Under what conditions can Ukraine avoid default — Parashchyi

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From the fragmentary information on the progress of negotiations regarding the restructuring of Eurobonds to avoid default in Ukraine, the Ministry of Finance and creditors are still far from a final agreement. But everything looks hopeless. What can be understood from the proposals of the government and creditors, Told me head of Concorde Capital's analytical department Oleksandr Parashchyi.

Debt cancellation

The Ministry of Finance insists that creditors agree to a one-time unconditional write-off of at least 25% of the debt.

Creditors do not want to hear about such an unconditional write-off. The position of creditors can be understood, because: a) during the restructuring of 2015, there was no unconditional write-off; b) they want to leave at least some possibility that they will be able to "restore" their asset in full (for example, if the situation in Ukraine improves significantly in the near future).

Accordingly, the government's refusal to write off any portion of the debt unconditionally appears essential to reaching a compromise.

Payments in 2024-2027

The Ministry of Finance cannot afford large bond payments until the end of March 2027, because the lack of such payments is "predicted" by the current IMF program.

But, surprisingly, in its updated proposal to creditors, the Ministry of Finance agreed to pay approximately 1,2% per annum on the debt during 2024-2027, which appears to be a significant departure from the "IMF vision". But, apparently, this is the last proposal of the government - there is nowhere to improve it further.

At the same time, lenders here have shown considerable greed — they want more than 3% per annum. Obviously, they will have to reduce their appetites to reach a deal.

Long-term interest rate

Creditors here are also behaving quite brazenly — they demand a rate of 7,75%, starting from 2034, and (if events develop positively) for the entire debt. This is higher than today's average interest rate on this debt (about 7,5%).

The alternative proposal of the Ministry of Finance is 6%, and only for part of the debt (the one that will not be written off).

Obviously, here the parties need to somehow "closer" their positions.

Price and discounted value of bonds (NPV)

As of the beginning of June, the market price of the bonds was approximately 29% of their face value. This means that, in theory, creditors "were ready to exchange" dollars of the nominal value of debt securities of Ukraine at 29 cents cash (or approximately $6,8 billion in cash in exchange for securities with a notional face value of $23,4 billion). Of course, in practice, no one will offer them even $6,8 billion now (and they won't sell it either).

But they want to receive in the form of future discounted cash flows (NPV) no less. The only question is at what rate to discount those future flows.

If you look at the "market" (for example, the longest dollar bonds of MHP or Metinvest), it seems that the "market discount rate" should be close to 15% in dollars.

If you calculate the NPV of the proposed cash flows at this rate, it turns out that the government's proposals "give" value from 16% to 30% of the nominal value (and honestly - about 23%). While lenders' proposals "predict" a much higher cost (38%-44%). It seems that the lenders believe that the discount rate (or the rate of their annual earnings) should not be 15%, but 20%. This is definitely an overkill. The last proposal of the creditors generally looks like a mockery: they propose that the government pay off all the accumulated debt (which is $18-23 billion) in just two or three years - during 2034-2036.

Hence, creditors have "substantial scope" to yield on the general terms of the restructuring.

Here, a compromise is possible if: a) creditors will not demand a sky-high yield, b) the Ministry of Finance will slightly increase the "upper limit" of NPV in case of some "positive development of events". This can be done by refusing to write off part of the debt unconditionally.

So, it doesn't take much to compromise:

  • The Ministry of Finance should abandon unconditional debt cancellation.
  • Both sides need to come to an agreement on the long-term interest rate.
  • Lenders need to put up with very low payments for the next three years and not demand "skyrocketing" returns on Ukrainian debt.

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