Ukraine’s gross external debt has reached its highest level in the last 6 years. Its rapid dynamics reflect the disparities in the domestic credit market and incurres high risks of debt refinancing.
Ukraine’s gross external debt was USD 125.7 billion at the beginning of 2021, having increased by USD 4 billion for the year.
The absolute amount of debt has reached its highest level in the last 6 years. This is demonstrated by both the increasing financial integration of Ukraine (positive aspect) and the distorted nature of the domestic monetary system, which pushed solvent borrowers out of the credit market of Ukraine (negative aspect).
The most dynamic component of the external debt growth in 2020 was the debt of the general government sector (+ USD 3.3 billion, see Figure 1).
Gross borrowings of this sector from private creditors amounted to USD 4.9 billion, including:
- EUR 1.25 billion attracted from the placement of 10-year bonds denominated in euros;
- USD 2.0 billion – from the placement of 12-year bonds denominated in dollars;
- USD 0.6 billion – from the additional placement of these bonds in December;
- USD 0.33 billion – from the additional issue of bonds in 2015 with their focus on early redemption of GDP warrants;
- USD 0.25 billion – Cargill Financial Services International loan;
- USD 0.34 billion – from a 6-month loan from Deutsche Bank AG London.
Source: data of the NBU
In relative terms, the external debt of all sectors of the economy amounted to 80.8% of GDP, which is significantly higher than the thresholds values and average values for developing countries.
It is significant that at the beginning of 2021 all indicators of Ukraine’s external debt burden were in the red zone (Figure 2).
In particular, the external debt relative to exports reached 207.2% with threshold value of 200%.
And short-term external debt was 166.4% of international reserves with threshold value of 100%.
Source: author’s calculations according to the NBU and the State Statistics Service of Ukraine
The severity of debt risks in Ukraine is partially mitigated by significant amounts of external assets accumulated by the private sector of Ukraine, as well as the artificial nature of individual loans provided by non-residents to related entities in Ukraine.
For example, the geographical structure of the external debt of corporations and banks of Ukraine shows that the share of 6 countries (Cyprus, Great Britain, the Netherlands, Panama, the Virgin Islands and the Cayman Islands) reaches 70.7%.
At the same time, the share of creditor countries whose financial systems are hardly used to avoid taxation and money laundering is insignificant:
• Germany – 3.5%,
• the USA – 2.7%,
• the UAE – 0.8%,
• Poland – 0.7%,
• France –0.7% (see Figure 3).
These indicators indicate a violation of the classic functions of external lending in the private sector.
Some Ukrainian companies use external loans as a way to minimize tax liabilities in Ukraine andto protect the property available in the country from misappropriation.
At the same time, the rest of the enterprises are guided by sound motives for attracting loans for business needs, given the lower cost of loans in foreign banks compared to domestic ones.
Source: author’s calculations according to the NBU
The problem of repayment and servicing of external debts will remain acute in the coming years for the non-financial corporations and the Government sectors.
Their short-term external debt by remaining maturity in early 2021 was USD 38.5 billion.
Such debt levels and the volatility in the international capital market trigger high risks of debt refinancing and generate threats of debt crises.
In this context, an alarming symptom is that since the beginning of the year, the volatility of international financial markets has been increasing with the growth of long-term interest rates in advanced economies.
For example, the market yields on 10-year US Treasury bonds grew from less than 1% at the beginning of the year to 1.6-1.7% in April 2021.
There has also been a sharp increase in interest rates in the UK and a more modest rise in Japan and the Eurozone.
The rise in long-term rates in advanced economies is explained by the growth of the premium for maturity and reflects investors’ fears about future inflation and the rate of money supply.
Such processes in the markets of advanced economies enhance the volatility of capital flows for emerging markets.
Since if the central banks in advanced economies respond to the growth of long-term rates by raising their key policy rates, portfolio investors will begin to leave emerging markets in large numbers.
IMF experts have found that each percentage point (p.p.) of increase in the key policy rate of one of the world’s leading central banks turns into an increase in market rates by 2/3 p.p. for economies with a speculative sovereign debt credit rating.
It is significant that the market yields on Ukraine’s eurobonds from February 15 to April 14 already went up from 5.7% to 6.9%.
In such conditions for Ukraine, as well as for other emerging market economies, risks of access of external market financing are becoming relevant.
In April, the IMF recommended that central banks of emerging market economies reactcountercyclically to rising global interest rates and pursue an easier monetary policy (Shifting Gears: Monetary Policy Spillovers During the Recovery from COVID-19).
But the National Bank of Ukraine, contrary to such recommendations, is tightening monetary policy in the country and has already raised the key policy rate by 1.5 percentage points since the beginning of the year.
In my opinion, prudent management of debt processes and reduction of external vulnerability of the economy should be based on the use of the following tools:
1. Increase in volume and improvement of the structure of international reserves by:
1. repurchasing the surplus of foreign currency in the market during the seasonal growth of export revenues;
2. Ukraine’s continued cooperation with international creditors while strictly observing thenational interests;
3. raising the share of gold from the current 5.3% to at least 15%; of the total value of international reserves;
4. enhancing investments in AAA-rated corporate bonds issued by the corporates from the EU and the USA.
2. Gradual reduction of the budget deficit starting from 2022 and the use of the following instruments of fiscal consolidation:
1. increase in taxes on property, wealth and capital gains;
2. improved administration of corporate profit tax;
3. growth of environmental taxes and rent payments (especially for the extraction of iron and manganese ores);
4. reduction of budget expenditures on state administration, security and judiciary.
3. Development of the domestic capital market on the basis of:
1. ensuring the modernization, consolidation of the exchange and depository infrastructure while expanding the set of securities;
2. establishment of the Private Investment Guarantee Fund;
3. overcoming the “bottlenecks” of the market for government bonds by building up a civilized secondary market and controlling the activities of market makers;
4. wider involvement of individuals in the market by simplifying the sale and purchase procedures and abolishing the requirements for documentary proof of the sources of funds.
Scientific Director of the Growford Institute Tetiana Bogdan for Business.Censor.