Ukraine shifts gears with debt deals as war weighs on finances

Tougher choices face Ukraine after last week’s debt restructuring highlighted the lack of urgency for Kyiv donors to step in and provide the financing needed to cover a budget shortfall $5 billion monthly.

Last week, Kyiv reached preliminary agreements with bondholders and a group of Western governments to postpone debt repayments for two years from August 1 after calls for allies to close the deficit remained largely unresolved. ignored.

The agreements, which if signed would free up around $6 billion and were associated with a 25% devaluation of the hryvnia, ease the immediate pressure on Ukraine to meet its obligations to foreign creditors. Some say they also better reflect the financial situation in the war-ravaged country. “Some investors were puzzled why Ukraine hadn’t already done this,” a foreign banker said after last week’s announcement.

The sharp drop in the pegged exchange rate was aimed at slowing down the rapid depletion of Ukraine’s foreign currency reserves. Citizens who fled abroad used hryvnia bank cards to withdraw $1.5 billion a month from the country at an artificially cheap rate, said Maria Repko of the Center for Economic Strategy, a think tank at Kyiv.

But, with the restructuring covering just over a month of public spending, economists warn that Ukraine remains under severe financial strain. The war forced Kyiv to increase its monthly military spending from $250 million in February to $3.3 billion in May.

The government, which has already imposed severe cuts in current service spending to cover its military bill, may be forced to take even more drastic measures.

“Something has to happen on the domestic side – either raise taxes or cut non-essential spending,” said Yuriy Gorodnichenko, an economics professor at the University of California, Berkeley. “Everyone thought the war was going to end quickly. . . but it will last for months, even years.

Kyiv’s room for maneuver is extremely narrow. With all but the most essential expenses reduced to the bone, and VAT and customs duties on imports – suspended after Russia’s invasion – now reinstated, there are no easy options. According to Repko, any new tax on companies would risk tipping them into bankruptcy, thus aggravating the humanitarian crisis.

If maintained at current levels, the massive increase in military spending would mean the government would run out of funds again in the fall, she warned.

Ukrainian Finance Minister Sergii Marchenko says printing money for much longer risks fueling inflation © Ministry of Finance of Ukraine

Credit rating agency Moody’s has projected a budget deficit equal to 22% of GDP, leaving the Ukrainian government with a funding gap of around $50 billion for 2022. Most of that $50 billion gap is made up of the government’s budget deficit, which amounts to $5 billion a month. .

Without foreign financial support, Repko said Ukraine “would enter a spiral and the military effort would be impossible to sustain”.

About $38 billion in budget aid has been pledged by foreign governments and multilateral agencies since Russia invaded in February, but only $12.7 billion had been disbursed by early July, according to Ukraine’s finance ministry. . Another €1 billion in EU funding is expected by the end of the month. “Commitments are very high but disbursements are insufficient and slow,” said a foreign banker working with Kyiv.

Ukraine has exhausted its foreign exchange reserves to finance its war effort. The central bank has also purchased government bonds worth $7.7 billion since the invasion, including $3.6 billion last month alone – a de facto money-printing exercise.

Finance Minister Sergii Marchenko told the Financial Times last week that relying on money printing for much longer would be ‘very risky’ as it would fuel inflation, which has already doubled since the invasion to reach 20% and is expected to climb further after. currency devaluation, which will drive up the price of imports.

Net reserves now stand at just $12.9 billion, down from $19 billion in February, enough to pay for about two and a half months of vital imports of agricultural inputs, vehicle parts and fuel.

A deal struck with Russia last week to protect Ukrainian grain exports would bring in around $800 million in export revenue a month if it sticks, according to Dragon Capital in Kyiv. But the deal was in jeopardy after Russia fired missiles at the port of Odessa a day later.

Viktor Szabó, chief investment officer at UK asset manager Abrdn, said the government’s options were very limited.

“If they run out of supplies, they’ll have to decide whether to pay soldiers or nurses. They will have problems running schools and hospitals,” he said. “It is a disaster.”

Additional reporting by Mark Raczkiewycz in Kyiv

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