unless that is Western government have the political balls to address the legal issues around frozen Russian assets. One could then even imagine debt treatment perhaps collateralised by frozen Russian assets, et al.
Fourth, in terms of the restructuring parameters targeted by the Fund in the EFF documentation, there is mention of cutting the public sector debt/GDP ratio to 60-65% and the GFN to 8.5% to levels seen as sustainable. Why these levels? In the on-going case of Sri Lanka, also a market access country, the IMF had set only a 95% debt to GDP ratio as the target and cutting the GFN to 13%. Ukraine has government revenue to GDP ratio three times that of Sri Lanka, so in that sense surely a higher debt carrying capacity. And going back the 2015 treatment, the debt/GDP ratio was only cut by less than 5% and was still at 80% coming out of the debt retructuring in 2016. This returns to the perennial problems with IMF macro frameworks, DSA, and restructuring parameters, that they always just seem to be plucked from mid air somewhere around the top of the IMF Ivory Tower, with little actual input with other stakeholders, particular the private sector.
Fifth, and just labouring the point, because I can. Debt relief for Ukraine will help in ensuring its victory in the war and succesful post war recovery but really the heavy lifting has to be done either from Western tax payer dollars (it’s a Western public good) or much rather utilising frozen Russian assets. Actually I don’t think there is really political appetite in Western countries to write a blank cheque for Ukraine recovery and reconstruction using tax payer dollars or write offs on debt (owed again to Western tax payers or pensioners). But if not our politicians need to be honest with us where they will get the money. The only credible source is actually frozen Russian assets. Fact. Just do it.
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