With all eyes focused on the recent hot button issues of the Greek debt saga and the Iran nuclear deal, the Ukrainian crisis, which was at fever pitch as recently as this March has been firmly relegated to the back burner of the world’s attention. The Minsk II agreement, ushering in an (official) end to hostilities, and the imposition, and recent extension of sanctions on Russia seemed to have been sufficient to buy the Kiev government the breathing space it needed to begin mending its battered economy. But the $40 billion bailout package from the IMF and other lenders which was further intended to stabilize the country’s finances have now set the stage for a new conflict, not with militants this time, but with bondholders.
The problem is that, despite the bailout, economic activity is still contracting and is expected to fall by up to 10% this year, prompting the Ukraine government to consider imposing a moratorium on repayments. This is intended to buy time for negotiations with creditors with a view to restructuring the debt to allow for longer maturities, reduced interest rates, and a write-down on the principle owed. This, however, is being met with fierce resistance by bondholders. An alternative plan put forward by a group of creditors led by Franklin Templeton, an asset fund company, also proposes extending maturities and reducing interest rates but is adamantly opposed to a write-down on the principle.
If no agreement is reached, market analysts are betting that Ukraine will miss the July 24 deadline for a $120 million coupon repayment and slide into default. The fact that Russia holds $3 billion worth of Ukrainian bonds, which they bought from the previous pro-Kremlin government, adds to the geo-political quandary from which Ukraine was trying to escape in the first place by accepting the bailout.
But the Ukrainian government may have some tricks up its sleeve that would allow it to shirk paying the Russian bonds. They could argue that Russia’s debt is unenforceable due to its annexation of Crimea, or that they cannot be expect to pay a GDP linked bond to the very government responsible for destroying its GDP. Either way, they would be making the point that Ukraine is a special case and thus worthy of the kind of leniency that was not afforded to Greece. To further distinguish their situation from that of Greece, and bolster their claim to a debt restructuring, they say that, unlike Greece, the Ukrainian government has shown good faith in implementing the reforms required of them as part of their aid package.
The liberalization of the gas market has resulted in a price rise of some 400%, a situation exacerbated by the fact that late last month Russian Prime Minister, Dmitry Medvedev, announced a reduction in the discount that Ukraine receives on Russian gas from $100 per 1000 cubic metres down to $40. This increase in the price of gas is just the latest example of how energy pricing has come to be wielded as a punitive weapon against Ukraine in its ongoing dispute with Russia. On previous occasions in 2006, 2008, and most recently after the ouster of the pro-Kremlin government in 2014, gas supplies were cut off entirely. Since then, however, Ukraine has made great strides in diversifying its energy supply, and in 2015 60% of its gas imports came from the EU, with only 40% coming from Russia. By way of counter offensive Russia has vowed to cut Ukraine from its transit route altogether by 2019 with its Turkish Stream project to bring gas to Europe via Turkey instead.
In a demonstration of how tangled the web of energy politics is, Ukraine may finally be able to ensure its energy independence from Russia by striking a deal with another state that has found itself at the sharp end of Russia’s capricious energy policies - Turkmenistan. The gas rich central Asian nation was once a major supplier of Ukraine’s energy needs, selling its gas at record low prices ($95 per tcm versus the $248 negotiated by Brussels earlier this year). Everything changed when Viktor Yushchenko rose to power on the crest of the pro-EU Orange Revolution. This was because Dmytro Firtash, the owner of RUE, the company that imported Turkmen gas into Ukraine, was seen to have close ties to the previous government and was summarily dismissed. But now with Russia having drastically reduced its intake of Turkmen gas from 45 bcm to 11 bcm, and with Ukraine in desperate need of a secure gas supply from anywhere but Russia, this has rendered Ukraine and Turkmenistan potential allies once again.
Of the two threats now facing Ukraine, it may just turn out that the more destructive one is posed by the West in the form of intransigent bondholders, and not, for a change, from the East and Russia’s bullying energy policies. This should give Ukraine and its supposed allies pause for thought.