On March 29, the High Court in London has decided that the sanctity of Eurobond debt trumps Ukraine’s special pleading to treat the Russian $3 billion loan to the late Yanukovych regime as odious debt and wave it away on account of Russia’s supposed “aggression” against it.
This is not the final judgment, which is still a few weeks away, but Ukraine’s chances of winning have now diminished to the purely theoretical.
Once that happens, Ukraine will be found to be in default on its loan to Russia, and since Russia belongs to the Paris Club of major creditor countries, the IMF will be prohibited from any further lending to Ukraine.
At that point, the IMF will have to decide whether it is willing to bend its own rules to continue to lend to Ukraine. On the one hand, Western countries – the United States, the EU countries, and Japan – hold a narrow majority of the voting power in the IMF, so perhaps a pro-Ukrainian decision could be lobbied through.
However, I agree with Alexander Mercouris that this is unlikely. The Ukraine has made zero to negligible progress on combatting corruption, and with the recent transport blockade of the Donbass and the nationalization of Ukrainian enterprises in the LDNR, a huge chunk of Ukraine’s foreign currency earnings are now going to go up in smoke. The IMF decision to forego a planned $1 billion tranche on March 20th cannot augur anything very good for the Ukraine.
At that point, the Ukraine could either comply with the court decision for IMF lending, or it could not.
The former will be politically risky, especially given that Poroshenko’s position now seems to be far more fragile than it was even a few months ago, with the Kolomoysky-Turchinov-Tymoshenko alliance flouting his authority with apparent impunity, from the Donbass blockade to the ejection of Russian banks from Ukraine. The alternative would be to live without the IMF, but could the Ukraine manage that?
The economy, at least until the Donbass blockade, showed signs of finally turning the corner, recently clocking up 4.7% growth by the end of the year (albeit from an extremely depressed base). The loss of the LDNR enterprises means will force the Ukraine to make deeper than planned cuts this year, and will sink its current account deep into the red just as the positive effects from its post-Maidan devaluation begin to wear off. Even in 2015, Ukraine’s government debt to GDP ratio was at 79% – anything over 60% is considered to be the danger zone for emerging economies (Russia defaulted at 75% in 1998) – and it will be worse today. Meanwhile, its war chest of $15 billion in foreign currency reserves, though a great improvement over its nadir at $5 billion in 2015, could drain away rapidly if shorn of IMF support.
The markets agree that the situation is fraught. 5 year credit default swaps for Ukraine are currently at 628 basis points, which implies that the default risk for Ukraine is higher than for any other major country bar Venezuela.