Many fund managers who made tidy profits from Ukraine's bond restructuring this year are opting to sell out, troubled by the country's messy politics and a looming legal battle with Russia over a $3 billion debt. Kiev imposed a payment moratorium on Friday on the Russian bond, which due to be repaid this weekend, having earlier argued that Moscow should have joined this year's debt restructuring.
The Kremlin, dubbing the Ukrainians "swindlers", threatens to sue if it is not paid within the 10-day grace period. Russia's view that it should not have been expected to restructure debt alongside private sector creditors was probably vindicated by this week's International Monetary Fund decision to class the bond as "official" or sovereign-to-sovereign debt.
Many investors are not hanging around for the outcome. "The easy part of the rally is behind us. The Ukraine story is going to be more complicated next year than this year," said Claudia Calich, head of emerging debt at M&G Investments. Calich was among those who snapped up dollar bonds issued by Ukraine at default-level prices, then enjoyed a 50 percent rally after Kiev announced a generous restructuring which also offered years of payments linked to Ukraine's future economic growth.
Ukraine bonds are among 2015's top performing assets. But new bonds issued as part of the restructuring have fallen 5-7 cents off peaks hit after they first traded last month. Calich has reduced her holdings, saying: "I can't think what could be the next wave of positive news that could come out of Ukraine." There is plenty of negative news Aside from Russia's lawsuit threat, separatist violence continues, and divisions in Ukraine's pro-Europe coalition parties have fuelled speculation the government could fall.
The IMF warned on Friday that parliament's reluctance to approve a proposed tax code and budget for 2016 could derail a $17.5 billion lifeline extended to Ukraine this year. Failure to pass the measures has already delayed $2.7 billion in overseas financing as well as urgently needed IMF cash. Finally, economic turnaround may be delayed due to falling prices for Ukraine's main exports, iron, steel and grain. The economy is set to contract 11.5 percent this year.
"In Ukraine we took a bet on restructuring and we benefited from the 50 percent rally. But the restructuring game that we played is over and now we have to look at the macro," said Yerlan Syzdykov, head of emerging debt at Pioneer Investments.
"So we have taken off some risk." Asset manager Franklin Templeton, which led the restructuring committee, held around a third of Ukraine's bonds in late September. Provided Ukraine sticks to other IMF loan terms, the dispute won't threaten its bailout. The Fund's lending-into-arrears bar was recently abandoned, allowing it to keep assisting a country that falls behind on debt repayments to another sovereign.
The Russian bond now ostensibly falls under the Paris Club which deals with debt owed to official creditors. Many will argue that Russia, having annexed Ukraine's Crimea region and widely seen as fomenting separatist fighting in eastern Ukraine, does not deserve to be repaid.
Nevertheless there is the possibility, however remote, that a British court will uphold Russia's position. As Argentina's experience shows, Kiev could, in theory at least, be told to pay Russia or halt payments to other bondholders, pitching it back into default. "There is a bit of a risk this could deteriorate into another Argentina. I am not sure from a legal perspective how strong the Russian case is, but the fact there is such a case does not help," said Zsolt Papp, client portfolio manager at J.P. Morgan Asset Management.
The biggest risk ultimately may be Ukraine's economic funk. Many reckon this year's 20 percent write-down on the bonds' value was not big enough to improve its public finances, making another debt restructuring likely within a few years. Regis Chatellier, head of sovereign credit at Societe Generale noted that Ukraine's economy, almost entirely oriented towards Russia, would have to be rebuilt from scratch "Basically they have to start from ground zero," he said.
"Everybody was surprised by how soft the restructuring was, so we had an amazing return on Ukraine. But in the long-term this deal was terrible," Chatellier said. "I don't see a start or momentum for fundamentals to improve significantly, and on top of that you still have the Russia bond."
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