Ukraine: One Year on But No End in Sight

Fixed Income
  • After 12 months of fighting further action is needed from the west to prevent a balance-of-payments crisis and to support the reconstruction costs faced by Ukraine
  • With valuations trading close to the lows, what might a suite of restructured Eurobonds look like?
  • Ukraine’s Eurobonds offer neither a clear asymmetry in the future return profile or a sufficient margin of error for upside assumptions to be wrong. Failing these criteria for investing in non-performing distressed credit, we find it hard to turn more constructive on the bonds

A year on from Russia’s invasion of Ukraine we are unfortunately no closer to seeing an end to the war than when the first bombs dropped on 24 February 2022.  In the meantime, the Ukrainian economy has collapsed by a third, 20% of the population has left the country and immeasurable damage has been done to physical and human capital. While the west has stepped up to provide financial support, more will be required to prevent a full-blown balance of payments crisis: IMF estimates for 2023 external financing needs are as high as $57 billion2. Pressures on the currency persist and the central bank continues to lose an average of $500 million per week3 via FX interventions to support the new currency peg following the 20% devaluation last July. Given these uncertainties it is no mystery why Ukraine’s Eurobonds have materially lagged the rally in emerging market (EM) distressed debt since October.

Figure 1: total return of EMBIG Ukraine versus Global Credit C Index

Source: JP Morgan, February 2023

We have supported Ukraine’s efforts to defer Eurobond debt service in the best interest of all stakeholders to ameliorate near-term economic damage and maximise future growth and recovery values4. The current standstill will expire in August 2024, prior to which sovereign bondholders will need to either extend the standstill or conclude a more sustainable debt restructuring. While bonds are already pricing in deep haircuts and deferrals, the lack of visibility around the duration of the war means further downside cannot be ruled out.

When we consider investing in distressed EM credit we try to answer two main questions: what is the upside/downside? And do current valuations offer a large enough cushion for us to be wrong in our assumptions about recovery values? Unlike in most sovereign restructuring cases there are massive uncertainties, including – at the extreme – whether the issuer will even exist as a sovereign entity in the medium term. Therefore, estimating the amount of debt Ukraine can reasonably afford to service and what a suite of restructured Eurobonds looks like is subject to multiple possibilities. 

In a positive outcome we think recovery values could be around $305; in a downside scenario the recovery value could be closer to those realised in the post-war Iraq restructuring, at around $10. In an extreme downside scenario the bonds could ultimately recover nothing for many years. Hence, at current prices in the high-teens/low-20s we see risks as largely symmetric. With valuations not pricing in a deeper margin of error and possessing no discernible edge in how the war will play out, we find it hard to take a more constructive view on adding to current holdings in Ukrainian Eurobonds.
Nevertheless, we will continue to support Ukraine’s efforts in negotiating for a sustainable long-term debt service profile. We also encourage multilaterals, bilaterals and investors to explore more innovative solutions – whether in the form of bond guarantees; creative use of IMF special drawing rights (SDRs), which are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund; or a modern-day Brady Plan. With enormous reconstruction costs estimated at up to $1 trillion6, the private sector will need to be offered incentives such as a realistic EU accession path and assurances provided by an IMF policy anchor to restore market access and mobilise the full amount of financing required in coming years.
1 2Reuters, IMF approves Ukraine monitoring program to help spur donor financing, 20 December 2022 3Reuters, World Bank disburses additional $500 mln to Ukraine, 25 October 2022
4Columbia Threadneedle Investments, Standstill on Ukraine debt is right for both the country and our clients, August 2022
5Columbia Threadneedle Investments analysis, February 2023

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