America’s growing differences with Russia are playing out on a variety of fronts. Perhaps the most consequential – and least understood – involves international finance rather than military deployments in the threatened, pivotal nation of Ukraine.
Kiev’s economy has been reeling since Russia annexed Crimea last year and rebels continue to destabilize the eastern Ukraine. Right now, the beleaguered government is struggling to plug a $15 billion funding gap.
More is at stake than a few billion dollars of sovereign debt. The West’s ability to counter Vladimir Putin’s geopolitical ambitions could rest on whether bankers can keep the Ukrainian economy afloat by negotiating a long-term restructuring.
Ukraine has asked private bondholders to write off billions in debt so that it can marshal its resources to fight the Russian-backed separatists. But that kind of short-term thinking could cripple Ukraine and pave the way for a Putin victory.
If Ukraine imposes write-downs on private creditors or, worse, defaults on its obligations, it would effectively become a financial pariah. It would lose access to the capital markets, thus depriving it of essential funding. Ukraine would be unable to raise the money it needs to revive and reform its economy, which, in the long term, is essential to preserving Ukrainian independence.
Ukraine would also put a proposed bailout by the International Monetary Fund at risk because the IMF has conditioned its funding on Ukraine being able to raise $7 billion by 2020. Experience has shown that once a nation loses its access to markets, investors’ faith takes a long time to restore.
Ukraine’s private sector would also be hit hard. The Ukrainian private sector currently needs to borrow roughly $70 billion a year to stay in business. Global investors are crucial here. Ukraine has historically relied a small number of creditors. To grow and prosper, it must expand that pool, not limit it. Both the government and private businesses would benefit greatly if negotiators were able to reach an accord that satisfied investors rather than ran them off.
Ukraine’s Prime Minister Arseniy Yatsenyuk and his talented Finance Minister Natalie Jaresko recently visited the U.S. to talk up their country’s prospects. But the debt deal that Jaresko is seeking is flawed. She has demanded a 40 percent write down on bonds held by private investors but not on bonds held by other creditors. But her plan would affect only $19 billion of Ukraine’s $70 billion in publicly held debt. Debt restructurings for other entities such as Ukreximbank, the state-owned lender, are being offered on distinctly more favorable terms. How can this be credible?
Markets, instead, are seeking equal treatment among bondholders. To that end, private creditors have devised a plan that distributes the pain widely and, thus, more equitably. They oppose the targeted, 40 percent write off and instead want to extend the repayment period for all of Ukraine’s debt until 2019. They reason that Ukraine’s economy will recover quickly enough by then to begin making repayments.
The proposal should satisfy the IMF’s conditions by making Ukraine a welcome participant in the markets. At the same time, creditors would provide significant concessions in Ukraine’s time of need, including saving the country about $15.8 billion in debt service.
The proposal, though costly to creditors, has been endorsed by the holders of most of Ukraine’s privately‐held debt and would no doubt be supported by the broader investor community as well. Uncertainty would be reduced because all investors will be treated equally. If the goal is to build the Ukrainian economy in order to enable Kiev to resist the Russian challenge, this is the way to proceed.
Richard Burt is a former Assistant Secretary of State for Europe and is now managing director at McLarty Associates.