Ukraine prepares to restructure debts — like Pakistan?

Whether we like it or not, any declaration made by the Ukrainian government about serving its Eurobond debt is an exceptionally important signal to the market, showing how the borrower views his solvency and prospects of making it back to the market in the foreseeable future.

Throughout the past year international business circles have actively discussed what Ukraine should do and how: announce default, pay its debts, talk its lenders into writing off their credits, or at least defer payments. In a word, the topics of those discussions came down to what standard we should live by tomorrow, that is, today.

De facto D-day has arrived, and there is no longer anywhere to put aside these signals. In conjunction with this Ukraine’s Western partners cautiously state that the country will not pay everything and will not refuse anything, because it is simply “prepared to exchange its Eurobonds worth $1.9 billion, maturing in 2000 and 2001, for new securities in order to lower the cost of servicing the national debt.”

Hence, the line of conduct has been chosen and it stands to reason to ask oneself what will this government achieve (except lowering the cost of debt service) by initiating a voluntary restructuring? We may assume the refusal to carry out this category of obligations promises some benefits. But let us first consider the obvious disadvantages.

First, all the known precedents of restructuring belong to issues of bonds that were not very large or with a number of holders that were more or less clearly identified, numbering dozens at best. The government’s foreign agents claim that Ukrainian securities are held by tens of thousands of market operators, including thousands of retail investors in Germany, Austria, the Benelux countries, and Italy. (Understandably, the larger the number of holders, the worse the exchange conditions, and the bigger commercial secret the information about the actual number of the fortunate bondholders). So one should not underestimate the legal and organizing complexities of a simultaneous restructuring of liquid bond loans totaling over a billion dollars. Because there are no guarantees that they will all show understanding and will not demand the imposition of a lien on Ukraine’s assets abroad.

Secondly, arrangements for debt restructuring are not a cure-all as many seem to think. Often to the contrary, the restructuring conditions give an impetus to new diseases. Our government, striving to convince opponents with positive examples of restructuring, persistently refers to the Pakistani experience where an arrangement was made for the restructuring of bonds, in contrast to Ecuador’s announcing default. But for some reason Ukraine persistently refuses to follow Russia’s example. Russia had a hard time defending its bonds against restructuring, but finally caved in, despite pressure from official creditors and international financial institutions.

Let us make a brief digression and analyze the situation in Pakistan — which is not much better than that in Equator. At present, Pakistan is gripped by a severe crisis, ranking with the world’s most impoverished countries where 51% of the populace is below the poverty line. Over the past decade, 62,000 persons have died of starvation, and the situation is getting worse.

The Pakistani government, changing composition every so often, has actually stalemated the country. After collecting a staggering amount of loans to finance its arms race with India, support Afghani mujahedin, and more often than not just stealing this money; no one has ever bothered to think about how these debts will ever be repaid. To save the economy and one’s own capital, a number of very burdensome IMF conditions have to be accepted. Otherwise the IMF threatens to disclose the identity of 28 persons holding shadow funds and being responsible for the economic crisis in Pakistan. In addition, IMF threatens to freeze $82 billion transferred by Pakistani thieves to US banks. The IMF conditions are as follows: before 2000 Pakistan had to carry out privatization of the entire economic sector by selling over 5,000 industrial enterprises. Most of them are unprofitable and there is little doubt that they will be closed, thus sharply increasing the number of the unemployed in a country where the jobless constitute a very significant part of the population. Pakistan must also cut its budget; instead of 43 ministries there are to be 14 left and the army must be downsized from 500,000 to 100,000. These measures will allow the creditors to get their money back from Pakistan, the debt of which is twice the amount of the annual national income. As a result of the reform IMF counts on 56% of its national budget being spent to pay debts; 40% will finance the army and other police structures, with 4% left to supply the nation’s other needs (education, medicine, and culture). At present, Pakistan is spending 1.2% of the national income for its national needs. Ten years ago, it was 8.2%.

But let us return to the disadvantages of restructuring.

Third, such a precedent will inevitably result in a sharp decline in the market quotations of the sovereign debts of all the developing countries, barring them access to new loans in whatever form. Indeed, if bond loans are not secure, belonging to the so-called senior category of obligations a priori on the strength of documentation standards, rather than because of someone’s ill will, what can be expected from all the other instruments? The collapse of the Eurobonds’ status will inevitably cause the international financial gendarmes to control and direct external financing on their own conditions.

Fourth, while the bonds came in place of discredited bank syndicated loans, it is absolutely unclear what market instrument can replace compromised international obligations in the eyes of frightened investors jumping away from any risk. Probably small and absolutely illiquid and inflexible emissions secured by collateral or financial flows from foreign assets, which is more characteristic of the nineteenth and by no means the twenty-first century. In any case, it will be quite some time before this problem becomes pressing in Ukraine.

Obviously, it is impossible to work out a universal criterion of what must be restructured and what not. Tolstoi pointed out that one’s decision to pay or not to pay debts is outside the limits of a purely moral dilemma, being subject to a rational economic choice (although the author most likely did not approve of this approach). Nevertheless, all debtors abide by precisely this logic.

In this sense, the Bolsheviks’ decision to refuse to pay the Tsarist debt after the October coup was perfectly rational. Although they must have failed to realize that they would sustain a civil war in lieu of such payments. The same applies to a country willing to fence itself off from the rest of the world, because the gains of default by far outweigh the potential losses.

How can Ukraine benefit from restructuring its debts? Given a “rational” approach to the pros and cons of a specific debt position, there is only one positive aspect about the Ukrainian restructuring: it could be perhaps the last chance for the government to overcome the trend, changing from an economy existing at someone else’s expense (inevitably fraught with crisis like the ones in Ecuador or Pakistan) to a self-sufficient one. Naturally, restructuring as such means nothing to that end, except that it allows some more time.