You're reading: Ukraine defaults on domestic debt

Foreign investors exempted from mandatory T-bill conversion

The Ukrainian government has effectively defaulted on its entire outstanding debt to domestic banks, issuing an order that automatically converts treasury bills held by those banks into longer-term paper.

The surprise order, issued on Sept. 10 but kept secret until late in the evening on Sept. 11, came after two weeks of repeated government promises that it would not follow in the footsteps of Russia, which caused investors huge losses by automatically converting most of its foreign and domestic debt three weeks ago.

Although analysts in Kyiv pointed out that the terms of the Ukrainian conversion were much more favorable than the terms of the Russian conversion, the response among local investment houses was decidedly cold.

‘The Ukrainian government will always have the default stamp on its forehead,’ lamented one local analyst.

The order was not sent out to banks until well after working hours on a Friday evening. By that time, banks’ T-bills had already been converted.

The conversion order applies to all T-bills maturing before Aug. 27, 1999 – the latest date at which any outstanding Ukrainian T-bills mature. Although foreign investors were exempt from the conversion, foreign banks registered in Ukraine, such as Societe Generale, were subject to the order.

President Leonid Kuchma on Monday denied that the conversion constituted a default, saying it had been agreed with the banks and was not forced.

‘That is not true, that it was forced,’ Kuchma told a news conference. ‘This issue was absolutely, 100 percent agreed with all banks.’

Few people agreed with him.

Reuters reported that some banks said they had not received the order until Monday morning when they were informed that the exchange had already been effected. Others said the move would push some banks to the verge of bankruptcy.

‘With this order, banks are driven to the verge of bankruptcy,’ said Valeria Hontareva, financial director at Societe Generale in Kyiv. ‘They will not be able to meet their obligations to each other or toward their partners.’

Kuchma’s words aside, the announcement of the new scheme appeared to signal an end to the government’s bid to lure banks into accepting a voluntary debt restructure scheme unveiled at the end of August.

The scheme offered to restructure debts of up to one year into paper maturing over the next 3 to 5.5 years, yielding 40 percent over the first year and prevailing market rates plus one percentage point beyond that. The terms of last Thursday’s new conversion deal are the same, with the exception that the Finance Ministry will no longer tack on that extra percentage point.

The scheme also exempts bonds in personal accounts. But analysts said such holdings are insignificant. National Bank of Ukraine Governor Viktor Yuschenko and Finance Minister Ihor Mityukov took great pains to stress the voluntary nature of the August conversion plan in an effort to distance Ukraine from Russia.

At that time, the government immediately brokered a deal with six major banks to accept the terms of the voluntary deal and eventually lured 10 more into agreeing to the scheme. These banks together converted roughly Hr 800 million worth of T-Bills, or 35 percent of the total held by resident banks.

But with Ukraine’s foreign reserves dwindling and with the International Monetary Fund demanding that Ukraine restructure its debt in a hurry, Hr 800 million was not nearly enough.

Debt restructuring is one of the conditions the IMF has imposed on Ukraine to receive further tranches of the $2.2 billion loan. The first $257 million tranche was handed over last week.

The condition has placed the IMF at loggerheads with foreign holders of Ukrainian T-Bills, who would prefer to receive their money now than see their debts restructured.

Meanwhile, foreigners are weighing the pros and cons of a voluntary conversion scheme to convert their own treasury bills. Announced by the government last Wednesday, the scheme gave foreigners until 5:00 PM on Sept. 16 to decide whether to nibble on the offer or not.

The terms have received a tepid response thus far from non-residents.

‘At this stage it looks like a pretty ugly offer…ugly just because it is not market-based,’ Caren Gaboutchian, emerging markets analyst at ING Barings in London, told Reuters. ‘It is based on calculations of decreasing debt servicing costs.’

The finance ministry aims to convert 80 percent of outstanding non-resident T-Bills, most of which mature before the end of this year, for new bonds maturing on Sept. 22 or Dec. 22, 2000. The new bonds would be denominated in hryvna and yield a minimum 45 percent in hryvnas. But they would have a variable coupon to ensure a minimum 22 percent dollar yield.

On the outside, the deal is much more attractive than the conversion deal fed to non-residents in Russia. There, foreigners were forced to automatically swallow 66 percent losses. Here, investors actually stand to gain from the conversion.

The problem is, nobody trusts the government will be any better prepared to meet its obligations in 2000 than it is now.

‘If Ukraine does do a soft conversion now, foreigners will be forced to wonder whether or not they will do the same thing in [2000],’ noted Patricia Bartholomew, an economist at Wood & Company in Kyiv.

That attitude could make it hard for Ukraine to meet its goal of converting 80 percent of non-resident debt. If the Finance Ministry does not reach the 80 percent plateau, it has said it would cancel the restructuring offer.

Canceling the offer would put the government in a bind. Ukraine must redeem a total of Hr 1.8 billion of OVDP bills from foreigners, even as reserves have slumped to $860-$890 million.

One investor summed up the situation best: ‘Come Thursday, Ukraine could be faced with either defaulting on their non-resident debt, or not receiving further [IMF] tranches.’

At least one expert thinks this simple math leaves investors with no choice but to go for the conversion. ‘If investors are told, ‘You have to convert and if you don’t convert then we will default because the IMF will not give us money,’ that’s a very plain statement,’ Gaboutchian told Reuters.

‘Whether right or wrong, if people are told that, I would imagine they would rather convert than not.’ At 5 p.m on Thursday, the answer will be known.