Ukraine Skirmish Fears Rejoin Economic Realm

As the world was on notice for all-out military conflict on the Russian troop buildup on Ukraine’s border before pullback, foreign investors exited exposure to local stocks and local and international bonds. Prior to the pandemic foreign holdings of local debt were about 15%. After fleeing to safer havens through most of 2020, many cautiously re-entered the market late last year. Overseas ownership rebounded from about 8% of the total outstanding to over 12% in February, attracted by high yields and settlement through Euroclear and expected JP Morgan index entry. Since then inflation has accelerated, rising from 5% in December to 8.5% in March.  In response, National Bank of Ukraine hiked rates 50 bps. in March and 100 bps. in April, and  upped its inflation forecast for the year from 7% to 8%. The currency over the period was down 1% against the USD and 3.5% against the EUR.

The local stock market index fell in recent weeks on war worries at the same time Covid-cases rebounded and lockdowns resumed, but is still up 11% in local currency terms. Last month the Ukrainian Stock Exchange announced its first IPO for 15 years with Veres Rivne, a local football team, to list. The buzz was offset as the only listed banking stock in the UA Index, Raiffeisen Bank Avil, was punished after parliament passed a law on mandatory restructuring of FX loans secured by homes. Under the new legislation debt will be converted into UAH at the average rate the time of loan issued and the interest rate at the day of reset.  It also cancels all fines and penalties on the loans. The Independent Association of Banks estimates the forced conversion will cause bank losses of more than UAH 10 billion (USD 355 million+).

Ukraine’s biggest bank, PrivatBank – nationalized in 2016 after regulators discovered a massive hole in its balance sheet – may be offered for sale next year, according to the NBU. PrivatBank accounts for 20% of the sector. The state cannot offload the bank until multiple country court cases and investigations are resolved, including locating  USD 5.5 billion in bailout cash that went missing.  PrivatBank’s net profits fell in 2020 by 22.4%. The NBU plans to reduce the state’s overall share of the banking sector from 55% to 25% in the next five years under longstanding IMF and World Bank-guided reconfiguration.

Investors are resigned to indefinite suspension of the current USD 5 billion IMF program approved last June as the sovereign faces massive debt redemptions through the rest of the year.  Peak payments of USD 11 billion come due in September.  The standby deal came to a halt on lack of promised energy/fiscal reforms and reversal of several anti-corruption laws.  However, assuming the IMF’s board approves the G-20 supported new SDR general allocation of USD 650 billion for distribution in August, Ukraine could receive an estimated USD 2.7 billion, no-strings-attached windfall to help with Q3 payments.   Even with that cash, the country will have to dig into its reserves to service its debt absent additional IMF and multilateral assistance which could flow quickly in the event of actual war footing.  Currently reserves stand at USD 27 billion, 4 months of imports. While the current account recorded a surplus of 4% of GDP last year, a slight deficit is expected this year on a pick-up in imports. The economy, which contracted 4% in 2020, continued to shrink early this year.  The NBU has downgraded this year’s GDP forecast to 3.8% from an earlier projection of 4.2%.

Despite the search for yield, rising inflation and lack of reform will frustrate foreign portfolio investment inflows this year, and Ukraine’s local bond index weighting will be minor for increased allocation. Pressure on the currency absent resumption of the IMF program will accelerate in the coming months, even if SDR funds boost the NBU’s foreign reserves before the critical September payments.  While the government believes it can issue USD debt at home and overseas to meet upcoming obligations, the banking sector will have less capacity to absorb the paper under the new mandatory FX loan restructuring program and delayed recognition of last year’s soured business and consumer credits. Russian troop withdrawal offers a breather after a geopolitical and fiscal scare, as economic and financial sector conflicts otherwise swirl until investors at least sense a truce without outright victory signals.

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