Ukraine’s debt dilemma — to pay or not to pay

According to data provided by the Ukrainian Ministry of Finance, this year Ukraine has to make debt service payments amounting to UAH488bn (USD20bn). Internal debt accounts for UAH344bn, while foreign debt accounts for UAH144bn.

The Ukrainian oligarch Ihor Kolomoisky suggested in an interview with “The Financial Times” that Ukraine should unilaterally stop servicing its debt. “In my opinion, we should treat our creditors the way Greece does. That’s the example for Ukraine to follow”, he argued, referring to the Greek referendum of June 2015, in which the voters rejected the conditions for the macroeconomic assistance for that country. This ultimately led the Greek government to temporarily suspend its debt payments to the IMF.

However, according to at that time the Ukrainian Prime Minister Volodymyr Groysman, the possible suspension of Ukraine’s debt repayments would have serious consequences. “Even discussing the possibility of a default hampers our efforts to stabilize the situation. The absence of payments is equivalent to a global crisis. Just think about the 1990s. Ordinary Ukrainian citizens would be the first to suffer,” he argued.

In May 2019, which was the first month of peak repayments of foreign and internal debt, Ukraine did not encounter any issues with the payments. A total of USD2.6bn was paid.

“There is no reason to stop servicing the country’s debt. Such a decision could lead to an inflation increase and a drop in the UAH exchange rate, and would make it difficult to obtain new loans from international financial organizations. All these factors would lead to lower standards of living for Ukrainian citizens,” commented the Finance Minister Oksana Markarova.

According to the Ukrainian Ministry of Finance, the problem is not the repayment of debt in itself, but the lack of effective debt management strategies. At present, up to 70 per cent of Ukraine’s debt is denominated in foreign currencies, while the maximum level of such debt that could be considered safe from the point of view of a country’s financial stability is 30 per cent.

Olesya Verchenko from the Kyiv School of Economics believes that there are no grounds for withholding payments to creditors, which is confirmed by the ratio of Ukraine’s foreign exchange reserves — currently reaching USD20bn — to the amount of debt that has to be repaid in 2019. In her opinion, any possible positive effects of such a decision would be short-lived.

It is not beneficial for any country to stop servicing its debt, and Ukraine is no exception. “Any country announcing such a decision would run the risk of losing its financial stability. As a result it would lose access to the capital markets, and in the case of Ukraine this would be associated with a decline in GDP. This would cut off the inflow of even those small amounts of capital that we receive today in the form of foreign direct investment,” said Oleg Ustenko from the Blazer Foundation, who serves as an economic adviser to the Ukrainian President.

Although most economists and government officials are opposing the idea of suspending Ukraine’s debt repayments, some are also presenting the positive results that such actions would supposedly have for the economy.

Zakhar Popovych and Volodymyr Hoshovsky from the Centre for Social and Labor Research have analyzed the actual cases where various states officially announced their insolvency. They came to the surprising conclusion that such a situation isn’t always unfavorable for the national economy.

They note that sovereign defaults have been a common phenomenon in the global financial relations, and that there are countries that have spent half of their economic history in default. In the period from 1820 until the present day, the scientists identified 248 such cases in 107 countries. These statistics were dominated by Latin American countries, such as Ecuador, Mexico, Uruguay and Venezuela. Each of them declared insolvency eight times in their history. According to the calculations of Ukrainian researchers, Ecuador and Honduras have been insolvent for a total of 120 years each, while Greece has been in default for a total of 90 years.

The effects of the decision to suspend debt repayment on the given country’s economy vary from case to case. According to the Ukrainian economists, Argentina and Russia benefited from such decisions made in 2001 and 1998, respectively. “Regardless of the substantial amount of debt reduction and its unilateral announcement, they led to a rapid restoration of economic growth in these countries,” they claim. Popovych and Hoshovsky point out that Argentina suffered from a recession in the years 1998-2002, but thanks to the radical debt reduction reaching up to 70 per cent and the five-year moratorium on debt repayment, the government managed to accumulate substantial financial resources and rebuild the economy in a relatively short period of time.

The Ukrainian researchers also bring up the example of Ireland. They believe that the harsh, neoliberal economic policies of the Irish authorities and their efforts to service debt “at all costs” actually hindered the economic growth. They argue that instead of announcing a suspension of debt repayments, in the years 2009-2010 Irish authorities decided to save private banks by all means possible and to nationalize the losses of private business. The latter caused a decline in the standard of living of most residents and hampered growth.

“One could say that under certain conditions, and combined with certain development strategies, a unilateral announcement of the suspension of debt repayments could enable a faster restoration of the economic growth and could even ensure a faster return to the global debt markets than some variants of debt restructuring agreed with the creditors,” economists argue. In their opinion, the government of a sovereign country acts as the representative of all citizens. Consequently, the main criteria used to determine whether the decision to suspend debt repayment is rational should involve the prospects for kick-starting economic growth, and especially for increasing prosperity and reducing poverty, and not the possible improvement in the state’s financial condition or in the relations between the debtor and the creditor. The decision to suspend debt repayment could enable the government to redirect the financial flows spent on debt servicing towards activities stimulating economic growth. They admit, however, that the suspension of debt repayments could limit the borrowing capacity of businesses and thus inhibit investment and development, thereby resulting in economic deterioration instead of improvement.

According to Vitaly Shapran, chief expert at the National Bank of Ukraine (NBU), the problem faced by Ukraine is that the country’s debt constitutes a significant — and growing — burden on the state budget. The Ukrainian Ministry of Finance found itself in a situation where its only option is to take out new loans in order to pay off the old ones. However, in his assessment the suspension of debt repayments would not bring the expected results, because 85.5 per cent of Ukraine’s debt are bonds purchased by the central bank and state-owned banks. Debt towards foreign creditors, which could be affected by the decision to suspend repayments, only amounts to USD11-12bn. The latter amount also includes loans from the IMF, which are characterized by very favorable interest rates. “As a result, we would destroy our country’s image in order to gain so little, and we would not be able to borrow on the external markets in the coming years. Moreover, such actions would deprive us of the ability to take out the cheapest loans,” stated Mr. Shapran.

Thus far the discussion on whether Ukraine should suspend its debt repayments hasn’t deterred international investors. The Ministry of Finance reported that the foreign investors’ demand for Ukrainian bonds was growing and that at the beginning of July they already accounted for 7.3 per cent of the total volume of the UAH-denominated bonds, with a total value of UAH56.23bn.