Debt noose: Will Ukraine be able to cover all debts
Ukraine's national debt has reached $82 billion, while the Cabinet continues its borrowing spree, each week placing bonds, most of which are being purchased by non-residents. What are the risks of such a policy, and will the country be able to pay off its debts?
The Ministry of Finance of Ukraine in the penultimate working week of 2019 held another weekly auction for the placement of domestic state loan bonds, raising over UAH 11 billion. Most likely, most of the securities were traditionally bought by non-residents, who from year-start have increased their portfolio to UAH 110 billion (by 11 times).
Funds attracted have become one of the main sources of money for the state treasury. The Accounts Chamber noted that in January-November, the state budget was financed mainly through borrowing, which amounted to UAH 384 billion and slightly exceeded the target. And there is no other way out, since the budget is still seeing deficit, lagging behind the revenue target plan by almost UAH 56 billion, while the government also chronically fails to implement the plan for state property sales.
Meanwhile, previous debts accumulated over the years of independence are yet to be paid off. The volume of public and state-guaranteed debt in January-October 2019 increased in dollar terms by $3.5 billion, up to $82 billion. In hryvnia equivalent, this is more than UAH 2 trillion, which puts a burden of about UAH 49,000 on every Ukrainian, including infants and the elderly.
What's happening to the public debt and how safe is the practice of accumulating debts, including through the active sale of securities to non-residents?
All is calm at the Finance Ministry
Polina Yarovaya, chief of the debt policy department at the Ministry of Finance, explained that external debt is quite a normal thing for any state, as countries usually accumulate debts during crises, then paying them off successfully in growth periods.
According to the ministry's forecasts, the volume of public debt, despite its growth in absolute value, will remain below the safe level of 60% percent of GDP as of the end of 2019, while the peak value at the end of 2016 was 82%.
The official notes that the rates on Ukrainian government bonds are indeed very high compared to those of some European countries. But this is about paying investors for risks as their confidence in Ukraine after the restructuring of 2015 has not yet been fully restored. At present, servicing public debt makes up almost 12% of the state budget expenditures, alike Greece and Italy, but the Ministry of Finance expects this indicator to decline by late 2024 to 10%, which is the level in the U.S., the world's largest economy.
Yarovaya stressed that the current situation had nothing to do with the debt pyramid, which is characterized by constantly rising rates and extremely short maturities. Her words are confirmed by stats: since year-start, the largest growth in the public debt structure has been seen in long-term government bonds maturing in two to six years, while the yield has decreased from 18-19% per annum to 11-12%.
The official disagrees with some experts who predicting a mass sale of government bonds by non-residents and the imminent collapse of the national financial market.
"Non-residents mainly invest in long-term bonds, while there is almost no long-term money on the market in Ukraine. So if they want to sell these bonds to someone, they can only do this on the foreign market, to other non-residents, which is unlikely to have any significant impact on the domestic market," she explained.
The NBU shares the ministry's calm.
According to the NBU's latest financial stability report released this week, more than half of the Ukrainian government bonds purchased by non-residents mature in 2022–2025, while payments over the next two years are fairly evenly distributed over time.
Are there any risks?
Experts consider the debt policy of the Ukrainian authorities quite reasonable. Dragon Capital's Serhiy Fursa notes no signs of a debt pyramid in Ukraine, since state budget deficit has been decreasing each year, as well as the public debt to GDP ratio, while the Ministry of Finance each time borrows cheaper and cheaper.
"Such a radical decline in profitability was made possible thanks to demand from external players. That is why the country needs foreign investment. The Ministry of Finance began to borrow a third cheaper this year alone, that is, taxpayers' costs related to debt servicing are dropping significantly," the expert explains.
Fursa highlights the fact that long-term bonds are in the greatest demand among foreign investors, since the most successful were auctions where four to five-year government bonds were placed. That is, professional foreign players are to stay here for long.
"The Ministry of Finance can borrow in dollars on the foreign market or in hryvnias – on the domestic one. We are Ukraine, so it's safer for us to borrow in hryvnias because the income is in hryvnias. And it is much safer for the country to have a hryvnia debt. Indeed, in the event of a global crisis and devaluation, this will protect us," the expert added.
Fursa admits that non-residents may have a sharp desire to "flee" if the government starts making destructive moves. That is, the presence of foreigners in the Ukrainian debt market is a kind of "anti-fool measure", which is not so bad for the country.
Place on the world's debt map
If we analyze debt indicators of neighboring states, Ukraine occupies a worthy place among European neighbors. ICU analysts, referring to the forecasts of the International Monetary Fund and their own calculations, expect that next year, with a forecasted public debt to GDP ratio at 48%, Ukraine will beat Hungary (65%) and almost catch up with Poland (47%).
As for the non-residents' portfolio of government bonds, it's 14% in Ukraine, which is not so much compared to 20% in Hungary and 24% in Poland.
The ICU predicts that non-residents' demand for Ukrainian bonds will prevail, and next year the volume of foreign investments in government bonds will reach UAH 160 billion, or about 20% of the total volume of said securities in circulation.
At the same time, ICU analysts expect the initial placement rates of Ukrainian government bonds maturing in two to three to four years to drop next year to about 10-11% per annum.
"The Ministry of Finance will place bonds with a longer maturity. Already in January, they can offer seven-year bonds at the request of non-residents. The further inflow of non-residents in combination with a reduction in the key rate and inflation will pull the rates down," predicts Taras Kotovych, a senior financial analyst at ICU Group.
Growing out of debt
According to the law on the state budget for 2020, the debt ceiling at the end of next year is set at UAH 2.4 trillion, or about 52% of forecast GDP. That is, the government expects further growth of debt in absolute terms amid a decrease in relation to GDP, adhering to the scenario of a gradual reduction in the debt burden due to economic growth.
Meanwhile, the next years, like the outgoing 2019, will see peaks in terms of debt payments.
According to the NBU, in the next three years, foreign currency debt payments will amount to over $24 billion, plus interest. And since most of this amount will need to be refinanced in foreign markets, the National Bank considers it critical to continue cooperation with the country's key creditor, the International Monetary Fund.
The government expects that the new three-year program with the IMF in the amount of $5.5 billion dollars, set to be launched in the first quarter of next year, may be the last one, after which Ukraine will be able to do without the support of the main creditor.
"Ukraine really has a chance in three years to become completely self-sufficient. The years of 2019, 2020, 2021 is when there are peaks in payments and servicing of debts, some of which had been accumulated earlier," said Finance Minister Oksana Markarova.
The Minister explained that until 2013, the public debt of Ukraine was characterized by a high share of foreign currency borrowing, short maturity, and high rates, while the domestic market remained closed, but now these issues have been resolved. And a further reduction in debt to GDP ratio amid the accelerating economic growth will make a real change within three years.
In these new realities, Ukraine will spend taxpayers' funds on development, infrastructure, education, health care, security, and social programs, instead of paying off accumulated debts. At the same time, the debt market will become just a convenient tool for redistributing financial flows, not a key source of money for the country's budget.
Of course, that's if the government forecast becomes a reality.