Sergei Kuznetsov -

Ukraine made a $120mn interest payment on its Eurobonds on July 24, once again staving off a much speculated default scenario on billions in external debt that the country owes private creditors.

With the International Monetary Fund (IMF) pressuring Ukraine to quickly agree the restructuring of $15.3bn in privately held debt with a group of main creditors, the latest payment creates valuable breathing space for further talks before the "big one", a $500mn payment on bonds due September 23.

Artem Shevalev, Ukraine's Deputy Finance Minister, first informed Russia's TASS news agency that Kyiv paid the $120mn. Ukraine's UNIAN news agency also cited an unnamed Kyiv-based government source who confirmed the information.

Up to the last moment, analysts did not conceal concerns that Ukraine, battered by deep economic crisis and military conflict in its eastern Donbas industrial region, may use a recently passed law on a moratorium on debt reimbursement and refuse to pay.

Goldman Sachs credit analyst Andrew Matheny predicted in late June that Ukraine would not make the July 24 interest payment and, as a result, would enter into default. "We do not expect the ad hoc committee [of private creditors] to accept Ukraine's latest restructuring proposal," Matheny wrote in a note to clients.

Passed in early June, the adoption of the new law allowing the government to declare a moratorium on foreign debt repayments to private investors ramped up pressure on bondholders to agree to a restructuring demanded by Kyiv or wind up empty-handed after a default.

Hard bargaining

However, months of negotiations between Ukraine and the investors, led by the US asset manager Franklin Templeton, have so far been fruitless. While Ukraine insisted on a restructuring of the $15.3bn debt with a 40% haircut to allow Ukraine to resurrect its battered economy, the creditors rejected any reduction in the principle, arguing that Ukraine's debt was at a sustainable level.

Instead, in May, the creditors proposed a deal that foresaw a reduction of the country's debt burden by $15.8bn over the next four years, which exceeds the $15.3bn target previously set by the government. According to the proposal, the country's central bank should use $8bn of its reserves to repay 40% of the debt. Another $11bn would be re-profiled, alongside the extension in the maturity by up to 10 years with a reduction of interest payments.

"If they pay the coupon on Friday [July 24] they keep all doors open for a compromise agreement," Michael Ganske, the head of emerging markets at Rogge Global Partners in London, told Bloomberg on July 20. "Once you go into a moratorium you have cross defaults, acceleration, and then Ukraine will end up in a messy situation."

However Ukraine's leverage in its talks decreases each time it makes coupon payments, as this shows its unwillingness to go down the default road: In June, the finance ministry already paid a $39mn coupon on a $1.25bn Eurobond due in 2016, and $75mn on a $3bn Eurobond held by Russia.

And with the country now so dependent on external credits to survive, few people are convinced by Finance Minister Nataly Jaresko's earlier comment that a default "will not affect Ukrainians".

IMF awaits debt agreement

On July 23, the IMF announced that it was ready to provide the next tranche of $1.7bn to Ukraine as a part of a four-year $17.5bn support programme, but said also that it expected further progress in the country's talks with private creditors by July 31, when the IMF executive board should discuss the tranche.

According to Fund spokesman Gerry Rice, the Ukrainian authorities and the ad hoc creditors committee "have been making good progress in their discussions" over restructuring the state debt, but more was neeeded.

"It's vital that Ukraine and its creditors would make significant progress toward an agreement … and to do so before our review [on July 31]. We want and expect that outcome," Rice said.

Rice's statement gave confidence to those who believed Ukraine was able to make the repayment of a $120mn coupon payment on its bonds. "Ukraine is unlikely to want to annoy the IMF," Forbes wrote on July 24.

Earlier this week, the Ukrainian government sent a revised letter of intent to the IMF that "leads to the possible appointment of the IMF board meeting" to decide on the second tranche under the support package, the Finance Ministry said.

"Earlier, IMF officials claimed that for this to be approved, Ukraine also has to demonstrate that its public debt is sustainable, i.e. show some progress with the debt operation,"  Alexander Paraschiy at Kyiv-based Concorde Capital said in a note to clients on July 23. 

The readiness of the IMF to approve the loan without a completed debt operation actually allowed Ukraine to postpone this completion for a while, Paraschiy noted. This meant "there was no need for the Finance Ministry to introduce a moratorium on debt repayment as the $120mn payment loomed".

Russia wants its money

By paying $120mn to investors, Kyiv obtained some space for manoeuvring. The Ukrainian government has a window to negotiate debt restructuring until September 23, when $500mn are due for repayment.

On July 15, Jaresko announced some progress during the debt talks with private creditors which took place in Washington. However, she added that the sides had not reached final agreement.

Interfax news agency reported on July 23 that the next round of direct talks between Ukraine and the creditors' committee, scheduled to take place this week, had been cancelled.

However, when the talks resume, they will not be easy. Kyiv should not expect that creditors will be especially compliant due to position of Russia on the $3bn Eurobond, issued by the former Ukrainian president Viktor Yanukovych's government in late 2013.

The Kremlin refuses to consider possible restructuring of the debt, insisting on full repayment, and this may fuel the desire among Western creditors to reject Kyiv's demands.

Russian President Vladimir Putin said on July 15 that Ukraine should use financial aid received from the IMF to repay its $3bn Eurobond to Moscow. According to Russian Finance Minister Anton Siluanov, Ukraine is expected to obtain from the IMF by the end of the year up to $5bn as part of existing support programme. "Of this amount, $3bn should be given to us," Putin said.