Ukraine – Risk of Broader Default

Ukraine’s access to international financing, including regular disbursements of the $17.5 billion EFF arrangement with the IMF, in in jeopardy following the government’s failure to repay $3 billion in emergency loans that former President Viktor Yanukovych obtained from Russia shortly before his government was toppled by a popular revolt in early 2014. The risks have been compounded by the further erosion of the reformist government’s parliamentary majority.
For now, the Russian loan is being treated as a special case in order to overcome the IMF’s statutory prohibition on lending to sovereign borrower in default. However, with the latest political turmoil casting doubt on the government’s ability to fulfill the terms its lending agreement, the IMF has delayed the disbursement of funds, preventing Ukraine from accessing other international assistance that is required to fend off a balance of payments crisis and a broader default on maturing sovereign and selected corporate debt payments.
The government was shaken in early February by the shocking resignation of Economy Minister Aivaras Abromavicius, who departed in frustration over the weakness of the government’s anti-corruption efforts and delays in implementing structural reforms. The subsequent resignation of Deputy Prosecutor-General Vitaliy Kasko, who left in protest over alleged political pressure being exerted on his superior, Viktor Shokin, has similarly sown doubt about the efficacy of judicial reforms.
Defections have reduced the government to a two-party coalition made up of President Petro Poroshenko’s eponymous party and Prime Minister Arseniy Yatsenyuk’s People’s Front. Yatsenyuk is scrambling to woo allies, a task made all the more difficult by the government’s rapidly falling popularity, and there is speculation that Finance Minister Natalie Jaresko might be invited to form a technocratic government.
The alternative of a snap election is almost as likely, but the risk implications are more substantial. The uncertainty regarding the composition and policy direction of the government formed after an early election would not only increase the danger of damaging market instability—with significant negative repercussions for debt repayment, corporate viability, and banking-sector stability—but also an escalation of both the separatist insurgency in the east and civil protests in the capital. Under such circumstances, it would be difficult to sustain the modest improvement in the economy that followed the conclusion of an agreement with creditors last year.