On August 1, a two-year moratorium on public debt payments to private foreign bondholders, which amount to 15% of GDP per year, ends. Our country has a month to avoid default. At the same time, the IMF insists on writing off the debt, but in the remaining month, this agreement is unlikely.
What is hidden behind the terrible word “default” and what could be the scenarios of the development of events in Ukraine?
Default is a condition in credit relations that occurs when the borrower does not pay his debts or payments. That is, it is a violation of the borrower’s payment obligations to the creditor, the inability to make timely payments on debt obligations or fulfill other terms of the loan agreement. The concept of “default” can be applied both to the state and to the enterprise. It arises when the country cannot fulfill its debt obligations on time and in full, which leads to negotiations with creditors about writing off part of the debt and postponement of payment terms. In the worst case, the country can refuse to pay its debts, but Ukraine has never done this.
If a company declares default, it may be liquidated as a result, but the country continues to function in this case. But for 5-7 years, it cannot borrow on foreign markets, except for specialized organizations such as the IMF and the World Bank.
The current situation in Ukraine in 2024
On June 17, the Ministry of Finance stated that during official negotiations, Ukraine was unable to reach an agreement with a group of bondholders regarding the restructuring of international debt in the amount of about 20 billion US dollars. Finance Minister Serhii Marchenko offered creditors a deal that would reduce 60% of the current value of the debts, but creditors refused, considering a 22% discount more acceptable terms.
Earlier, the Chairman of the Verkhovna Rada Committee on Finance, Tax and Customs Policy, Danylo Hetmantsev, stated that by the end of 2023, Ukraine’s public debt exceeded 5.5 trillion hryvnias, having doubled since the beginning of the full-scale invasion of Russia.
As the government notes, at this time, there are no objective reasons for default in Ukraine. The economy shows some growth, and the budget deficit is within the limits set by the IMF. At the same time, there are statements that the government is able to fulfill its debt obligations in a timely manner.
Possible scenarios of the development of events
If no agreement is reached with the creditors, there may be two options for the development of events in Ukraine.
Option 1: Agree on the continuation of the freezing of debt payments.
In this case, the government of Ukraine will continue active negotiations with creditors, trying to reach a compromise that involves freezing debt payments until 2027. It is possible that the so-called standstill agreement on freezing the debt will be signed. This means that the debt is considered in default, but the parties agree to negotiate a solution to the problem, and no further action will take place at this time. However, signing such an agreement requires the consent of creditors, so it is not guaranteed. But there is a possibility of this.
If there is neither an agreed restructuring nor an agreement to freeze the debt, creditors can start suing our country. This will not have any quick and obvious consequences, and most likely, it will complicate the situation with attracting international funding, as well as create a negative informational background.
If, after all, an agreement on restructuring is reached, then this, in principle, will also be a kind of default, but it will not have significant negative consequences for Ukraine. On the contrary, the ability to work constructively and professionally with private creditors (with the IMF, etc.) during the war and to demonstrate good will is a contribution to Ukraine’s reputation.
At the same time, the state will see a decrease in pressure on the state budget, as well as an opportunity to direct more funds to the development of the economy and social programs. In addition, there will be a certain influx of foreign investments, withsafeguarding the stability of social benefits and pensions.
The restraint of private investors reflects not only Ukraine’s financial prospects. Under normal conditions of restructuring, creditors bet on the country’s economic prospects. But when it comes to lending to a country at war, they make an extra bet on its victory. At the same time, a large part depends on the level of support from the West. Taxpayers can get tired of spending billions of dollars on an ongoing basis.
Donald Trump, who has been skeptical of the bailout, is increasingly looking like a likely candidate to return to the White House in November. Bondholders are also skeptical about Ukraine’s long-term recovery plans if it wins. Although allies and the IMF say restructuring will now allow Ukraine to return to financial markets after the war ends and the debt is written off, investors doubt that day will come.
They are likely to believe that this restructuring will be the first of many attempts by Ukraine’s allies to shift the financial burden of the war and the costs of reconstruction from the public sector to the private sector.
Scenario 2: Declare a default.
In this case, there will be a suspension of the country’s economic growth, devaluation of the national currency due to a decrease in investment inflows, refusal of some investors to invest in private companies, reduction of the budget deficit due to the need to reduce expenses or increase revenues, which often leads to the reduction of social and investment programs. Also, as a result of the default, the most vulnerable sections of the population are the first to feel it due to the reduction of salaries, pensions and social benefits. That is, the poor become even poorer. At the same time, those who are not afraid to invest in Ukraine can win, as Ukrainian assets will become cheaper. Most likely, these will be investors who will be able to receive guarantees from the government to protect their investments.
However, default has certain positive aspects – devaluation can make goods of domestic exporters more competitive. In addition, there is a possibility of agreements with the IMF on financial support in exchange for carrying out reforms.
Default in Ukraine in 1998
Ukraine already declared default in 1998, it was then part of a wider economic crisis that engulfed many countries of the post-Soviet space after the collapse of the USSR. The economy of Ukraine at that time was very unstable – until 1998, the exchange rate was about two hryvnias per dollar, then it became five hryvnias per dollar. Consequently, inflation was high, and the national currency depreciated significantly. At the same time, Ukraine had a significant foreign debt, which was difficult to service due to a lack of foreign exchange reserves. High interest rates on debt obligations also complicated the situation.
The financial crisis in Russia, which at that time was one of the main trading partners of our country, had a serious impact on the economy of Ukraine. This crisis led to a reduction in exports and a decrease in Ukraine’s income. In addition, then as now, corruption and lack of reform contributed to the economic crisis. However, despite the difficult conditions, Ukraine was able to gradually recover from the crisis thanks to the support of the IMF, international financial institutions and the implementation of certain economic reforms.
Since the 2000s, rapid economic growth has begun in the world, the demand for resource goods – metals, agricultural products, etc. – has grown significantly, which has contributed to the development of Ukraine. However, at present, due to the wars, the world economy is expected to slow down, so it will not be as it was then. Ukraine’s likely default will undermine investors’ confidence in it and be disastrous for the country’s recovery.
