| LONDON/KIEV Sept 1
LONDON/KIEV Sept 1 Global investors' view of
Ukrainian bonds as a relatively safe bet anchored by Western
support is taking a battering as the country's economic gloom
deepens, with many starting to brace for some form of debt
Fund managers, among whom Templeton's Michael Hasenstab is
prominent, have until now figured that Ukraine would avert
all-out war with Russia, allowing its economy to recover.
Second, they have reckoned the International Monetary Fund,
which has pledged a $17 billion loan deal, has Ukraine's back.
For these reasons Ukrainian bonds have traded not far off
their launch prices, levels many analysts consider astonishing
given the level of economic distress the country is suffering.
But recent days have shattered investors' faith, as Russian
troop moves have effectively ruled out any speedy peace deal or
economic rebound. Analysts predict Ukraine's economy may
contract by up to 8 percent in 2014 and by 5 percent in 2015.
And crucially, IMF comments last week are being interpreted
by some as bringing Ukraine closer to debt restructuring.
The fund released more cash but said that if Ukraine's
situation worsened, "the programme would need to be
significantly recalibrated, including potentially the
"There's two ways you can read last week's IMF statement on
Ukraine. One is, don't worry there is more money coming. Or
second, there is more money coming but you guys (investors) will
need to contribute," said Gabriel Sterne, head of global macro
at consultancy Oxford Economics.
He was referring to "bail-ins" that force private sector
creditors to bear some of the rescue burden by restructuring
debt or reprofiling it by extending debt maturities. With little
debt this year, many see the latter option as more likely.
For a TABLE on maturing Eurobonds click
IMF programmes by themselves don't exclude default, Sterne
notes, citing Greece which was on a fund lifeline for two years
before forcing investors to take a 70 percent debt write-down.
Possibly chastised by the Greek experience, a 2013 IMF paper
said future restructurings should be timely, without "allowing
an unsustainable debt situation to fester". It also wants to
stop using its resources "to simply bail out private creditors."
For sure, Kiev has a far lower debt ratio than Greece at
just half its annual economic output (GDP). And the West, locked
in a political standoff with Russia, is unlikely to let Ukraine
sink. But lenders may want to rope in private creditors if they
find themselves increasing the size of the aid.
"Ukraine need a bigger programme, and reading between the
lines, they haven't decided whether they need to reprofile or
not. I think the temptation will be to reprofile," Sterne said.
Bond prices fell 8-12 cents on the dollar over August, and
the cost of insuring exposure to Ukraine via credit default
swaps has risen steadily. One-year CDS now cost more than 5-year
swaps, data from Markit shows, a sign of short-term debt stress.
JPMorgan advised clients to cut Ukraine holdings. It doesn't
see a crash on the bonds as imminent, but says the "likelihood
of eventual restructuring in 2015 has increased significantly".
Original economic recovery assumptions for Ukraine have
turned out way too optimistic. As recently as end-2013, the IMF
had assumed a 1 percent growth rate for this year.
But the economy shrank 4.7 percent in the second quarter
compared with the same year-ago period while industrial output
plummeted 12 percent in July. Tax revenues from the heavily
industrialised eastern provinces have fallen, even as Kiev is
forced to up military spending.
In July, President Petro Poroshenko estimated Ukraine was
spending $6 million a day on the conflict, but this will have
risen since then, as fighting has intensified.
The hryvnia currency, meanwhile, is approaching the 14 per
dollar mark - at the start of the year it traded at 8.
The relentlessly depreciating currency is shrinking domestic
GDP in dollar terms while making it costlier to service debt, 70
percent of which is in hard currency, says Steve Ellis, a fund
manager at Fidelity, calling it "a vicious downward spiral."
"We know Ukraine is strategic but the IMF don't disburse
money in a deteriorating situation and when you see debt-GDP
going above 60 percent, the IMF will be running just to stand
still," Ellis said. "Bond prices have not deteriorated because
investors always believed there will be an official backstop but
the reality is this backstop will probably not be sufficient."
Debt ratios are 45 percent of GDP, versus 36 percent in
2012. The IMF's baseline forecast was for the 60-percent mark to
be hit in 2018 but many now expect it by 2015, enabling Russia
to demand immediate payment on a $3 billion bond it holds.
But because ratios are still fairly low, the Fund may prefer
a debt reprofiling to restructuring - extending the time for
repayment but without marking down the value of the debt.
Extending the 2017 bond, for instance, to 2020, would change the
profile of the yield curve and give Kiev more time to pay.
HASENSTAB PUT, HIGH YIELDS
Surveys suggest investors are underweight Ukraine, meaning
average holdings are less than its weight in bond indexes. But
its high yields - yield premia to U.S. Treasuries are more than
triple the emerging markets average - have kept many hanging on.
Also of comfort to investors is the presence among their
ranks of Hasenstab, the Templeton fund manager who has made his
name with contrarian - and ultimately lucrative - bets such as
Hungary. At last count, Templeton held almost a third of
Ukraine's outstanding sovereign Eurobonds across its funds.
Angus Halkett, a fund manager at Stone Harbor Investments,
says he is no fan of Ukraine but finds it hard to avoid the
high-yielding asset. Then there is the Templeton factor.
"(Templeton's) presence absolutely makes a difference to
everyone, the price of our position essentially depends on them,
they are pricemakers," Halkett added.
Hasenstab argued in a June interview with Morningstar that
Ukraine faced a liquidity, rather than solvency, problem and
Western aid would help it overcome that. He said he was looking
past short-term volatility into a three- to five-year horizon.
If debt reprofiling allows Ukraine to sort out its finances,
Hasenstab may yet come out on top, as it would enable investors
like him to clip 8-9 percent coupons for a few years more.
(Additional reporting by Carolyn Cohn in London; Editing by