Why Ukraine Matters More Than You Think (Or "Only Wimps Pay Their Debts")

Tyler Durden's picture

Ukraine, we are told, is infamous for its colorful proverbs and as the title suggests Citi's Matt King warns that emerging market (EM) bond investors may yet become familiar with more of them in coming weeks. Unfortunately Ukraine’s importance is greater than its economic or even geopolitical significance would suggest. Risk premia everywhere have been compressed by the prolonged force-feeding of central bank liquidity. EM in particular has benefited from enormous inflows. However, for developed market (DM), King believes even a serious deterioration in Ukraine still feels unlikely to really derail the serene march tighter we see in spreads – but even so, he warns there are some broader implications of the EM woes which investors would do well to be aware of as "drunkards know no danger".

Via Citi's Matt King,
“Drunkards know no danger”

In some ways, the lack of market reaction to the Ukrainian revolution is entirely understandable. Sovereign debt is small (40% of GDP, and only 20% external) – so if there is a crisis, it ought to be one of liquidity, not solvency. EM investors have long thought of the Ukraine as a potential trouble-spot, typically categorizing it with Argentina and Venezuela – so their individual exposures ought to be quite manageable. Besides, it only amounts to around 3% of EM bond indices. And spreads are already high, and the curve inverted, meaning shorts are expensive and at first sight a lot is priced in already.

Dig deeper, though, and we are not nearly so sure – both on the Ukraine itself, and on the broader implications.

The markets seem to be making two main attempts to justify bond prices still trading in the low 90s. The first is that ‘surely the EU and US would not remove their support and leave the country to its fate: one way or another, an IMF bailout has to be forthcoming’. The second is that even in a disaster scenario, long-term average EM recovery rates are around 60%. To us, both lines of reasoning seem flawed.

For an example of a country where an uprising that initially looked set to bring democratic and state reforms has been followed by that country being abandoned to its fate, with disastrous humanitarian consequences, you only need to look as far as Syria. Perhaps in the Ukraine it might be slightly clearer to the EU/US which side ‘merits’ their support, but it is not at all difficult to imagine a scenario in which they fail to win power, or – worse – there is no clear government with whom to negotiate.

At a minimum, the country’s first large bond maturity in June makes the timing of the planned elections in late May extremely awkward. On balance, our economist Ivan Tchakarov thinks that provided there is a government in place, the IMF will end up disbursing. Probably this would come in the form of one small ($2bn?) tranche prior to the elections with the promise of a much larger sum afterwards.

But the probability he attaches to this happening is only slightly better than 50% (around 60:40). And it is in the alternative scenario that we come to the second flaw in consensus reasoning.

“Only when you eat a lemon do you appreciate what sugar is”

EM historical recovery rates do average around 60% – but with an extremely wide range (Figure 2). Indeed, as the IMF note in a recent paper,3 they tend to be divided in an almost binary fashion. On the one hand are prompt, pre-emptive, restructurings and maturity extensions, with recoveries little below par. On the other come outright (and frequently protracted) defaults and repudiations.

While there is some chance the IMF might insist on private sector involvement as a precondition for disbursement, to our minds the overwhelming risk is that any default would fall into the second category, most likely as part of some form of sovereign break-up. In this case, recovery would likely be far below 60% – as was the case in Iraq and Serbia.

As such, we are more inclined to attribute continuing high bond prices to overoptimism – or, at best, illiquidity, given that nearly one-third of the outstandings are known to be held by one account. While the recent statement from the newly appointed head of the central bank is encouraging, unless there is decisive progress made in coming days, we think bonds will come under downward pressure. Frankly we are staggered that the invasion of the Crimean parliament by around fifty armed men – which would seem to significantly increase the chance of break-up – has only led to bonds selling off by another point.

“One malicious cow disturbs the entire herd”

And yet it is the broader backdrop which we find most interesting and important here.

The scope for immediate economic contagion from any default in the Ukraine is relatively limited (though the relatively large exposures of some Austrian and Italian banks, mostly through subsidiaries, may raise a few eyebrows – Figure 3).

The geopolitical significance is obviously much larger, but here too we struggle to see as likely a scenario in which increasingly acrimonious relations between the West and Russia lead to serious repercussions for the world economy, beyond, say, higher gas prices for western Europe.

But these events are occurring against a backdrop of a steady stream of negative stories in EM – from Turkey’s alleged corruption tapes, to the protests in Thailand, to China’s constant struggle to rein in credit without destroying growth. And despite growing tactical underweights by many investors, EM – along with all other high yielding assets – in strategic terms has been the darling of asset allocators over the past decade, and has seen huge institutional inflows which have yet to fully reverse (Figure 4).

As we see it, each additional headline, and each downward revision to EM growth prospects, takes us closer to the point where investors undertake a wholesale reevaluation of the risk-reward of EM assets for their portfolios – just as has already happened with gold, and is happening with commodities more broadly. At best, this would result in drastically reduced inflows, rendering problematic the refinancing of the large volume of (mostly corporate) EM debt which has built up in recent years; at worst, it could lead to a rush of outflows.

In the long term, we think even DM is vulnerable to a similar re-evaluation. Indeed, in a world in which the run-up in asset prices owes more to central bank largesse than it does to fundamentals, 6 it feels almost inevitable. And yet the price action in DM credit remains so strong, the shortage of paper so acute, that we think it would take a major intensification of the crisis for that to become likely. Until then, we expect EM assets to underperform, but DM credit to grind tighter. We have to give the last word to the Ukrainians, though: “He who licks knives will soon cut his tongue.”

Furthermore, UBS' Kathleen Middlemiss warns specifically on Ukraine:

Ukraine's bond term structure remains massively invered...

The situation in Crimea drags on. For corporate bondholders we feel the risk has moved to focus on those issuers with upcoming coupon payments and debt maturities in Ukraine along with the threat of economic sanctions against Russia's issuers. The scarcity of obtaining US Dollars domestically coupled with the devaluation of the Hryvnia is also a concern for upcoming US Dollar payments. Any significant further devaluation would certainly put financial strain on issuers.

Ukraine Financials have upcoming USD payments due...

The liquid non-financials paper is not trading at distressed levels, yet. The crisis looks far from over and should Ukrainian corporate issuers restructure debt, we believe the Eurobond holders would not escape financial pain.

Best case scenario for Ukraine sovereign credit: already in the price?

While the government's recent discussions with the IMF delegation do give us some assurance that Ukraine would be able to strike a funding deal and roll over its short term FX debt, we do not see terrific value in being long at these levels; we find that the bonds are hardly priced for distress, with the implied probability of default on the CDS less than other high yielding names like Argentina and Venezuela. The upcoming Crimea referendum also has the potential to further inflame political tensions, and we prefer to stay side-lined until we get more signs of the situation normalizing.

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robertocarlos's picture

When I owed the local gas compay $1.5 billion they simply left phone mesaages every fricking day. They finally passed it on to a debt collector but they never sent men with guns.

Looney's picture

All of this doesn’t count, while our DICK-tator-in-Chief is playin’ golf.

BTW… Do his secrEting service agents carry him in a throne around the golf course or does he, as a people person, just rides his pink tricycle?  ;-)




knukles's picture

Not to fear, McCain, Lew, Yellen and Kerry are here.

Looney's picture

Uncle Knukles, does it mean we are all phucked?  ;-)


knukles's picture

Well, I wasn't gonna say anything, but, given circumstances, I'd say that's a pretty good point of view.
I mean, Vlad the Evil and Bad, can probably invade and conquer the whole of Ukraine ("The" Ukraine) and what's DC, London, Paris, Bonn, NATO, whoever gonna do?
Drone some more brown children in Yemen or some such shit?

disabledvet's picture

is it Dick-tater or Dick Tatar now?

In any case by far the largest holders of Ukrainian debt are Russian Banks...so any "total annihilation strategy" would best be served by taking reality into account.

No, the "Chinese water torture" method is any better for the Russian Banks either.

I do agree...one should wait on Operation Imperial Overlord Response before buying into that .90cents to the dollar thesis. Having said that...we're still talking .90 cents to the dollar here and everyone agrees (even the Russians) "the Russians parts aren't competitive if subjected to free market pressures."

Think of it as ballast being tossed overboard on your way to "free market Nirvana." If Wall Street can come with 3 billion of Puerto Rico i'm sure we can work out something "with the entirety of Europe" here. The term "securitization" does just roll off the lips here.

Then again "maybe just 35 billion straight up"?

Independent's picture

Well if the largest holders of debt are ukrainian I guess the lender is picking up his collateral.  Same thing with that Chinese aircraft carrier, its to make sure Chinese loans in Africa and around the world are not ignored and defaulted on.

gmrpeabody's picture

Well..., it all seems to be a mute point to me.

Soon, very soon probably, it will all be an issue for Russia..., not the EU.

Can you say..., write-off.

max2205's picture

And.....thats why I never trade foreign bonds.....

The Dunce's picture

The Ukraine isn't worth jack shit to Americans.  Let the Euro-trash handle their own problems.  Bitches.

CrashisOptimistic's picture

Yo, Tylers.

Find someone to look into the swaps profile on the Chinese institutions defaulting.

disabledvet's picture

surprised this one hasn't gotten 100 down arrows actually.

Hangfire's picture

Don't worry the debt collector is climbing into his t-90 and will be there shortly.  

Looney's picture

How difficult is it to get a motorcycle license plate for a T-90? Wouldn't it be fun to ride one of those around DC during the Cherry Blossoms Festival  ;-)



TeamDepends's picture

Drunkards are intimately familiar with danger, which is why they are drunk.

McMolotov's picture

My blood-alcohol level confirms this statement.

"He that increaseth knowledge increaseth sorrow. And then he gets drunk."


(two Bible quotes in one day, a new record)

knukles's picture

I absolutely LOVE quotations that have roots in the Bible, when their origin is pointed out to my Uber-Liberal Statist friends.
You can feel their nuts shrivel.

McMolotov's picture

With this Ukraine shit, we're wandering dangerously close to the kind of scenario in that movie Threads (it's on youtube; feel free to watch it and then piss yourself in fear). One side decides to do something stupid, the other side retaliates, and it's lights out for everyone. Good times.

DoChenRollingBearing's picture

Right on, knuks, you got that right!

DoChenRollingBearing's picture

Well, for the moment Peruvian banks and companies are paying their debts.  Even we have very few customers who are seriously delinquent in paying us (the ones we give credit to...).

This could change very quickly though if China (a BIG customer of Peru) goes down the chute.


Ukrainian debt?  LOL!  I had trouble enough decades ago trying to collect money owed to me by a GREEK-AMERICAN (yeah, I´m talking about you Spyros G!), so Austria et al may have a problem here.

Better call Saul?

Independent's picture

DoChen you need a gun in your hand and storm in like OJ to get paid lol

DoChenRollingBearing's picture

Spyros G. had a habit of changing addresse and names frequently.  And this was a long time ago, he may have even passed on by now.  No chance I will ever get that money back.

QQQBall's picture

In every deal someone gets screwed, in that one it was you. 




Spyros, G. 

dirtyfiles's picture

and this is why Puytin dont want to deal with EU and US

DoChenRollingBearing's picture

Yeah, QQQBall, that was me!

Except he never signed anything.   Not even after a losing a judgement.  Ol´ Spyros, God bless him, also screwed two others after losing judgements as well.

Spyros is mostly why my first business failed.  But at least I paid all my debts and did not shaft anyone.

Independent's picture

wait so Spyros G is a zerohedge regular?

DoChenRollingBearing's picture

It is highly unlikely that Spyros is a ZH reader!  Thanks for the LOL!

UselessEater's picture

Putin, IMF, SDRs, Obama, More Taxes & Centralised Control....interesting article:


"The globalist establishment, Russian authorities, and the Obama administration are pushing hard for a series of controversial “reforms” aimed at massively expanding the power and resources of the International Monetary Fund (IMF) while further scaling back U.S. influence at the institution. Using various pretexts — and especially the crisis in Ukraine — governments and dictatorships, including Vladimir Putin’s Russia, are even threatening to proceed with the radical plot to empower the IMF whether the U.S. Congress approves it or not.  

The most important and far-reaching elements of the “reform” agenda include a doubling of taxpayer resources available to the IMF...... Ironically, the Times suggested that it was in “America’s interest” that authorities in Ukraine and other countries receive bailouts from U.S. taxpayers through organizations such as the IMF rather than from Russia directly. The claim is especially ridiculous considering that the Kremlin is leading the push to adopt the IMF “reforms” without approval from the U.S. Congress. The argument becomes even more absurd when realizing that Moscow is participating in the IMF bailouts agreement for Ukrainian officials. And it borders on lunacy when considering a New York Times report last week acknowledging that much of the “aid” to Ukraine will end up in Russian institutions anyway."

layman_please's picture

who could have thought countering ussa supremacy would further supranational world government agenda?! putin might be a chess player but most of his aficionados clearly aren't.

thanks for the link!

TrustWho's picture

You will never see this, but the USA Federal Reserve will print the dollars. Who knows what these guys do? Even at $55 billion a month, this debt crisis is peanuts. Why would Fischer/Yellen risk a crisis?

ShrNfr's picture

When the Crimea becomes associated with Russia, not if, the Ukraine debt/gdp ratio will increase. The debts will remain to the old Ukraine. Russia has a put on their bonds that they just got for their 3 bn in aid at that level. Obama and Kerry have words, Putin has leverage. Point, set, match, Putin. Ugly, dumb, yapping, Obamakerry. Some people should never play the game, Obama and Kerry are two of them.

401-Kulak's picture

How do you make that work?  Crimea sucks about $13 billion a year from its host...which will now be the Russians. Add to that deficit the amount of lost revenues from "Who the fuck wants to vacation in Crimea this summer"

Volkodav's picture

Russia was paying 90 million a year, I think for the base...

However end expenses work out....for Russia it is well worth it..

I am very curious and plan to get some numbers later from economist there.


Iam Yue2's picture

"we prefer to stay side-lined."

Pure Genius.

chump666's picture


The  Malaysian aircraft disappearance fiasco

Chinese satellites spot "wreckage" on the day of the crash, releases the images now:

Peter Goelz, former director of the US National Transportation Safety Board, told CNN:  Quote They have got to get vessels and aircraft there as quickly as humanly possible to find out where they have drifted to and get eyes on."  On why China had delayed three days before releasing the images, Mr Goelz said:  Quote It does not surprise me that China would be reluctant to come forward. They might not want to reveal what kind of satellite capability they have in the region." 

22.30 There is more confusion concerning why the images released by the Chinese have not been acted on sooner - and even if the Malaysians are reacting now. They were first tweeted several hours ago (note the time stamp on the below tweet from CCTV - the Chinese branch of an English language broadcaster - that contained one of the images).

The next major conflict won't come out of Europe or the middle east.  This Asian drama says it all...

 01.15 Malaysia’s civil aviation chief, Datuk Azharuddin Abdul Rahman, has said Malaysia had not been officially informed by China about the satellite images, which he said he was learning about from the news. He said if Beijing informs them of the coordinates, Malaysia will dispatch vessels and planes immediately.

Like a f*cking Marx Brothers movie

Dewey Cheatum Howe's picture

What is 40 tonnes of gold worth is the amount of credit the IMF is going to extend in the form of funny money and not a cent more then claim ownership of their gold in return when they can't pay it back and probably on top of that charge them interest also so they can never dig out of the debt hole.

swmnguy's picture

Right now, with Au at around $1365 USD/oz., 40 tonnes is worth about $1,755,430,950.00.

Flying Wombat's picture

Dr. Paul Craig Roberts on Western economic pressure on Ukraine:  "Sanctions are likely to speed up the implementation of the BRICS negotiations to leave the dollar system and settle their international accounts in their own currencies. All countries with financial and economic links to the West can be intimidated, punished, and destabilized by Washington. National sovereignty is inconsistent with being part of the US dollar system."


Full article:  click here.

shovelhead's picture

No offense meant, Ukranians, but are you umm...kinda stoopid?

Putin's loan conditions: Steal less and discount gas.

IMF's loan conditions: First-born children and higher gas prices.

You're gonna find the lumps in the bed you made for yourself are snakes.

Granted, Putin ain't the belle of the ball, but it sure beats chubby-chasing a tattooed Walmart woman.

jonjon831983's picture

Claims that Ukrainian pensions will be halved - no other source, from RT.

"Pensions in Ukraine to be halved - sequestration draft"