Billions on Credit: How and Why Ukraine Borrows

“Thousands of dollars of debt for every Ukrainian”, “… unacceptably high interest rates”, “… destruction of Ukraine’s national interests”, and finally “… why default is bad?”

In this way, Ukrainian politicians comment on Ukraine’s state debt. They say that every Ukrainian owes tens of thousands of hryvnias to external creditors, and the government attracts loans at huge interest rates and unfair conditions. And in general, it is worth declaring a default, because, for example, it did not harm Greece at all.

Within the framework of the joint project “Percentage of Truth” VoxCheck and “Ukrainian Radio” have  figured out what is state debt, what does it consist of, who and how lends Ukraine and how we repay debts

State debt. What is it? 

State debt means the total amount of liabilities of the state on received and outstanding loans. Its planned size is specified in the state budget law annualy.

State debt includes the debt of the central government, regional and local authorities, as well as the debts of all corporations with state participation, in proportion to the state’s share in their capital.

There is a direct debt and state – guaranteed  debt.

Direct government debt is the amount of borrowing received directly by the government.

State-guaranteed debt means the total amount of liabilities of Ukrainian resident business entities on outstanding loans which are guaranteed by the state. State guarantees are a kind of state aid. The principle of their action is the following: if the borrower for some reason cannot pay off the lender, then the state will do it.

Government guarantees for creditors are an indicator of the borrower’s reliability and a guarantee that the debt will be repaid in all circumstances. State guarantees are issued in two cases: by decision of the CMU and on the basis of international treaties.

State (government) debt is also divided into domestic and external.

External government debt is borrowing made in foreign markets from foreign lenders or governments of other countries.

The largest external creditors of Ukraine are: the International Monetary Fund (IMF), the European Investment Bank (EIB) and the European Bank for Reconstruction and Development (EBRD), the International Bank for Reconstruction and Development, the Japan International Cooperation Agency, and the Credit Facility for Reconstruction (KfW).

In addition, external debt includes borrowing from the placement of external state loan (OZDPs) bonds in foreign markets. OZDPs are documents that show that the government is obliged to repay to a foreign lender a certain amount of interest at a specified percentage within a certain time.

Domestic state debt is formed as a result of obtaining credits and other debt obligations in the domestic market. Domestic government bonds (OVDPs) are placed on the domestic market. These are the same Eurobonds (OZDPs) only for the domestic market.

Why does the state borrows?

The right to carry out state borrowings on behalf of the state belongs to the Minister of Finance of Ukraine upon the instructions of the Cabinet of Ministers of Ukraine (CMU). The CMU defines the underlying terms and conditions of state borrowings, including the basic terms of the loan agreements and the basic conditions of issuance and the procedure for the placement of government securities.

State borrowings are carried out in order to cover the state budget deficit and to refinance state debt (this is a situation where budget expenditures exceed revenues), to finance individual targeted programs or to pay off current debts. The latter is also called debt refinancing.

Debt refinancing is done when the state does not have enough own budget funds to pay off its debt. Unless refinancing is done, other expenditures, such as subsidies or road building, will have to be reduced. That is why the Ministry of Finance re-borrows the required amount every year and tries to make it as cheap as possible (i.e. at the lowest interest rate).

The budget deficit could also be covered from another source – from privatization proceeds of state-owned enterprises. However, if the privatization plan is not implemented (and it has not been implemented since 2011, after a large-scale sale of UkrTelecom), the necessary amount has to be borrowed.

So state can borrow as much as it wants?

No, the state can not. There are some limitations. In particular, there are the Maastricht criteria or the EU criteria. They stipulate that the amount of government debt should not exceed 60% of nominal gross domestic product (GDP). The same restriction is enshrined in the the Budget Code of Ukraine.

The government also does not give endless guarantees. The marginal amount of government guarantees is 3% of the general budget fund’s revenue.

The concept of repayment and servicing of the state debt should also be distinguished. Debt repayment is the repayment of a “body of debt,” that is, the amount that has been borrowed. And servicing of the debt is repayment of interest accrued on the body of the debt, as well as commissions and penalties related to the debt.

What happens when a country can’t pay  its debts?

When a country is unable to pay its debts on time and in full, a default  is declared. In this case, starts the negotiation process with the creditors to write off part of the debt and transfer the other part of it to a later date. At worst, the country simply refuses to pay back its debts.

Sometimes the default is compared to the bankruptcy of an enterprise. However, these concepts are not quite identical. The enterprise may be liquidated as a result of bankruptcy. The country cannot be liquidated. It continues to exist and function, but for 5-7 years it cannot borrow money on foreign markets. Only organizations such as the IMF, the World Bank, and others are open for borrowing during this period.

Default is not as good and simple  as some politicians try to prove. The national currency is starting to fall as investment inflows decrease. At the same time, some investors who invest or intended to invest in private companies in this country are trying to withdraw their dividends or refuse to invest. Therefore, there is a decrease in the exchange rate and a decline in economic growth.

 State will have to reduce the budget deficit by increasing revenues or reducing expenditures. Accordingly, the country reduces spending, which means reducing any social or investment programs of the state. As a rule, these are capital expenditures that can be reduced relatively unnoticed by the public. But the effects are noticeable in the upcoming periods as infrastructure in the country deteriorates.

Default  does not mean that you can refuse to pay back the debt. If the government says that it will not pay anything at all, then there will be international courts, arrests of Ukrainian property abroad, reserves stored in foreign banks, or investments in foreign securities. There are mechanisms in place to force at least part of the loans to be repaid, even if the government simply refuses to pay.

However, the advantages of default still remain. Usually, after the announcement of default, the country agrees with the IMF on financial support in exchange for implementing the reform program. Difficult economic conditions simplify the promotion of political reforms. That’s a positive side of default, but reforms can be implemented without it.

 Why rumors of default are  dangerous?

There are no objective prerequisites for default. There is economic growth, public finances are in a relatively good state – the budget deficit is within the limits set by the IMF program. Therefore, the government is able to make debt payments on time. 

Talks of default without due cause can give the false impression to investors. This may adversely affect the decision of businessmen to invest in Ukraine or buy Ukrainian debt obligations. As a result, it will be more difficult for Ukrainian companies to attract foreign investment.

How politicians are lying  and manipulating about state debt?

Politicians and unqualified “experts” repeat roughly the same manipulative thesis on state debt. Here are some examples.

1) The previous government (Groysman government, 2014-2019 government) has raised debt above the threshold

The  state debt-to-GDP  ratio depends not only on new borrowings, but also on the national currency exchange rate – if the rate falls, the currency part of state debt denominated in hryvnia grows, so does the debt-to-GDP ratio measured in hryvnia. It is clear that this ratio also increases when the country’s GDP falls. That is, the  debt- to-GDP ratio is not exclusively a consequence of government action.

In 2009, debt-to-GDP ratio was 35%, in 2010 – 41%. In 2014, when Ukraine’s GDP declined sharply and the national currency weakened, this figure almost doubled and reached its maximum in 2016 – 81%, as shown in the graph below. With the stabilization of  hryvnia and GDP growth, the index has started to decline, and this trend continues: 72% in 2017, 64% * in 2018, 62% * in 2019 (* according to IMF estimates).

As of the end of 2013, the state debt was UAH 584 billion, as of 30.06.2018 it amounted to UAH 1 998 billion. Therefore, it increased by 342%. However, such a comparison is manipulative since the debt is denominated in different currencies. To understand whether the state debt has increased and to what extent, it should be divided into 3 components – external debt (all denominated in foreign currency), internal debt (denominated in national currency), domestic debt (denominated in foreign currency).

External debt. By the end of February 2014, it was $37.15 billion. By the end of June 2018, it was $47.16. So, it increased by $10 billion or 26.9%.

Domestic debt in UAH. At the end of 2013 – UAH 236.7 billion (or $29.4 billion in equivalent). In January – February 2014, domestic debt increased by UAH 28 billion (from 284 to 312). As its equivalent in dollars has not increased, but rather decreased due to the devaluation (from 35.55 to 31.3), we can assume that all these 28 billion UAH were taken in national currency. Thus, at the end of February 2014, domestic debt in UAH was UAH 264.7 billion ($26.5 billion). At the end of June 2018  – UAH 643.1 billion ($24.56 billion). Consequently, the domestic debt denominated in UAH increased by 243%.

Domestic debt denominated in foreign currency. At the end of 2013e, it was $ 6.65 billion. By the end of June 2018, it was $ 4.6 billion. So, it decreased by $ 2.05 billion or 31%.

2) Every Ukrainian, even newborn, has tens of thousands of state debt

It is about the state debt, that is, including the debts guaranteed by the state-owned private companies. As of January 1, it amounted to UAH 2,141 trillion, or UAH 50.7 thousand per person. But the state guaranteed debt, which is UAH 308 billion, should be repaid by the state only if it is not returned by private companies. The manipulation is that the domestic public debt does not need to be repaid in a moment and in full, because often current debts are repaid at the expense of new ones (however, it is not necessary to increase the amount of debt uncontrollably). In other words, Ukrainian families do not need to return anything right now, especially with “live” money.

On January 1, direct state debt amounted to UAH 1,833 trillion, ie. UAH 43.4 thousand per person.

It is a question of the state debt, that is, including the debts of private companies guaranteed by the state. As of February 28, it amounted to UAH 2,068 trillion , or UAH 48.86 thousand per person.

Ukraine’s debt to the IMF is $12 billion. There are 42 million people in Ukraine. That is, about $286 per person, not $10 thousand.

3) In 2015, the Yatsenyuk government carried out such restructuring, through which Ukraine is now limited in economic growth

It it about the restructuring of part of the external debt in August 2015, within which 20% of the principal amount, or about $ 3.8 billion, was written off, and the average coupon rate was increased from 7.22% to 7.75% annually. Government bonds maturity was delayed for 4 years – from 2015-2023 to 2019-2027.

That allowed to avoid the default in 2015-2016. For this, creditors received GDP warrants (VRI) – securities whose payments depend on Ukraine’s GDP growth.

But it’s not true that “they will take anything above 4%.” In fact, the conditions were as follows:

• with growth up to 3% annually payments are zero;
• from 3% to 4% – 15% of every percent of GDP growth over 3%,
• above 4% – 40% of the value of each additional interest.

In addition, in 2021-2025, payments on GDP warrants may not exceed 1% of GDP.

Firstly, during the restructuring, Ukraine was written off less than the speaker says. Secondly, the debt-to-GDP ratio declined only in 2017, sometime after the restructuring it increased. So the verdict is – false.

Under the terms of the restructuring, Ukraine wrote off $ 3.8 billion, not $ 5 billion. It is worth adding that special debt instruments of the VRI have been issued, which provide repayments over 20 years from 2021 to their owners in case of GDP growth of Ukraine over 3%.

From 2015 to 2017, state and state-guaranteed debt increased from $ 65.5 billion to $ 76.3 billion. Most of the borrowings during this period were actually taken for repayment (IMF tranches) and lending (issue of Eurobonds in September 2017). At the same time, debt as a percentage of GDP varied from 72% in 2015 to 76% in 2016 and 68% in 2017.

Default has not harmed anyone yet

During the first wave of the crisis in 2010, Greece’s total debt (together with private sector debt) reached $557-588 billion  billion at the then average exchange rate of $ 1.3 / EUR. But that doesn’t mean Greece has written off that amount of debt – if Kolomoisky had that in mind. In fact, in 2012, 107 billion euro  was written off by private investors, while attention to Greece was triggered by its membership in the European Union and the Eurozone.

Greece’s debt problems have been a consequence of the government’s unbalanced economic policies in recent decades. In 2009, Greece’s budget deficit reached 12.9% of GDP, with GDP decreasing from 2008 to 2015 (with a minimum increase in 2014). Has default harmed Greece? 

Kolomoisky is partly right: default is not the end of the world. For example, in his article What We Know About Default, VoxUkraine Editorial Board member Tom Coupé writes that default is a fairly common occurrence in the world. “The advantage of default is that it releases additional funds at least in the short term. The government thus has more financial resources to spend on priority areas of the economy”, the researcher wrote.

But it is not right to treat the default easily. If a country is unable to repay its debts on time or negotiate with creditors on acceptable terms of restructuring, and as a result declares a full-scale default, the external capital markets are closed for it as a result of a crisis of confidence, including for private companies. The possible downside of a total default or a “severe” restructuring is the seizure of government assets worldwide.

In the case of the 2014 model of  Ukraine, the default would be aggravated by war and economic downturn through:

• breaking business ties between Crimea, Donbas and the rest of Ukraine;
• falling export earnings due to the crisis in world markets;
• panic in the currency market.

And that’s not all: in 2014, Ukraine entered with a huge state budget deficit (about 10% of GDP) and rapidly waning international reserves of the National Bank. The announcement of a default  at that time would mean the complete closure of the external capital markets for Ukraine, which it needed at that time.

Therefore, the claim that Ukraine would not have a negative effect from the default is manipulative. It was impossible to close the budget deficit on its own at that time (although in 2014 Ukraine made a significant sequestration of the budget), while resources of other creditors other than the IMF were no longer available. At the same time, the IMF loan thawed Ukraine’s access to other credit institutions. In 2014, Ukraine received $ 4.6 billion from the IMF, of which $ 1.6 billion was allocated to the National Bank reserves, $ 3 billion to the state budget.

Where to find reliable data and analytics on state debt?

On the website of the Ministry of Finance of Ukraine you can find:

• explanation on state debt, its classification, debt management programs;
• monthly dynamics of government and government-guaranteed debt;
• estimated debt repayments until 2045;
• medium-term strategy for the management of the national debt for 2019-2022.

State debt limits and debt management regulations are set out in the Budget Code of Ukraine.

How much Ukraine plans to pay in a given year is determined by the State Budget of Ukraine: in Annex 3 the budget defines the amount of expenditures for the servicing of the state debt, and in Annex 2 – financing for its repayment. Articles 5 and 6  of the Law of Ukraine “On the State Budget” determines the amount of public debt for the planning year and the marginal amount of state guarantees.

On the website of the International Monetary Fund, on the page Ukraine and the IMF  you can see what loans the IMF gave to Ukraine and how much the Ukrainian government repaid to the Fund.

The following experts write professionally and impartially about the state debt:

• Olena Bilan, chief economist at Dragon Capital;
• Yuriy Butsa, government commissioner  for public debt management;
• Olexandr Paraschiy Head of Concorde Capital’s Analytical Division;
• Natalya Shapran, Head of Credit Expert Group, Expert Rating.