Getting Even: How Will Ukraine’s Debt Policy Change as a Result of the Crisis?

We are publishing the most interesting points of the debt discussion, which took place on November 27, 2020.

Speakers: Yuriy Butsa, Government Commissioner for Public Debt Management, Serhiy Nikolaychuk, Head of the ICU Macroeconomic Research Department, Yuriy Sholomytskyi, Head of the Center for Macroeconomic Modeling of the Kyiv School of Economics, Daryna Marchak, Head of the Center of Public Finance and Governance of the Kyiv School of Economics. The discussion was moderated by Olena Bilan, Chief Economist of Dragon Capital, Member of the Supervisory Board and Editorial Board of VoxUkraine. 

Olena Bilan noted that due to reforms and proper fiscal and debt policy over the past three years, Ukraine’s public debt has decreased from 81% of GDP in 2016 to 50% of GDP at the end of 2019. However, the pandemic in most countries of the world has led to an increase in expenditures due to borrowing, which is why, according to Olena, the expected amount of public debt by the end of 2020 will grow to 60% of GDP. This is not a problematic level, but the growth of the currency share of public debt has a negative impact on ratings and the cost of borrowing, so the question of what to do in 2021arises — to keep on increasing the debt or to get back to its reduction. 

Public debt in 2020 

At the beginning of the year, the situation looked quite manageable and predictable: the debt-to-GDP ratio was less than 50%; in January, the Ministry of Finance successfully placed government bonds with a maturity of seven years at the historically lowest rate of 4.375%. However, the crisis requires the widening of the budget deficit and, accordingly, its financing. After changes to the budget in April 2020, the deficit rose to 7.1% of GDP. It was realistic to finance such a deficit under the condition of cooperation with the IMF. The program with the Fund could “open the door” for loans from other international organizations and the issuance of Eurobonds. In late June, the government agreed with the IMF on a USD 5 billion Stand-by Program (the conditions were the adoption of laws on banks and the land market). USD 2.1 billion under this program were immediately received to the budget. The government has also agreed on a new USD 1.2 billion macro-financial assistance program from the EU and a USD 700 million loan from the World Bank.  

According to Yuriy Butsa, the increased budget expenditures could be financed under the condition of UAH 5.8 billion borrowings, of which USD 2.8 billion have been received to date. The difference is due to factors that do not depend on the Ministry of Finance. (ed. note — refers to the state of implementation of the terms of the program with the IMF). In fact, the government will need to borrow less because not all of the planned expenditures will be conducted. 

Public debt in 2021

Given the widening of the budget deficit in 2021 (5.5% of GDP), the progress made in recent years is leveling off — the debt-to-GDP ratio will increase. Next year, the government is to finance a UAH 220.8 billion budget deficit. Taking into account the proceeds from privatization, the amount of required financing is UAH 208 billion, and the repayment on the domestic market is UAH 369 billion. Yuriy Butsa, the Government Commissioner for Public Debt Management, assured that next year the debt management tactics will remain unchanged and will consist in maximizing cheap borrowings (i. e. from international organizations, not in the market). In particular, it is planned to attract additional resources from the World Bank, which will go to the budget for social support and health care. 

Yuriy Butsa stressed that if the large deficit is covered by commercial borrowing (internal and external), the cost of debt service will increase significantly. Currently, 14-15% of budget expenditures are spent on debt service, and the government does not plan to increase this share. 

The level of state guarantees will also remain at the level of 2020 — UAH 40 billion. They will follow two main directions: guarantees for program loans of international financial organizations and guarantees for resolving the situation in the field of renewable energy.  

On the ratio of debt to GDP  

Serhiy Nikolaychuk noted that the state can reduce the debt-to-GDP ratio through three channels: reducing the primary budget deficit, higher rates of economic growth and a lower interest rate. Mr. Nikolaychuk compared 5 approaches to the public debt: 

1. tolerance of high debt. For example, in developed countries, the ratio of public debt to GDP is high, but if the value of this debt is lower than economic growth rates, it does not create an additional burden on the budget; 
2. inflation tax or debt depreciation. This path is risky for Ukraine, as our inflation expectations are very sensitive to the actions and statements of the government; 
3. financial repression. This is a set of actions for reduction of the nominal interest rate. In developed countries, it may be a program of redemption of state assets by state-owned banks, in developing countries — pressure on commercial banks to buy bonds. However, such a policy can “crowd out” investments — that is, banks will invest in government securities rather than in the real sector; 
4. default and debt restructuring. For Ukraine, this option cannot be considered, as it will be accompanied by a banking and currency crisis. 
5. fiscal consolidation. During the pandemic and the accompanying crisis, on the contrary, public spending should be increased. However, you can always find opportunities to make better use of available resources. 

In his opinion, the best strategy for Ukraine is to tolerate a high level of public debt, focus on attracting cheap money and gradually reduce the budget deficit by increasing the efficiency of public spending. 

On the impact of ratings and terms on the cost of borrowing  

Yuri Sholomytskyi shared the results of the IMF study, according to which there is a U-shaped form of dependence of ratings and borrowing costs. Changing the level of debt for the countries with the worst and best ratings does not greatly affect the country’s rating and, accordingly, the cost of borrowing. Instead, for those with average ratings, rising of the debt-to-GDP levels significantly change the country’s risk perception and cost of borrowing. However, for countries with a non-investment rating, such as Ukraine, it is not so much the cost of borrowing that is important as access to it. He also proposed the idea of ​​raising UAH 1 billion under US guarantees, given the arrival of the new White House administration. 

Daryna Marchak noted that the Ministry of Finance is now at a dead end, when any action will have a negative effect. By the end of the year, the Government should finance budget expenditures in the amount of UAH 190 billion. At the same time, the borrowing plan has not been fulfilled in recent months. As the Ministry of Finance urgently needs to find money on the market, it reduces the term of borrowing. This has a negative impact on the situation development next year, as debt repayment expenditures are growing in the first half of 2021. This can be seen from the changes in the repayment plan for 2021 — in three months the repayment plan for next year increased by 64% (from UAH 285 billion in September to UAH 468 billion at the end of November). Thus, the need for borrowing in 2021 is growing, which increases the risk of a repeat of the current budget crisis and increases Ukraine’s dependence on external financing. 

About the actual and planned budget deficit

Olena Bilan noted that according to her forecasts, the actual budget deficit in 2020 will be lower than planned (5.5% vs. 7.6% of GDP), as due to the policy of the Ministry of Finance at the beginning of the year the debt service costs had reduced, and some expenditures will obviously not be conducted. The situation of smaller actual deficit is quite typical for the budget process of the recent years. Speakers noted that the practice of “drawing” a high deficit on paper should be abandoned. Adoption of a budget with a deficit of 3-4% of GDP (as it actually will be) will have a positive impact on Ukraine’s ratings and reduce the cost of borrowing.  

Finally, they discussed ways to finance public debt in the domestic market, if not to take risky for Ukraine quantitative easing. Yuriy Butsa assured that non-residents are ready to return to the market, but they are stopped by uncertainty with the IMF. He stressed that the government is focusing on increasing the share of domestic borrowing in the debt structure. Local banks continue to be the main domestic investors. According to Serhiy Nikolaychuk’s forecasts, next year the value of bonds of domestic public debt will remain at the level of 2020 — 10-12%.