Ukrainian default: Guide to understanding

Author : Ivan Zatsarin

20:25, 19 October 2015

Ukrainian default: Guide to understanding

Author : Ivan Zatsarin

A theme of Ukrainian default became a top story for the last 2 years. Because of it, curious attitude to it appeared: they always talk about the default, but it does not happen - then all this is nonsense and horror fiction. It would therefore be useful to understand what is happening, avoiding frightening economic terms, numbers, and specific information

20:25, 19 October 2015

It is useful to start with a definition. What is the "default"? This is inability of the subject (private persons, companies, or states) to refund their debts. A default may be technical - when such failure relates only to the present moment, but the one can repay it in future.

A bit of history

Not all now could remember that the theme of default has arisen for the first time under Viktor Yanukovych’s rule, in late 2013. That threat was predicted by Mykola Azarov’s Cabinet in its forecasts on future of the Ukrainian economy in case Ukraine signs the Association Agreement with the EU. Why there was such a forecast, where is the relationship between the Agreement and default?

If you look at the statistics of Ukrainian exports in the last 4-5 years, you may find that 2011 was one of the most successful for Ukrainian producers. Exports to Russia (then it was a major trading partner of Ukraine) reached $19.8 billion, perhaps the largest index for all years of independence. However, in subsequent years, it began to decline - at first slowly ($17.6 billion in 2012), then faster ($15 billion in 2013), followed by landslide ($9.7 billion in 2014). Azarov's government certainly could not know the latter figure, but it seems that they expected further deterioration in 2014 in comparison with 2013. Why is that?

2011 was a turning point for Yanukovych in a relationship with Russia. It was when he made it clear to the Russian leadership (or they themselves had made such a conclusion), that he was not going to participate in Russia's reintegration projects. After that Russian business has received the signal: you should transfer ordering, execution of works etc. to similar enterprises in Belarus and Kazakhstan, later joined by Armenia and Kyrgyzstan. In some cases, it was even about the establishment of replacement industries in Russia. The same is certainly true of the labor market. If a few years ago Ukrainians had been quite welcome to work in Russia, now this opportunity became limited by the need to purchase and monthly renewal the labor patent.

This was the long process, difficult to observe and evaluate in day-to-day routine. However, even then, two years ago, the direction of it was clear: the Ukrainian producers were losing markets in Russia, and Ukrainian citizens were gradually deprived of the opportunity to work freely in Russia (now the labor market for our citizens is regulated by quotas established list of occupations. Employment of Ukrainians to "unlimited" position should be justified, and then they must pay a special tax). Consequently, the Russian Federation ceases to be a source of revenue for Ukraine funds. Which money we are speaking about?

If in 2011 it was possible to talk about $22 billion (export of Ukrainian companies, remittances, estimated receipt of money through informal channels), then in 2014, the same set of giving has only $12 billion, and up to 6 months of 2015 we can talk about $3 billion. And the dynamics of remittances and export dynamics say to be even worse than the previous year. It is unlikely that the total figure for all of 2015 will exceed $6-6.5 billion.

It seems that all is clear, but then why default?

A bit of economy

Earlier gains from trade with Russia gave Ukraine an opportunity to build and maintain public debt, and put a blind eye to the negative trade balance (the difference between income from exports and expenditure on imports). Despite the fact that during the reign of Yanukovych negative balance only increased, it did not lead to significant fluctuations of hryvnia. And even created a false sense of welfare among Ukrainians: a couple of years ago, our average salaries were not too different from the income of Bulgarian citizens, one of the EU countries. Some residents of the western regions, and then of the capital and other regions, became accustomed to buying Polish and Italian goods in supermarkets and shops.

It is necessary to briefly recall the main dates of Ukrainian "almost defaults" during the last two years. Initially, it was a spring (March-April) of 2014. This deadline was pushed Russian loan in the amount of $3 billion, taken by Yanukovych in December 2013 and moved to the autumn of 2014. However, after the change of power in Ukraine, the IMF released the credit program for the new leadership, providing $17 billion for two years in several tranches. Then wait for spring again moved - already to 2015.

However, in April 2015 it did not happen. In Kyiv, an investment forum was held in which Ukraine had managed to attract a number of borrowings from European financial institutions, as well as the US loan guarantees. Default was again postponed - for the current fall. And this time, almost no wrong.

Credit agencies Moodie's and Fitch lowered the credit ratings of Ukrainian to pre-default (and even up to "restricted default") in the summer. As it turned out, not without reasons. On October 8, Kyiv declared the technical default (on loans totaling $550 million, which is about ⅔ of the Ukrainian credit obligations). What happens to the public finances?

In summer, the government managed to convince the holders of the Ukrainian debt for its restructuring. $4 billion of $19 billion total are forgiven (total score is about $70 billion), plus up to 2019 Ukraine pays only the interest on the remaining $15 billion without paying the actual body of the loan. However, it was not arranged it should be done (actually the government approval of the plan by the Verkhovna Rada took place only 17 September). So now the Ukraine does not pay with the knowledge and consent of the lenders that the country will soon have to start paying in the new way. Optimistically? Not really.

The dark side of the coin

Firstly, in 2016 the Russian Federation threatens Ukraine by the full trade embargo. This means that next year Ukrainian exports to Russia cannot get even those miserable $5-6 billion, which is projected in 2015.

Secondly, the reduction in migrant remittances is explained not only by the tightening of the Russian legislation. The workers have stepped up exports of their families. So, the fall of transfers from year to year, will also accelerate.

In addition, Ukrainian debt wasn’t relieved so easily. Firstly, we still need to return it, though less painful than before. Secondly, Ukraine has pledged to reduce the debt ratio to 70% (from the current 90%) under conditions where the country's credit rating at the level of junk bonds, only an increase in GDP can keep creditors from mass dumping Ukrainian debts do is it will be very difficult given that exports to Russia falling to 50-60% for the third year in a row.

On the other hand, the Ukrainian default is not quite market, so to speak. Holders of 82% of the external debt of Ukraine are the American funds, therefore, the rating agencies may provide the lowest valuation to Ukrainian credit ratings, reserves of the NBU can go to zero (as well as indicators of Ukrainian exports), hryvnia may fall even several times. However, the real default on Ukrainian bonds will not be declared. Is it good or bad?

The good and the bad

On the one hand it’s well. The default is always a shock to the population, devaluation of savings in the national currency, the collapse of banks, cheaper wage labor with rising prices... Stop. Is it not exactly what we are seeing for the second year? Moreover, pro-government economists recently even put a plus - they say, the labor force has no place cheaper, soon investors will line up in a queue. Only now after all - the investor need not only a cheap slave labor. Also in Tajikistan, for example, it is not too expensive, but the investment boom is somehow not observed.

So default in Ukraine, most likely, will not happen. Firstly, because it is not profitable for the principal holder of the Ukrainian debt. Secondly, because it in fact has already occurred. At least its basic signs are obvious. Now let's examine what is bad.

Even though the fact that the situation can be stabilized, if not infinite, then a long time. Poroshenko together with Yatsenyuk managed to lead the very balance of trade to a small plus. That by the way isquite easy with the rise in import price for three times and stopping of fertilizer plants (working on Russian raw materials). But "stabilize" does not mean "change". Yes, Russia has committed itself to cutting off our exports since in 2012. However, the current government does nothing to somehow prevent it. Moreover, it does not even idle, and actively helping Russia to create, pardon for the neologism, Ukraine-substituting economy. And it is not hidden. Here's what the press says economic advisor to the Prime Minister: "The great and low-wage labor in these dying plants hinders Ukraine in its European traffic. Yes, it will be painful. But the alternative is to leave everything as it is and be friends with Russia, it is much worse."

It's funny that even 300 years ago, people thought very differently. The end of the 18th century, British industry competes with the Spanish. English economist D. Carey suggests the government buy back the entire Spanish wool to burn... What for? Britain has not enough capacity to recycle it, but removing it from the market can strengthen its position and to prevent the occurrence of spinning facilities in other countries.

While the British industry was much weaker than the Spanish or Dutch. As a maritime nation, owning colonies (captured from the same Spain and the Netherlands), the British might well exist in the colonial rent. However, unlike the current Ukrainian government advisers, they knew that better than a bad industry, than none at all. And only one resource rents not enough at all.

In other words, the current government's economic policy of Ukraine is the fact that there will not be sharp, one-shot default. Instead, the default will be extended and permanent. Good thing we have a relief for $ 4 billion and delay of return of another 15.5 billion. The bad news is that after the loss of markets in Russia, in principle, we become indifferent to the amount of our debt. Because without a working economy we cannot return these billions, regardless of the amount and regardless of the concessions that we will go to creditors.

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