Analysis: Ukraine assets still only for the brave
LONDON (Reuters) - Ukraine's slowing economy, messy politics, and above all the $60 billion of debt it must repay in 2012 are driving foreign investors away from the country and are likely to push up its bond yields and default insurance costs in the coming months.
Contrary to expectations, Ukraine's co-hosting of the Euro 2012 soccer finals has generated little positive publicity as investors focus on its dire financial state, widening balance of payments deficit and a plunge in its currency to two-year lows.
Instead, the jailing of opposition leader Yulia Tymoshenko has prompted some European politicians to boycott a tournament the former Soviet republic had hoped would showcase it as a modern state eligible to join the European Union, with allegations of racism further souring the mood.
Central bank data shows Ukraine owes foreign creditors $56.7 billion this year, equivalent to one-third of gross domestic product. With half the year gone, most of this cash has yet to be raised.
Finding so much money could prove tricky, given Kiev is at loggerheads with the European Union and Russia, is refusing to accede to IMF demands that would unlock aid and faces parliamentary elections in autumn. All this has effectively sealed access to global markets, raising risks of a balance of payments crisis.
Added to that, its economy that is expected to grow just 2 percent this year, as prices for Ukraine's main export, steel, take a hit, while many reckon staging the soccer championship will further worsen the country's debt metrics and balance of payments deficit.
JP Morgan data shows Ukrainian dollar bonds currently yield over 9 percentage points more than U.S. Treasuries, among the highest levels in the EMBIG government bond index, and double their levels of a year ago. The cost of insuring exposure to Ukraine's debt has also doubled in the same period.
"The yield is high, so from that viewpoint it appears attractive, but if you have concerns about the sovereign's ability to pay, the situation looks different," says Zsolt Papp, who helps manage 1.2 billion euros in emerging debt at UBP in Zurich and has cut his Ukraine holdings to the minimum.
Ukraine's dollar bonds have returned a respectable 6 percent so far this year, but that performance looks unlikely to last.
The country's finances have deteriorated steadily since the International Monetary Fund halted a $15 billion aid package in early 2011 after Kiev refused to hike domestic gas prices in order to cut its budget deficit. Instead, the government, eyeing the October elections, actually boosted social spending.
The government has until recently had some success raising cash on local bond markets, in hryvnias as well as hard currency, because of the high yields on offer. But in an ominous sign, three such auctions have failed in recent weeks.
All this rekindles memories of 2008-2009 when a debt default by Ukraine's state oil firm Naftogaz pushed risk insurance costs and bond yields to record highs and inflicted untold damage on the country's creditworthiness.
Analysts at Barclays have advised clients to trim exposure to Ukraine, predicting a tougher six months ahead.
"We think now is the time to take profits and scale back on risk in Ukraine credit, taking positions from overweight to market weight. Our call is partly based on political risks building ahead of the October elections," Barclays said.
It expects the factors supporting Ukraine's balance of payments, such as tourism inflows, to fade in coming months while central bank reserves may fall due to debt repayments. Ukraine must make a $600 million Eurobond payment in late June.
NOT ALL BAD
Ukraine's risk premium has eased somewhat since it repaid half of a $2 billion loan to Russian state bank VTB last month and said it would issue a $1 billion bond in lieu of the rest. Russia also advanced Kiev $2 billion to pay for gas imports.
And Ukrainian companies have managed to raise $475 million in the syndicated loan market this year, data from Thomson Reuters Loan Pricing Corp shows, although that total is less than at the same point last year and prices are higher.
Max Wolman, a fund manager at Aberdeen Asset Management, said another positive may be that much of the foreign debt due this year consists of loans and trade finance, which creditors usually tend to roll over. Central bank reserves of $33 billion should be sufficient to cover the other half if needed.
"At this moment things are balanced on a bit of a knife-edge for Ukraine. It's difficult to call it either way," Wolman said, noting that companies' low debt levels might also allow them to make some repayments outright.
Once October's elections are past, many analysts also expect Kiev to accede to the IMF's demands for higher gas prices and currency flexibility. That would unfreeze aid and might allow the government and some corporates to tap capital markets.
"Ukraine has not passed the point of being bankable," said Greg Saichin, head of emerging debt at Pioneer Investments. "They are bankable, but at a much higher risk premium."
He expects Ukraine to eventually comply with IMF conditions, comparing it to Hungary, which bowed to EU pressure to secure aid but inflicted much pain on bondholders in the meantime.
"When these countries are put against the wall, they end up complying. The risk-reward for the political class becomes asymmetric in a negative way and eventually that ends up unblocking politics," Saichin said.
Like Wolman, Saichin likes Ukraine's corporate debt, noting the reputation of local firms for being well managed, with good margins and low net debt levels.
But companies' strengths have not stopped bond spreads widening. According to Barclays, Ukrainian corporate bond yields have widened by around 400 basis points versus comparable Russian debt since mid-2011, reflecting relative political risk.
Barclays analysts have also advised reducing exposure to local banks, noting that 40 percent of their loan books are in hard currency and could be hit by a post-election hryvnia fall.
Others, however, reckon Ukraine's bonds are now fully pricing in the worst-case scenario, with extremely light foreign positioning meaning further sharp selloffs are unlikely until the election.
"Where Ukraine is trading it offers value on a risk/reward basis, hence we moved to overweight in the credit space," RBS analysts told clients this week.
But they added: "Only for the brave!"
(Additional reporting by Olzhas Auyezov in Kiev; Editing by Catherine Evans)
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