By Anna Gelpern, Yuriy Gorodnichenko, Sean Hagan, and Maurice Obstfeld
BERKELEY/WASHINGTON, DC – Public debt is rarely a matter of national survival, but it has become one for war-ravaged Ukraine. Two months into the country’s heroic defense against Russia’s invasion, it is becoming increasingly clear that the war could continue for many more months or even years. Victory depends not only on Ukraine’s brave, highly motivated armed forces and citizens but also on the country’s ability to muster the financial resources it needs to sustain an intense war effort indefinitely.
Even with donated weapons and other aid from the West, the Ukrainian government needs huge sums of money to buy more weapons and matériel, recruit soldiers and auxiliary personnel, and to support the civilian population. Russia has destroyed much of Ukraine’s productive capacity and infrastructure, leaving it with limited ability to raise revenues from fees or taxes. Moreover, the Russian blockade of Ukraine’s Black Sea ports impedes exports and further amplifies the challenges facing the Ukrainian authorities.
Under these conditions, Ukraine’s policymakers must establish clear priorities for using precious revenues and foreign reserves. Though the government can and should cut nonessential imports and postpone development projects, as it is doing, such measures will not free up enough resources to sustain a prolonged all-out war effort. So, Ukraine’s remaining financing options are thus to borrow or print money.
At the end of 2021, Ukraine’s external public debt stood at about $57 billion (more than a quarter of its GDP), including $13.4 billion owed to the International Monetary Fund, $6.5 billion owed on bilateral official loans, and $22.7 billion in Eurobonds. Ukraine continues to service its public debt punctually and plans to pay another $2 billion to bondholders by the end of 2022. The government regards continued debt servicing as a signal that it remains highly functional and in control of its finances. By staying on top of its repayments, President Volodymyr Zelensky’s government hopes to strengthen the country’s reputation as a reliable borrower.
We do not have enough information to determine the costs and benefits of such a strategy. But we do know that longer-term Ukrainian bonds currently trade at about 40 cents on the dollar, which suggests that investors have priced in the possibility that the government will, at some point in the future, not be able to pay. That expectation is justified, given the circumstances. Ukraine is receiving official grants and loans for now, but official donors and creditors will not want to continue subsidizing payments to Eurobond holders indefinitely.
In anticipation of this outcome, what should Ukraine and its allies do to stabilize Ukraine’s finances? It would be wise to recognize at least four potential difficulties and make plans to overcome them.
First, a debt sustainability analysis (DSA) is normally a prerequisite for negotiating debt relief, regardless of whether payments are merely pushed into the future or restructured to include a reduction in net present value. DSAs are challenging even for peacetime economies, because they require (among other things) a forecast of the growth trajectory for the next decade or longer. For a country that has been subjected to an intentionally destructive invasion, where it is unclear how much productive capacity will remain after the fighting ends, a credible DSA simply is not possible. Any restructuring deal made in the near term would rest on foundations of sand, which means that substantive debt negotiations with external creditors must wait until the war is over, or at least until there is much greater clarity on Ukraine’s economic outlook.
But this uncertainty does not mean that Ukraine should put off engaging with creditors. By reaching out now, the government can establish a formal framework for future negotiations and minimize the risk that scarce official resources will go to service pre-war foreign debts.
Second, a comprehensive and definitive restructuring will typically occur under the aegis of an IMF support program. The current IMF stand-by program for Ukraine is set to expire in June 2022, and it is hard to see how the IMF could agree to a new one under the current conflict conditions. Fortunately, the IMF’s management is already meeting with Ukrainian leaders to discuss post-war reconstruction. Here, too, Ukraine and the international community will need time to assess the country’s prospects, negotiate credible policies, and coordinate among the many bilateral, regional, multilateral, and private actors involved.
Third, foreign creditors may not agree to reduce their claims or defer payment, even if their holdings are trading at pennies on the dollar. Bondholders tend to negotiate hard and long to minimize losses, but protracted negotiations would delay recovery, harming Ukraine and its creditors alike.
Fourth, even if a substantial majority of bondholders is willing to provide relief, some holdouts might still try to gain an advantage by suing for the full value of their debt and asking a court to seize Ukraine’s assets or block its other international transactions. Argentina’s 15-year battle with holdout creditors after its 2001 default illustrates the problem.
Moreover, even official creditors are not above aggressive holdout tactics. Russia is still trying to collect the $3 billion that Ukraine’s government borrowed in 2013 under then-President Viktor Yanukovych, despite a broadly agreed debt-restructuring following Russia’s 2014 incursion into Donbas and annexation of Crimea. And even though Ukraine’s bonds trade at a deep discount, the prospect of extraordinary international support might make them more attractive to holdouts of all stripes.
Foresight and Forbearance
Given the extreme uncertainty and the humanitarian emergency on the ground, Ukraine’s official and private creditors should act immediately to defer payments on the country’s debt, so that official resources do not get siphoned off by the few at the expense of the many. If Ukraine’s creditors take the lead, its government would not have to signal diminished agency or an unwillingness to pay. A deferral would provide breathing room to prepare a credible DSA, negotiate a recovery program, and coordinate among the many institutions involved. The benefits of this approach would ultimately benefit not just Ukraine but all its creditors as well.
Official bilateral creditors can begin to address these challenges right away, by announcing a payment deferral and preparing the ground for debt relief as part of a comprehensive restructuring after the war. The European Union, for example, could unilaterally modify the terms on the €5 billion ($5.3 billion) that Ukraine owes it under the EU Macro-Financial Assistance program.
Official debt relief could then help Ukraine in its negotiations with private creditors. Even if debt relief replaces some official aid donations, official creditors would expect Ukraine to seek comparable terms from private creditors, consistent with long-established international debt-restructuring norms.
Would private creditors take the initiative to help Ukraine? In this case, some might, because deferring repayment in the middle of a devastating war would help preserve more of Ukraine’s future capacity to service its debts and secure additional official support. That would be in the collective best interests of investors, and it would certainly be better than the alternative: a hard default.
Contractual provisions in Ukraine’s Eurobonds allow creditors holding 10% or more of a bond issue to call a meeting, and those holding 75% or more to defer repayment. Depending on the design of the deferral, aggregated voting may also be available, further reducing potential holdouts’ leverage. Moreover, deferring debt payments temporarily during a humanitarian crisis is distinct from debt relief and would surely advance the ESG (environment, social, and governance) objectives that so many investors espouse.
Because Ukraine’s Eurobonds are issued under English law, and to the extent that Ukraine has debt governed by New York law, the United Kingdom and the United States can also act on the country’s behalf. For example, they could provide substantial protection from any creditors who may be tempted not to participate in a payment deferral because they are hoping to seize Ukraine’s international assets. The US and UK governments both took steps to shield Iraq’s assets from creditor enforcement in 2003, and though they were implementing UN Security Council Resolution 1483, they did not need UN approval to do so. Such measures are highly unlikely to result in market penalties for the sovereign debtor.
In Ukraine’s case, US President Joe Biden could issue an executive order shielding Ukrainian property from its creditors in US courts, as President George Bush did for Iraq in 2003. Similarly, the UK Parliament could limit judicial debt enforcement to avoid subsidizing other creditors. Parliament did so in a 2010 law that prevented private creditors from collecting proportionately more than official creditors from some 40 countries participating in the IMF and World Bank’s Heavily Indebted Poor Countries Initiative. By undermining the viability of a holdout strategy, such measures would enhance the prospects of broader creditor participation.
The Moment of Truth
Sovereign debt restructuring is seldom easy or pleasant, and Ukraine ultimately may be forced to choose between bad and terrible options. But it should not be forced to choose between life and debt. Recognizing Ukraine’s political situation, the common good, and their own best interests, creditors (public and private) should halt repayment until the situation on the ground permits a credible DSA and a negotiated recovery program. The official creditor community must lead the way, using all the tools at its disposal to ensure that every private creditor participates, and that none takes advantage of the official sector’s forbearance.
When a country’s very survival hangs in the balance, its government should not have to focus on managing market perceptions through costly financial signaling. As the eminent British economist Sir Roy Harrod observed many years ago, “Memories are short, and business is conducted mainly by reference to present advantage.” Harrod’s judgment applies especially in Ukraine’s case, considering the extent of deliberate destruction by Russia that would give rise to a debt deferral.
While we hope for the best, the world should prepare for the worst. Fortunately, Ukraine has many committed friends in the international community. Following precedents from past conflicts, these friends can act swiftly and effectively to help the embattled country navigate the worst-case scenarios while it focuses on what matters most: defending itself against an outrageous act of aggression.
Anna Gelpern is Professor of Law at Georgetown University Law Center and a non-resident senior fellow at the Peterson Institute for International Economics. Yuriy Gorodnichenko is Professor of Economics at the University of California, Berkeley. Sean Hagan, a former general counsel of the International Monetary Fund, is Visiting Professor of Law at Georgetown University Law Center and a non-resident senior fellow at the Peterson Institute for International Economics. Maurice Obstfeld, a former chief economist of the International Monetary Fund, is Professor of Economics at the University of California, Berkeley and a non-resident senior fellow at the Peterson Institute for International Economics.