As the drama of the political showdown over embattled Ukraine plays out, bond investors face less-publicized concerns over the fate of their Ukrainian investments and a potential bailout. But a bailout may not be all good news for investors.
Bond investors hope that massive international aid will enable Ukraine to make its debt-service payments. But a little-noticed April 2013 paper by the International Monetary Fund (IMF) calls into question that entity’s willingness to bankroll sovereign-bond payments to private lenders. How Ukraine’s issues—and those of its creditors—are handled will set a precedent. And we think investors may need to reassess their assumptions about how quickly they can expect a sovereign-debt restructuring.
The “Pre-Greece” Perspective
Before the Greek debt crisis unfolded in 2009, the IMF was ready and willing to help countries address their balance-of-payment issues—as long as local officials made the necessary economic adjustments. The IMF did so without necessarily expecting private creditors to pitch in and provide debt relief.
In light of that track record, many sovereign-debt investors came to view IMF assistance as a form of benign intervention. IMF aid would not only help governments maintain access to markets and attract capital, but would also improve their creditworthiness through stronger policymaking. To the extent that private creditors did provide debt relief, they generally did so in the very late stages of distress—and not enough to reestablish sovereign solvency. This is evident in the lack of a substantial improvement in debt–to–gross domestic product (GDP) ratios after the restructurings (Display).
A New Approach?
The IMF paper strongly suggests that this paradigm—in which official creditors provide liquidity and private creditors are the last to contribute to a sovereign issuer’s adjustment—may need to be revisited.
One possibility would be a “bail in” scenario, in which private lenders are required to make sacrifices much earlier in the process. In exploring better ways to handle sovereign-debt crises, the IMF paper argues that “a presumption could be established that some form of creditor bail-in measure would be implemented as a condition for Fund lending in cases where, although no clear-cut determination has been made that the debt is unsustainable, the member has lost market access and prospects for regaining market access are uncertain.”
In our view, Ukraine falls squarely in this zone.
Evaluating Ukraine’s Situation
It’s not clear that Ukraine’s debt is unsustainable: its public debt as a percentage of GDP is substantially less than that of other countries that have restructured their debt, as you can see in the display. Granted, a sharper depreciation of the hryvnia and a likely public recapitalization of the banking system would raise that percentage, but Ukraine’s debt/GDP ratio still wouldn’t be likely to approach that of other restructuring sovereigns.
What is certain, though, is that Ukraine has lost its access to capital markets. The government has been unable to issue debt since April 2013 (ironically, the publication date of the IMF paper, although that’s simply a coincidence).
What will the IMF do with Ukraine? Will it determine that Ukraine’s debt is sustainable and not request a bail-in? Or will it seek to establish the “presumption” of private-sector bail-ins when it provides liquidity?
The answer will have important implications for how investors price sovereign risk.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Marco Santamaria is a Portfolio Manager for Emerging Market Debt at AllianceBernstein.