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Ukrainian authorities announced on August 27 that they have secured a deal with international creditors after a six-month marathon of tense debt restructuring talks that are crucial to restoring the country's ravaged finances.

Investors agreed to a 20% writedown of the face value of around $18bn worth of Eurobonds, meaning Ukraine will avoid an immediate default scenario. While Russia, which holds another $3bn notes due in December, reiterated that it expects the debt to be repaid in full, the mood was jubilant among the leadership in Kyiv.

"The default so much expected by our enemies is not going to happen. Ukraine has reached a deal with the creditors' committee on restructuring and partial debt remission," Prime Minister Arseny Yatsenyuk said in a statement.

Yatsenyuk added "there had been little hope" that Ukraine would successfully conclude negotiations with the creditors, but that the ad hoc committee of private creditors finally accepted Ukraine's proposals. "It is also their [the creditors] contribution to economic and financial stabilisation in the country," Yatsenyuk said.

Fly in the ointment

However, a small question mark still hangs over the fate of the deal. Russia did not participate in the credit committee that negotiated with the Ukrainian government and it is not clear if the private bondholders have linked their deal to Russia's acceptance of the terms. Moscow rejected the deal out of hand after the announcement, as the core disagreement between Kyiv and Moscow has also not been resolved: Kyiv maintains that Russia's $3bn bond is 'commercial' debt, not state-to-state, and so should be included in this deal, whereas Moscow insists the debt is sovereign and so is not subject to the deal and must be repaid in full when the bond matures in December. 

Still, assuming the private bondholders go ahead and take the haircut, the restructuring would relieve the budget over the next four years sufficiently to comply with International Monetary Fund (IMF) conditions for a four-year extended funding facility it granted to Ukraine in March. "In the next four years Ukraine will not repay the primary loan and the bonds' maturities, which we had to pay starting from 2015, and have been prolonged for four years," Yatsenyuk said.

He added that the terms offered to Ukraine were unique. "They have never been offered to any other country... which haven't defaulted on their debts. An average amount of remission, which could be agreed without announcing default, was not higher than 10%. Ukraine has managed to be forgiven 20% of obligations to our bondholders," the prime minister added.

His US-born Finance Minister Natalie Jaresko also expressed relief at the resolution of the half-year imbroglio. "It gives us breathing space. Solvency and liquidity have been addressed," Jaresko told the Wall Street Journal on August 27. The creditors' committee, led by the US asset manager Franklin Templeton, declined immediate media comment.

In previous months, negotiations between Ukraine and the investors were fruitless, as Jaresko pushed for a 40% haircut to allow Ukraine to resurrect its battered economy. The creditors in turn rejected any reduction in the principle, arguing that Ukraine's debt was at a sustainable level.

Not enough to breathe freely?

However, the terms of the deal mean that the actual amount of debt that will be restructured will be less than the $3.6bn of debt under discussion. According to the terms, published by Bloomberg, if 75% of the bondholders of any of the bonds can force the deal on the other investors. 

Franklin Templeton holds the supermajority on “some” of the bonds, according to comments by Jaresko, and has already said it will accept the haircut. However, the fund owns less than 75% of “most” of the bonds and so the final decision on the deal will depend on persuading other private bondholders to agree, not all of which were part of the credit committee that conducted the negotiations with the Ukrainian Finance Ministry. 

The bondholder approval process will be launched on September 15, but investors will have 21 days to review the offers. The final amount restructured will probably not become clear until the end of October as the Ukrainian government needs to put in place new legislation to enable the debt deal, which it hopes to completed by the end of that month. In the meantime two payments – a $500mn principal payment due on September 23 and a €600mn payment due on October 13 -- will be temporarily suspended.

Finally, as the Russian government owns 100% of its $3bn bonds it doesn’t have to negotiate with anyone and has made clear it will not accept any deal. That means the Ukrainian government will have to decide whether to repay the full amount or default. If it takes the latter course and also gets a legitimate court decision that its debt is a sovereign debt, as Moscow claims, and not a commercial debt, as Kyiv claims, then the IMF programme will have to be suspended under the fund’s own rules.

Despite Jaresko's positive mood, some experts believe the deal will not provide to Kyiv's struggling economy enough financial relief in long term. According to the Ukrainian government, the deal would cut sovereign debt by 4.3% of GDP, while the IMF insisted previously that debt agreement should secure relief worth 6.1% of GDP.

Over the past months, the IMF pressured Ukraine to quickly agree the restructuring of $15.3bn in privately held debt. On July 23, the Fund 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 debt talks.

"Now other international donors need to come up with the necessary financing to cover the financing gap for 2015 and 2016," Anders Aslund, a senior fellow at the Atlantic Council, wrote in his blog on August 27. "Only $8bn has been committed [from debt deal], and another $7bn is needed. The main contributor should be the European Union, whose security is defended by Ukrainian troops."

Aslund added that Ukraine's critical need is to raise its international reserves from merely $10.4bn to $20bn to stabilise the Ukrainian currency and allow a liberalisation of exchange controls. The next tranch from the IMF will raise the reserves to about $12bn but if the government is forced to pay back the whole Russian debt the country will end the year with some $9bn. Ukraine still has a long way to go before a semblance of financial stability returns. 

Kremlin heels dig deeper

"Russia didn't join the creditors' committee," Yatsenyuk said, commenting Moscow's position on the $3bn Eurobond, issued by former Ukrainian President Viktor Yanukovych's government in late 2013. The Kremlin has refused to consider possible restructuring of this debt, insisting on full repayment when the two-year bond expires in December 2015.

"Therefore, the government of Ukraine officially declares that Russia, under no circumstances, will not get better terms than other lenders. It's their decision [to refuse debt restructuring]. Either you accept our terms, or you will never get better terms," Yatsenyuk said.

Russian Finance Minister Anton Siluanov again told news agencies on August 27 that Moscow will not participate in the restructuring. "We insist on a full repayment in December of this year of $3bn, including interest payments." Siluanov told the state-run Rossiya 1 television channel, stressing that Ukraine's debt to Russia is a purely inter-state.

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

Other officials also quickly fell into step with Moscow's no-deal on a deal stance. "The Finance Ministry of Russia has not received any official proposal from Ukraine on debt restructuring. The Russian leadership has said on many occasions that Russia is not participating in this debt operation," Russia's deputy finance minister Sergei Storchak told newswires on August 27.