Standstill on Ukraine debt is right for both the country and our clients
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Standstill on Ukraine debt is right for both the country and our clients

The daily headlines paint a very clear picture of the tragic and devastating human toll that Ukrainians are suffering at the hands of Russian invasion. What is also a threat, although not on the front pages of newspapers, is the very real danger of a balance of payments mismatch that risks a destabilising macro crisis. Ukraine has a large and growing need for dollars to finance critical imports and steady its economy. Public sector help includes additional financial assistance beyond the $30 billion pledged by western partners1 and a realistic path towards EU membership to anchor the structural reforms required for long-term economic success. The private sector can also help by granting the authorities’ request for a two-year standstill on Eurobond debt service.

 

We believe this combined private/public sector approach to stabilise Ukraine’s finances and accelerate reconstruction is in the best interests of both Ukraine and bondholders and will allow all stakeholders to participate in the gains from recovery.

 

A large and growing need for dollars to finance essential imports

The Ukraine central bank estimates the economy will contract by a third in 20222, leading to collapsing tax revenues while spending on military and social support surges. The result could be a massive budget deficit of roughly -30% GDP and a total debt stock set to rise north of 100% GDP by year-end. Ukraine’s Ministry of Finance estimates the country’s funding requirement at $5 billion a month3. But western aid commitments have not been disbursed fast enough to fill this gap, forcing fiscal authorities to rely on the central bank for deficit monetisation through money-printing.

 

Authorities are committed to a return to orthodoxy, but with markets strained and western funding lagging, the central bank remains the lender of last resort. To prevent fiscal dominance from destabilising inflation expectations, the central bank has supported the hryvnia by selling currency (FX) reserves even as it continues to print.

 

Combined with the decline in exports as Ukraine’s ports remain blocked, a significant external funding gap has emerged. Despite a recent international agreement to reopen Ukraine ports, implementation faces many challenges including lack of cargo insurability given risks of transiting through an active war zone. The Ukrainian central bank responded to these shocks in commendable fashion by initially anchoring inflation expectations via a stable currency and hiking policy rates to 25%. Unfortunately, western financial disbursements from March-July were not enough to prevent a massive loss of currency reserves (around $10 billion year-to- date through June). This reserve drawdown necessitated a devaluation of the official exchange rate on 21 July and a tightening in FX and capital controls.

 

The Ukraine central bank’s actions will slow dollarisation, temper import demand and reduce the arbitrage that was draining FX reserves as the central bank defended the peg. But the source of the problem – excess local currency liquidity due to deficit monetisation – remains unchanged. Without additional hard currency liquidity support the country risks running down reserves to precarious levels. The resulting devaluation/inflation spiral will be a setback to both Ukraine’s heroic efforts in the war as well as the subsequent reconstruction of its economy.

 

We support private sector assistance to ease the burden

As investors we can help reduce the odds of Ukraine tipping into a full-blown balance of payments crisis by supporting authorities’ request for a two-year deferral of Eurobond debt servicing4. Had the proposal been rejected, the Ukraine Ministry of Finance, wary of entering into a hard default, had pre-committed to pay these sums on the original due dates. Therefore, by rejecting the request bondholders would have been actively draining around $6 billion from Ukraine’s limited FX reserve holdings over the next two years. On 9 August, by voting to accept the standstill proposal5, the global asset management industry rightfully decided to put its money where its mouth was regarding its pledged commitment to a broader stakeholder-based approach. While direct financing of Ukraine’s reconstruction will be considered later, the first step was to support the requested debt service deferral. Doing so has reduced external financing needs and freed up scarce resources at a time when the country needs to conserve FX for critical imports of military equipment, energy and medical supplies (Figure 1).

 

Figure 1: Ukraine’s financing needs for the next two years

Ukraines financing needs for the next two years

Source: Columbia Threadneedle analysis of current account deficit, external debt service and other private financial outflows, August 2022

 

Approval of the proposal is consistent with asset managers’ fiduciary duty to end-clients. Ukraine’s Eurobonds currently trade at 20 cents on the dollar, already pricing in a much deeper restructuring than this two-year standstill proposal. The length of the war and severity of the destruction of Ukraine’s capital stock/productivity will ultimately determine recovery values for bondholders. But avoiding a macro crisis will no doubt increase the odds that a post-war Ukraine is able to accommodate higher recoveries and maximise value for investors. By helping Ukraine in its time of need, investors lay the groundwork for potentially realising asymmetric upside returns. We believe in advancing a stakeholder-based approach to emerging markets investing while fulfilling our fiduciary duty, and that accepting the standstill proposal is a win/win for both Ukraine and our clients.

22 August 2022
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Standstill on Ukraine debt is right for both the country and our clients

1 National Bank of Ukraine Financial Stability Report, June 2022
2 National Bank of Ukraine Financial Stability Report, June 2022
3 Ukraine Ministry of Finance/International Monetary Fund, April 2022
4 https://www.reuters.com/world/europe/ukraine-intends-postpone-debt-payments-24-months-government-resolution-2022-07-20/
5 https://www.reuters.com/markets/europe/ukraines-creditors-agree-two-year-payment-freeze-almost-20-billion-international-2022-08-10/

Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is a marketing communication. The mention of stocks is not a recommendation to deal.
This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services.
Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association.
In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.
In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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Important Information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). This is a marketing communication. The mention of stocks is not a recommendation to deal.
This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services.
Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association.
In the UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.
In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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