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Russian President Vladimir Putin may be toning down his rhetoric toward Ukraine, but he still holds potent financial levers to keep Kiev from turning westward.
First, Moscow can use the price it charges for natural gas supplies Ukraine relies on to fuel its economy, a power that gives it unprecedented to make or break the country’s finances. Ukraine’s turn to the West coincides with an escalation in the price dispute. The more Kiev looks to Europe as its future trade partner, the higher the natural gas bills seem to head.
Second, Moscow may be able to use a special clause in the $3 billion in Ukrainian bonds Russia bought in December to trigger a system-wide debt meltdown, says a Georgetown University law professor and debt expert Anna Gelpern. That financial nuclear option could pressure Ukraine’s new pro-West government from embracing a full-fledged European integration and a turn away from its former Soviet masters.
Ukraine’s newly-elected President Petro Poroshenko has already asked his European counterparts for more time to commit to a major economic and deal with the European Union.
Financial levers are part of the broader battle being waged over Ukraine, says Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics. Mr. Putin not only wants the country’s strategic assets such as the Black Sea naval port in Crimea, but he also wants Ukraine to be part of a Eurasian trade bloc and to prevent the country from becoming another member of the North Atlantic Treaty Organization, analysts say.
The country is in a particularly precarious economic position, even with an International Monetary Fund bailout.
The financial lifeline is already one of the IMF’s riskiest emergency loans. Just a day after the fund approved a $17 billion bailout for Ukraine in late April, IMF brass warned a bigger bailout than currently planned might be necessary, given the political turmoil the new leadership faces. Those risks are underscored as government forces continue to clash with militant separatists.
Some economists warn that a restructuring shouldn’t be ruled out and wonder if Ukraine is the new Greece, which received a record-sized bailout that eventually led to the biggest private debt restructuring in modern history.
“We see the IMF’s growth forecasts for Ukraine and Greece not as forecasts at all, but rather as assumptions necessary to justify the IMF’s interventions,” say Benn Steil and Dinah Walker in a Council on Foreign Relations blog post.
In fact, the natural gas price problem is such a problem that the IMF wouldn’t be able to lend to the country under its rules if it didn’t keep the country’s 100%-state owned Naftogaz company off the federal balance sheets because of the debt the firm owes to Russia’s GazpromOGZPY -2.39%. The IMF calls those debts “quasi-fiscal losses,” a technical move that also prevents the IMF from requiring a debt restructuring.
Although the IMF has no idea the extent of Naftogaz’s obligations to Russia’s Gazprom because it’s not allowed to see the contracts, the fund assumes only $2.2 billion in Naftogaz arrears to the gas giant and a natural gas price of $385 per thousand cubic meters. That’s mid-range in the price dispute and at the low end of the arrears Moscow alleges that Kiev owes.
“A slightly higher or lower price would be handled through an adjustment to IMF financing, but a significantly higher price for gas would outstrip Western financing and raise serious concerns about fiscal and debt sustainability,” says Robert Kahn, an international economics fellow also at the Council on Foreign Relations.
Meanwhile, Ukraine’s Prime Minister Arseniy Yatsenyuk said the country “won’t pay the high political price” on the table to keep Russian natural gas flowing into his country, nor will it pay Gazprom its arrears until a new price is agreed. Those gas arrears, says Ms. Gelpern, who’s also a senior fellow at the Peterson Institute, gives Moscow additional leverage over Kiev.
A small, unusual clause in the $3 billion in bonds Moscow bought as part of its ditched effort to prop up the former pro-Russian government in December gives the Kremlin power to destabilize Ukraine’s debt markets and boosts its bargaining power in the current political conflict, Ms. Gelpern said.
The Russian bond allows cross-defaults to “any indebtedness … owed to the Noteholder or to any entity controlled or majority-owned by the Noteholder,” the bond prospectus reads.
That clause, she argues, allows the bondholder to call the debt in default if Ukraine has any other debt unpaid, such as the Naftogaz arrears.
It’s an open question whether a court would uphold such a reading.
But in the meantime, other holders of Ukrainian debt would be forced to decide whether to also call the debt in default, and the uncertainty created by the act would potentially send the country’s borrowing costs rocketing to unsustainably high levels.