Ukraine has a month to avoid default

War is still exacting a heavy toll on Ukraine’s economy. The country’s GDP is a quarter smaller than on the eve of Vladimir Putin’s invasion, last year the central bank tore through foreign reserves and Russia’s attacks on critical infrastructure have hurt growth forecasts. “Strong armies”, warned Sergii Marchenko, Ukraine’s finance minister, on June 17th, “must be underpinned by strong economies.”

After American lawmakers’ decision in April to belatedly approve a funding package worth $60bn, Ukraine is not about to run out of weapons. In time, the state’s finances will also be bolstered by G7 plans, which were announced on June 13th, to use the profits from Russian state assets in Western financial institutions to lend another $50bn. The problem is that Ukraine faces a cash crunch—and soon.

For the past two years, Ukraine’s creditors have agreed to suspend debt-service payments. The let-off—from both government and private lenders—is worth 15% of GDP a year. If payments had been required, they would have been the state’s second-biggest expenditure behind defence. Now, though, the moratorium from private bondholders, including Amundi, a French asset manager, and PIMCO, an American one, is set to expire on August 1st.

Therefore Ukraine has a month to avoid default. The IMF is keen for Mr Marchenko to negotiate a write-down, but a deal seems unlikely in the time available. If Ukraine does default, it will reflect a troubling lack of faith among private investors concerning the West’s commitment. In the long run, that could spell disaster for the country’s recovery.

Few restructurings have been undertaken in the heat of war. Countries do so to ensure access to financial markets, which requires manageable debts. A quick restructuring takes months, a difficult one years—creditors are never eager to give up claims. But Ukraine has been shut out of international capital markets since the war began, meaning there is little urgency. In June Mr Marchenko offered creditors a deal that cut 60% from the present value of its debts. The creditors coolly replied that they thought 22% was more reasonable.

Ukraine would appreciate the fiscal room. At the end of the year, its debt-to-GDP ratio will near 94%—high for an economy with its financial history and of its size. The sums that allies provide are impressive, but come in the form of artillery, tanks and earmarked funds, rather than cash. Only $8bn of America’s recent package will go directly to Ukraine’s government, an amount equivalent to just over a quarter of Ukraine’s annual spending on social benefits, and even this is in the form of a loan. The EU plans to offer a little more, but still only $41bn over three years.

Although the let-off Ukraine wants is modest—$12bn from 2024 to 2027—the country has no spare cash to stump up if it is not granted. Under a restructuring deal as significant as the one Ukraine proposed, and bondholders rejected, the country would only just be able to make ends meet, reckons the IMF. For their part, bondholders question how exactly the fund can be so sure, especially since its analysis is now a few months out of date.

In the absence of a deal, Ukraine has a couple of options. One is to negotiate an extension on its debt-service freeze, as it has already with official creditors, who have agreed to forgo payments until 2027. The other is to default. That may sound drastic, but in reality there is little difference between the scenarios. Either way, Ukrainian payments will not resume.

The reticence of private-sector investors does not just reflect Ukraine’s difficult financial outlook. In a normal restructuring, creditors gamble on a country’s economic prospects. Lending to a borrower at war also entails a second gamble: that it will emerge from the conflict intact. “There has to be a country in existence to repay at the end of this,” notes one bondholder. A lot will depend on the extent of Western support. Taxpayers may tire of handing over billions. Donald Trump, who has been sceptical of the amounts disbursed, looks increasingly likely to return to the White House in November. The IMF’s usual models struggle to take such factors into account.

Bondholders are also sceptical about plans for Ukraine’s long-term reconstruction in the case of victory. Although allies and the IMF have argued that restructuring now will enable Ukraine to re-enter financial markets as soon as the war ends and its allies forgive debts, investors are far from convinced that such a day will ever materialise. Rather, they think that a restructuring would simply be the first of many attempts by Ukraine’s allies to push the financial burden of war, and the cost of reconstruction, away from governments and on to the private sector.

Much of Ukraine’s recovery—including the construction of basic infrastructure and civic buildings, as well as training people to rebuild the country—will never turn a profit, and will thus need to be shouldered by the country’s allies. The current impasse raises a worrying prospect: that distrust between them and private investors will slow down progress. Mr Marchenko was right to remind Ukraine’s commercial creditors that a country’s army is only as strong as the economy behind it. He could also have reminded Ukraine’s allies that an economy is only as strong as the army keeping it in existence. ■

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