Friday, June 12, 2015

12/6/15: IMF Tells Kiev: "Default"

Things are getting really testy Friday night in Ukraine. As I noted earlier today (see here:, IMF gave Kiev a bit of strong-man-behind-me support in negotiations with private sector bondholders.

Later today, IMF head had the following to say on the subject: "To ensure economic and financial stability, [programme] objectives need to be achieved in a manner consistent with maintaining a strong international reserves position over the medium term, in line with projections under the program. In this regard, the NBU’s international reserves cannot be used for sovereign debt service without the government incurring new debt, which would be inconsistent with the objectives of the debt operation. Ultimately, Ukraine’s debt repayment capacity is limited by its fiscal capacity."

De facto, Ms. Christine Lagarde means the following: forex reserves held by the National Bank of Ukraine will not be used to fund debt repayments or servicing. IMF loans cannot be used for debt redemptions or servicing. Which means Kiev can only pay out on bonds out of current revenues left or via new borrowing in the markets. Kiev has none of those funds available, so Ms. Christine Lagarde effectively gave Kiev an order to default, as "Ukraine lacks the resources under the program to fully service its debts on the original terms."

" the event that a negotiated settlement with private creditors is not reached and the country determines that it cannot service its debt, the Fund can lend to Ukraine consistent with its Lending-into-Arrears Policy."

Ms. Lagarde effectively said in Ukraine, IMF will act differently than it did in all European programme countries and differently from pretty much every other case in its history.

In addition, Ms. Christine Lagarde has gone as far as ordering the bondholders to accept Kiev deal or face a forced default. Ms. Lagarde qualified this order being in the interest of the bondholders, explicitly linking that interest to the IMF 'conviction'. This is a major point, because IMF is now indirectly dictating - via Kiev - to the private markets terms and conditions of their surrender.

Note: I tend to agree with Ms. Christine Lagarde on the necessity of a write down, but this is one of these rare (if not unique) occasions where the IMF is effectively ordering a default and expropriating private property of third parties.

Final note: private sector investors have based their proposal for haircuts on the premise that Ukraine will be able to use forex reserves at NBU as a source of repayments post-restructuring. Ms. Lagarde now cancelled that position in one go.

All of this means two things - beyond the immediate consideration of Ukrainian situation:
1) IMF is trying to hedge the risk of future (not current) slippage in the programme and insulate the funds it supplies from being exhausted on debt servicing and repayments. This means the IMF is seeing Ukraine as a huge risk engagement at this stage and is doing preemptive damage control. All the talk about debt sustainability under the IMF programme is a fig leaf of decorum: even if haircuts are delivered as planned, IMF sees big risk of programme being derailed and wants its money ring-fenced.
2) IMF is also trying to re-establish some sort of an independent agency reputation, post-European experience.

Ukraine's default is now a matter of days, unless private bondholders surrender. Prepare for a wild ride…

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