Ukraine's foreign borrowing costs could increase significantly. Photo from open sources.
Ukraine has been blacklisted among the world's debtors.
Over the past month, Ukrainian Eurobonds have fallen by 1000 basis points.
"They were trading at a premium of 8,3% on the monthly chart, and are now listed at a discount of -0,7% (1000 bp). This gives a total yield of 7,275%. Back in January, our Eurobonds were trading with yields ranging from 1,7% to 4,3%.
"We seriously expected that our Finance Minister Marchenko would soon enter the Eurobond market and attract everything the IMF didn't give us for rates below 5%. But now all that is in the past. We are on a downward spiral in the eyes of foreign investors," Mykhailo Kukhar, a macroeconomics professor at MIM-Kyiv Business School and senior economist at Ukraine Economic Outlook, wrote on his Facebook page.
"We're talking about the secondary Eurobond market. Simply put, holders who once invested in Ukrainian debt securities are now frantically dumping them, even at a loss, just to get rid of them. This is a very bad sign for Ukraine. Especially given the fact that there's a lot of 'excess' money in the world, and investors are actively putting it into a variety of instruments, even those that recently seemed unreliable, like cryptocurrencies. But, apparently, our economy doesn't inspire much confidence—people aren't willing to invest in it," explained Oleh Pendzin, head of the Economic Discussion Club.
"The country" I figured out what the collapse of Ukrainian Eurobonds means.
Eurobonds are falling, government bonds are rising
It should be noted that Eurobonds are clearly not a priority for the Ministry of Finance in the ranking of borrowing instruments.
Last year, the financial department entered the international capital market several times.
Thus, on July 23, the Ministry of Finance placed 12-year Eurobonds maturing in March 2033 in the amount of $2 billion at 7,25% per annum.
On December 11, there was an additional placement of these Eurobonds for another $500 million with a yield of 6,4%. And on December 18, an additional placement of $600 million was completed at 7,253%.
This year, the National Bank of Ukraine (NBU) plans to raise approximately $2,4 billion in Eurobonds. The NBU expects foreign investors to purchase $1 billion worth of Ukrainian government bonds. These forecasts were voiced by NBU Governor Kyrylo Shevchenko in an interview with Reuters.
"There's a new optimism in international markets. We hope this optimism won't bypass Ukraine," noted Kyrylo Shevchenko.
We've already written about the "new optimism" in global capital markets. We're talking about so-called "excess" money, billions of dollars that have appeared after leading countries fired up their printing presses in an attempt to quickly pull their economies out of the coronavirus crisis.
As soon as they flooded the market, investors frantically began searching for worthy investment targets. This wave sent shares of many companies soaring, as did prices for oil, commodities, gold, and other stocks.
"Excess" money has also reached our government bond pyramid—since December of last year, there has been a significant influx of speculative foreign capital into domestic securities.
But the situation with external bonds—Eurobonds—hasn't been going well since the start of 2021. Investors, on the contrary, are trying to get rid of them. This, in fact, led to their collapse—by 1000 basis points in 30 days.
The question is, why? After all, demand for government bonds from non-residents continues to grow. Since the beginning of March alone, bonds worth UAH 12,2 billion have been placed, including UAH 5,2 billion at the March 9 auction.
"Unreliable debtor"
"What's the difference between the buyers of our Eurobonds and government bonds? The former attract serious and cautious investors, while the latter attract speculative capital. Therefore, the fact that our Eurobonds are falling in value directly confirms that they don't believe in the Ukrainian economy. This can also be seen in the sharp decline in foreign direct investment last year—it fell by almost a third," says Oleh Pendzin.
That is, to convince investors to invest in Ukrainian securities, their profitability must be increased, which means the cost of borrowed money for our country will rise.
"Increasing bond yields are an indicator of investor sentiment toward a country. The lower the rates, the more reliable the borrower; the higher the rates, the more risks debt holders assume when working with the borrower," explained Andrey Shevchishin, head of the analytical department at Forex Club.
It is worth noting another nuance here, systemic corruption, as economist Alexey Kushch called it.
"In recent years, Ukraine has been placing Eurobonds at inflated interest rates—up to 7,5%. For example, Armenia recently placed 15-year bonds worth $750 million at 3,4%, despite the country experiencing a systemic political crisis and having just ended a war. The fact is that, after the initial placement at 7,2-7,5%, Ukrainian securities immediately hit the secondary market with a yield discount of up to 2-3%. This means that underwriters—the international financial companies that handled the placement—were effectively earning half the yield. But this time, there was an adjustment. And instead of a yield discount, the secondary market actually saw growth," says Kushch.
But why did Ukraine suddenly become an “unreliable borrower”?
Experts say several factors, both external and internal, came together here. Let's take a closer look.
"The Americans are to blame"
As for external factors, according to TeleTrade analyst Sergei Rodler, the reason lies in the United States.
"The debt markets of many emerging markets, not just Ukraine, are experiencing a veritable tsunami. The main reason is the rise in US Treasury yields, which is motivating investors to reconsider their positions. The recent correction in the Nasdaq 100 index (which includes technology stocks) was linked specifically to the increased appeal of Treasuries (US government debt obligations – Ed.). Investors are willing to buy risky instruments – stocks (especially tech companies) and emerging market securities – only when their yields significantly exceed the benchmark – the yield on long-term US Treasuries. The rise in Treasury yields is linked to inflation expectations: Wall Street predicts the yield will accelerate to 2,48% (an extremely high figure for the US) by December 2021. However, thanks to the Federal Reserve's ultra-loose monetary policy and Congressional stimulus, the American economy could grow by 5,95% by the end of 2021—the best performance since 1983. In other words, beyond purely speculative factors, fundamental ones are also driving interest in American securities," Sergey Rodler explained to us.
In other words, investors in emerging market securities have two modes: "risk-on" (when they actively buy securities in hopes of higher returns) and "risk-off" (when they prefer safer instruments). We are currently seeing the latter scenario, Rodler believes.
Andrey Shevchishin agrees with him.
"Currently, bond yields are rising in global markets due to rising inflation expectations. For example, the yield on 10-year US Treasuries was 0,8% at the beginning of the year, and now it's 1,5% and higher. That's almost a twofold increase. This is driving up yields on all bonds, including risky ones, which include Ukrainian ones," says Shevchishin.
However, other emerging market stocks haven't plummeted as significantly as ours over the past month. This suggests it's not just a matter of external conditions.
The IMF and the Failed Vaccination
Experts also cite a whole list of internal factors that are forcing investors to get rid of Ukrainian securities.
"Eurobond holders always closely monitor the economy of the country in whose securities they've invested, and the prospects for withdrawing their money. And recently, several alarm bells have been ringing for them. The first is the IMF. The Fund's mission concluded its work without results, citing several rather difficult-to-implement provisions that theoretically allow us to count on a tranche this year (reducing the budget deficit, raising gas prices for households, judicial reform, and so on). This means the chances of receiving a loan in 2021, whatever the authorities say, are slim. And this is a strong indicator for Eurobond holders. The second alarm bell is the decline in Ukraine's GDP in January and the bleak outlook for the first quarter. And this is happening at a time when other economies, on the contrary, are beginning to recover from the coronavirus crisis. The third alarm bell is the threat of another lockdown amid the failed vaccination campaign. "In other words, it's unclear when all these COVID risks will end. This entire list ultimately paints a general picture—one of investor disappointment," says Oleg Pendzin.
Expensive money
According to Andriy Shevchyshyn, trends in the international capital market will continue in the near future. This means that Ukraine's external borrowing costs will only increase.
"The situation is not expected to change in the foreseeable future: US yields will rise, which will make central banks in developing countries nervous and raise interest rates. Therefore, the potential for further declines in Ukrainian Eurobonds remains," added Sergei Rodler.
That is, an IMF loan for Ukraine is in question, and the placement of Eurobonds may also not be very successful, and, to put it mildly, not cheap.
"Right now, it's not even worth placing Eurobonds—the timing is very bad. We need to wait for the 'low tide' in US yields and take advantage of this 'window of opportunity.' It's entirely possible to place at 3-4%, but only at the right time," says Kushch.
Meanwhile, in 2021, we need to find 700 billion hryvnias: 450 billion to pay off old debts, 250 billion to finance the budget deficit. And there's really nothing to rely on, except perhaps the government bond pyramid, says Oleh Pendzin. He adds that, to funnel more money into government bonds, the authorities want to use them as a means of capital amnesty (Strana has already written about the relevant bill).
"They offer attractive terms for government bonds—you can pay 2,5% instead of the usual 5%, plus you can also earn income from the securities," Pendzin noted.
"The deterioration of international financial market conditions, coupled with the increase in the NBU's key rate, could increase pressure on the cost of government borrowing in Ukraine. This, in turn, will limit the government's ability to implement its government borrowing plan to fully finance budget expenditures and support the national economy. As a reminder, in January-February 2021, government borrowing amounted to only 68,6% of the planned amount, which constrained general fund expenditures, which were financed at 90,7% of the reporting period's budget," said Bohdan Danylyshyn, Chairman of the NBU Council.
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