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Write-off of the Ukrainian debt: by 2019 we will not pay the principal amount of the loan


"FACTY" figured out how and on what terms our country intends to repay the national debt.

On September 17 Verkhovna Rada adopted a law that defines the terms of restructuring of the state debt of Ukraine. Although the deputies voted for the adoption of these laws by a constitutional majority, some members of parliament still made statements that an agreement with creditors, represented by the Minister of Finance Natalia Yaresko, is terribly unprofitable for Ukraine. As always in such cases, populists didn’t trouble themselves with arguments and facts, using only emotions and accusations.

At the same time majority of national and foreign financiers estimate Ukraine’s agreement with creditors very high.

It is very difficult for majority of Ukrainians without special education to understand who is right. Therefore, the "FACTY" have decided to ask the experts to give simple and clear explanations of the agreement terms. First of all, we asked the Ministry of Finance. It is obvious that, having achieved success in complex negotiations with creditors, the Ministry should be interested in promoting its success. But, to our great surprise, the Ministry of Finance, represented by the press service refused to give any comments on the restructuring. So to help our readers to understand what is happening with debts of Ukraine and how our country is going to repay them "FACTY" asked the head of Strategic Planning Unit of UniCredit Bank Yegor Perelygin to give us explanations.

  • Will the entire external debt of Ukraine be restructured according to new law?
  • No. Those loans, which Ukraine got from the international financial institutions (IMF, World Bank and others), as well as the credits from governments of other countries will not be restructured. Only 14 issues of securities that the Ukrainian government has allocated on international markets will be restructured. They are held by private creditors. The Ukrainian side at negotiations was headed by the Minister of Finance Natalia Yaresko who worked in investment business and has extensive experience in securities. World well-known consulting company "Lazard" who has a great experience in the negotiations on debt restructuring (in particular, it was involved in the negotiations on Greek debt) was also on Ukrainian side. And according to the terms of cooperation with "Lazard" the company can count on a fee only in the case of successful results of negotiations. The company "Franklin Templeton", the world leader in securities business and the largest holder of securities of Ukraine was involved in negotiations representing Ukrainian creditors. One of the leaders of this company is Nicholas Brady, former the United States Secretary of the Treasury , who was engaged in the restructuring of Latin American countries debt. His name is associated with the appearance of the securities linked to the economic results of the USA – the famous "Brady bonds." They are the prototypes of the tools, which are now the base of the agreement between Ukraine and its creditors. In total, the creditors' committee represented holders of about 9 billion of Ukrainian debt.
  • What is the point of agreement with the committee?
  • The parties agreed that creditors will write off 20 percent of the current Ukrainian debt. An additional bonus is the fact that our country has received a grace period till 2019, during which we will not have to pay the principal amount of the loan.
  • Does the adoption of the law mean that the restructuring is finally resolved?
  • There must still be held the last meeting with the creditors, where an agreement about exchange of old securities to new ones in accordance with the law will be signed. The meeting is scheduled on October 14 in the UK. I have no doubt that voting on it will be positive. And then there will be an actual exchange of old securities for new ones.
  • What is a procedure of the exchange?
  • All securities that are now held by the creditors will be exchanged for new ones, released by the government of Ukraine. And the security valued of $ 1,000 will be exchanged by a new one valued of $ 800. So, the debt will be decreased by 20 % (or $ 3.8 billion).
  • Will these securities be the same for all creditors?
  • Yes, they all will get the same securities with the same terms and conditions of repayment. The interest rate on them will be 7.75 percent per annum.
  • Creditors, who were involved in the agreement with Ukraine, hold only 9 billion out of 17 billion debts. Holders of the rest 8 billion were not in creditor’s committee so we don’t have any agreements with them. How can we solve the issue with them?
  • These creditors can come to the forthcoming meeting in London or meet with representatives of the Ukrainian government at another time and sign an agreement about the exchange of old securities for the new ones under the same conditions. If they decide to insist on securities repayment on the terms they were issued, then the case will go to court and will last on for years. The experience of many countries shows that, facing with the inevitable the creditors usually sign an agreement on general terms. Perhaps many of them will come to a meeting on October 14.

And I think it will be the right decision. After all, they are offered a fair deal – the debt writing off in exchange for a compensation tool.

  • A compensation toll was attacked by the critics of the agreement the most. What is it?
  • It is derivative – a security which value is not defined in advance, but depends on certain conditions. In this case, the value of derivatives released by Ukrainian government will be connected with results of the economy. And I want to specify that these tools are not traditional. The new derivatives have certain properties of released before securities, but in this form were created for the first time especially for Ukraine.
  • What are the conditions of repayments under these securities?
  • The basic idea is that if the Ukrainian economy develops dynamically, and GDP growth will exceed 3 percent a year, we will pay creditors a part of growth that exceeds 3 per cent.

If the growth is between 3 and 4 percent, the payment will be 15 percent of the exceeding. Let’s assuming that GDP growth for the year reached 3.5 percent. So, we will have to pay creditors 15 percent of the 0.5 percent of GDP:

0.5×0.15 = 0.075 percent of GDP (0.00075 of GDP).

If the GDP growth is more than 4 percent, we will pay 40 percent of the growth exceeding 4 percent. For example, the growth of Ukraine's economy will be 4.5 percent. Then, we will pay 0.15 percent (for the growth from 3 to 4) and 40 percent of 0.5 percent:

0.15 + 0.4×0.5 = 0.35 percent of GDP (0.0035 of GDP).

  • How long will it take for Ukraine to repay the loans?
  • The first payment is scheduled on the beginning of 2021. Its size will be calculated on the basis of economic performance in 2019. Year of delay is needed for collection and examination of all the statistical data and for calculation of the GDP size and its growth rate.

Payments will last till 2040.

At the same time creditors will not necessarily receive money. According to the agreement payments will not start until the size of Ukraine's GDP has reached 125.4 billion dollars.

  • Where is this figure from?
  • According to the IMF forecast, this size of Ukraine's GDP should be reached in 2019.
  • And what is the size of our GDP now?
  • It is hard to say, because the year has not ended yet. But, according to a rough estimate, it is slightly less than 80 billion dollars. So to reach the level of 125.4 billion dollars, the economic situation must be completely changed and the growth must be rapid. GDP in dollar must grow by more than 50 percent. Otherwise, the creditors will get nothing.
  • Suppose, in 2019 Ukrainian GDP has not reached this amount. So payments will start later. Does this mean that payments last till the end of 2041?
  • No. Derivatives will only work from 2021 till 2040. The creditors will get the amount that will be payed only in this period. If, for example, during this time the GDP growth rate is below the 3% a year, the creditors will not get a penny for all 20 years. Another important term of the agreement: the total amount of payments to creditors from 2021 to 2025 can not exceed one percent of GDP in any circumstances. If Ukraine demonstrates fantastic growth, for example, 10 percent a year, we should pay:

0.15 + 0.4×6 = 2.55 percent of GDP

But still we will pay only 1 percent.

  • Populist claim that the creditors will get too much for their loans. Perhaps even more than it is written off now.
  • Usually these statements are explained by the war, Ukraine lost roughly one-fifth of the economy – it was either cut off from the country or destroyed. And that is why after the end of active military operations the country will made show a great development. In reality it will not. The economy is recovering very hard. And if we did not get a break today, in the next three years we will not pay the principal amount of the loan, as well as debt write off, we would be in very difficult situation. The conditions of the agreement will allow Ukraine to make the necessary reforms during the grace period that will enable us to show good economic performance in three or four years.
  • Are there any forecasts, how much will Ukraine have to pay for the derivatives?
  • To make this prediction, it is necessary to take into account various factors. First of all, the time value of capital.
  • What is that?
  • I think everybody understands that the value of a dollar today will be significantly different from its value in the future. Now creditors write off $ 3.8 billion of our debt. Suppose, after 20 years, we will return them precisely the same amount. It is obvious that after 20 years, $ 3.8 billion will be far less valuable than now. And it's not only because of reducing of dollar's purchasing power due to inflation in the United States. Today dollar is a recognized tool of international payments throughout the world.

And in different countries attitude to it is different.

For example, in Ukraine dollar is strongly overvalued now, because there is almost no inflow of investments, and there is lack of it in the market. But later when the economy works properly, the value of the dollar will decline from year to year.

Therefore we cannot just compare the numbers. It is necessary to take into account the discount factor, the value of dollar reducing. According to different estimates the discount rate will be 8-15 percent a year in the coming decades.

I calculated how much we will have to pay creditors for all 20 years of the derivatives in total. It turned out that with the average growth of GDP by of 2 percent a year during this period, and with a discount rate of 15 percent (in my opinion, this rate is closest to reality), we will pay an amount equivalent to only 1.6 billion of today's dollars. If you take lower discount rate, 10 percent, the amount will be slightly higher – $ 3 billion.

  • But at 2 percent a year, we do not have to pay anything.

- We are talking about an average growth during 20 years. That means, in some years it will be higher, in some – lower.

One year it is more than 3 percent – we will to pay something, in another less – we won’t pay anything.

If the average annual growth of over 20 years is 4 percent, we will pay 4 billion at a discount rate of 15 percent or $ 7.8 billion – at 10 percent.

However, this development is almost impossible, especially with the situation Ukraine is now in. Moreover, we must remember that now, in order to pay off debts, Ukraine has to find money, taking it from the most urgent needs of the rapidly falling economy. And payments for derivatives will be made only with from profits of a prosperous economy.

  • How fair are terms of agreement for Ukraine? Have we won or lost?

For the first in my practice I see an agreement, balanced for all parties. There is no winner and loser. Everybody won.

Egor Perelygin, head of strategic planning unit of UniCredit Bank

Date: 30.09.2015


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