As Ukraine's debt tangle unwinds, Russia holds key thread

Wed Sep 24, 2014 12:50pm EDT
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By Sujata Rao

LONDON (Reuters) - A selloff on Ukraine's dollar debt is focusing attention on a controversial $3 billion bond held by Russia, raising investor concerns that President Vladimir Putin could use the issue to trigger a cascade of defaults across Kiev's sovereign Eurobonds.

The so-called bail-bond, taken out late last year by former Ukrainian President Viktor Yanukovich, carries a clause which - given Kiev's steadily worsening finances - may enable the Kremlin to demand immediate repayment.

At best, that could force Western lenders to stump up more cash for Kiev. In the worst - albeit less likely - scenario, so-called cross-default provisions carried by most Eurobonds would force payment on all Ukraine's remaining dollar bonds at once if Moscow is not paid on time.

Putin, who has annexed Crimea and is widely accused of stoking a separatist revolt in eastern Ukraine, is seeking to maximize economic leverage to prevent pro-Western President Petro Poroshenko fulfilling a far reaching free trade agreement with the European Union.

Under Russian pressure, the EU and Ukraine agreed this month to postpone implementation of the accord until the end of 2015 after Kiev accepted a ceasefire with the pro-Russian rebels in a conflict that has killed more than 3,000 people.

At the heart of the bond issue is an unusual clause in the covenant which stipulates "total state debt and state-guaranteed debt should not at any time exceed an amount equal to 60 percent of the annual nominal gross domestic product (GDP) of Ukraine".

As Ukraine's economy has shrunk and its currency has fallen, that level may already have been breached - Commerzbank analysts reckon the current hryvnia exchange rate around 13 per dollar UAH= is the trigger point. If not, debt-to-GDP will top 67 percent by end-2014, the International Monetary Fund predicts.

"There is little doubt the ratio will be crossed," says Standard Bank analyst Tim Ash. "Russia will likely use this issue to make life very difficult for Ukraine."   Continued...

Pro-Russian rebels stand on top of a burnt-out Ukrainian armoured personnel carrier near the village of Novokaterinovka, eastern Ukraine, September 24, 2014.  REUTERS/Marko Djurica