News Analysis: Ukraine's moratorium on foreign debt payments raises default fears

An unexpected latest decision of the Ukrainian parliament to grant the government a right to impose a moratorium on state debt repayment has raised fears that the crisis-hit country may default on its debt obligations in the near future.

While some local experts suggest that the moratorium is just a tool for improving Ukraine's position in debt-restructuring negotiations with foreign lenders, others claim that the country's bankruptcy appears increasingly likely after the move.

ALL-OR-NOTHING GAME

The moratorium, which allows the government to halt payments on foreign debts to private creditors, came as a total surprise for the market amid fresh talks between Kiev and its lenders over restructuring of Ukraine's outstanding debt.

In fact, by adopting the legislation, Ukraine has decided to play an all-or-nothing game, openly saying that Kiev could refuse to fulfill its international obligations if its conditions are not met.

As the June deadline for restructuring about 15 billion U.S. dollars of foreign debt nears, Kiev is probably expecting last-minute concessions from its creditors by threatening to default, which would leave the lenders holding an empty bag.

But still, it is not clear whether Ukraine's intention is real or just a bluff.

"On the one hand this move is an attempt of psychological pressure on the lenders. On the other, it is a necessary step to delay the fulfillment of the obligations," said Taras Kotovych, an analyst at the Investment CapitalUkraine analytical center.

Ukrainian lawyers fear that a possible ban on debt payments can also pose serious legal risks to Kiev as its legality is questioned.

Inna Rudnik, a lawyer at the Kiev-based law firm Lavrynovych & Partners, said Ukraine's threat is nothing else but a "unilateral refusal to fulfill its obligations," which is prohibited by the Ukrainian and international law.

"According to international standards, any changes to the terms of agreements are possible only with the consent of all parties. So in case if the moratorium is imposed, our partners would have the right to appeal to the courts demanding forced recovery of the debt," Rudnik said.

TRUMP CARD IN TALKS

Although a solution to the dispute between Kiev and its creditors using international courts is quite possible, it goes without saying that a compromise outcome of the debt-restructuring talks is a preferred option for both sides.

Some local analysts suggested that the risky move to impose a repayment moratorium could be an effective instrument to strengthen Kiev's position at the negotiating table.

"Granting the cabinet a right to impose repayment moratorium is a technical solution, which gives the government additional arguments and a room for maneuver during the talks with foreign creditors," said Igor Mazepa, a chief executive at the Concorde Capital investment company.

Ukraine's debt service burden requires Kiev to pay 12 billion dollars to its foreign lenders in 2015, and investors seem to be aware that the cash-strapped country, which is experiencing its worst economic crisis in decades, appears unable to afford a repayment on time as it simply has no enough money at the moment.

Thus, the lenders could agree to accept partial haircut of Ukraine's debt instead of losing all invested money if Kiev declares default, or wait for their payments for an unspecified period of time if it imposes moratorium.

"The law on moratorium could act as a trump card in Ukraine's hands during negotiations with creditors," said Alexander Zholud, an economist at the International Center for Advanced Research.

In the most probable scenario, foreign lenders would grant Ukraine a clearly defined grace period on debt repayment, which could be a compromise option, Zholud said.

According to him, in this case, the investors would obtain guarantees to return their money within a specified period, while Ukraine will partially fulfill its obligations for the International Monetary Fund to receive a second tranche of an aid program involving 17.5 billion dollars.

DEFAULT RISK REAL POSSIBILITY

Yet, some experts were not so positive about the prospects to achieve a compromise with lenders soon, pointing out that the law on moratorium is not a manipulation tool in debt-restructuring talks, but rather a signal that Kiev is preparing to declare a technical default.

Ruslan Bortnik, a political analyst at the Ukrainian Institute of Political Management, said that by imposing a formal ban on debt repayment, the government is laying the groundwork to protect itself if the lenders would decide to sue Kiev over default in international courts.

"Default is a matter of time and the authorities seem to understand it. Probably, now they are preparing a legal basis to deprive the small lenders of the money they had invested in Ukraine as the moratorium is a legal ground to justify the refusal to repay the loans in the courts," Bortnik said.

Indeed, Ukraine's default risk seems a real possibility given the parlous state of the Ukrainian economy, which fell 17.6 percent in the first quarter of this year and continued sinking under the pressure of the conflict in eastern regions, which costs Kiev about 7 million dollars per day.

The political instability and a lack of economic reforms are having a dire effect on the already weak financial system, adding to the fears that Ukraine may plunge into a broader credit crisis.

"It is very difficult to make predictions on the situation, but currently the probability of technical default is nearly 50 percent," said Alexander Okhrimenko, head of the Kiev-based Ukrainian Analytical Center.

The situation is also exacerbated by the fact that Russia, which holds 3 billion dollars of Ukrainian Eurobond, whose full repayment is due by the end of this year, has reportedly declined to join the debt restructuring talks.

But even if Ukraine's debt-restructuring targets are finally met and its investors agree to postpone the payment or partially write off some credits, it would bring only short-term benefits to Kiev.

The threat of introduction of the repayment moratorium may have a long-term negative impact on Ukraine. It definitely will not add to a good reputation of the country as a reliable partner, and will probably lead to a continuous decrease of foreign investment in the country. Endi