Ukraine's default on Russia may have global repercussions for debt

After the International Monetary Fund (IMF) allowed the Ukraine to default on Russia last month, Gary Kleinman of Kleiman International suggests the move will have spillover effects for China and the euro-zone and could have global implications, considering the IMF's original stance; 25 years of "no tolerance" for missing commitments to government lenders. Kleinman highlights potential knock-on effects on lending by China to other Central Asian countries, such as Mongolia, suggesting a rethink is now desperately needed to avoid triggering a spate of additional crises where both debtor and creditor are emerging economies.

The International Monetary Fund (IMF) on December 8 unveiled its long-awaited policy revamp on lending into official creditor arrears to coincide with Ukraine’s first repayment on Russia’s $3bn Eurobond that was issued under ousted president Yanukovych, which has formally entered default.

The revamp has come under criticism for ignoring the wider implications of the Russia-Ukraine clash and could have knock-on effects on lending by China to other Central Asian nations like Mongolia. A rethink is required to avoid triggering a spate of additional crises with emerging economies both as debtor and creditor.

The IMF’s stance for 25 years has been “no tolerance” for missing commitments to government lenders including export credit agencies, although the Paris Club – an informal group of lending nations including Russia, whose objective is to find workable solutions to payment problems faced by debtor nations – could grant bilateral restructuring on equal terms with other mainly industrial countries in Europe, the US and Japan.

Since 1983 the Paris Club has struck 425 debt reduction agreements with 90 nations covering $583bn in debt, including the wave of post-communist write-offs such as Poland’s. The IMF’s proposed switch does not put the Russian obligations in the commercial category implying it is at risk of the same 20% ‘haircut’ that other debtors will incur, but offers a framework for assistance to be extended when either Paris Club or non-Paris Club credit lines as from China, India and Brazil are not honoured. Beijing currently has major programmes through its Export-Import Bank and other sources in place throughout Central Asia, and the new approach could compel it to withdraw them to avoid the spectre of less-than-full servicing outside its control.

The IMF’s policy review began in 2013 in advance of the war and debt dispute between Russia and Ukraine, and a new IMF $40bn financial aid package. It was intended to tackle the problem of potential holdout government creditors not participating in restructurings, just as private ones were countered with contractual collective action clauses compelling acceptance with a majority vote. This worry was particularly directed at non-Paris Club nations, especially China, that now account for the biggest portion of bilateral claims to low-income economies, at 12% of GDP in 2014 versus the traditional Paris Club’s 4%. Ukraine has argued informally that the Russian bond should be discounted or cancelled given its “odious” nature incurred under a former despot, or on “force majeure” grounds with the cost of the Russian-fuelled war in the east set against the sum.

In Ukraine’s previous early 2000s restructuring, all Paris Club obligations were met and President Vladimir Putin suggested the same this time with a delay. His finance minister, Anton Siluanov, reiterated that the 2013 bond package was for diplomatic not commercial purposes, and that Moscow has not triggered the provision calling for immediate repayment Ukraine’s debt/GDP ratio passes 60%, a threshold long breached. The IMF continued to treat Russia’s facility as official during the 20% haircut and maturity extension negotiated with private bondholders and did not change this determination in the arrears update.

For decades official creditors have maintained preferential status, since they often lend on concessional terms for policy reasons and in crisis periods, like that which Greece is suffering right now, are the only source available. Europe’s bailout mechanism could soon offer further relief to Athens after private bondholders took a 75% hit, but the “special role” of such emergency pools in global finance is cited in the IMF’s arrears reform paper. In Greece the bilateral contribution to the overall rescue was almost 75% versus multilateral institutions’ one-quarter share, the same percentage as in Latvia in the wake of the 2008 crash. However, the parallel experience with debt rescheduling under the 15-year-old Heavily Indebted Poor Countries (HIPC) initiative for the poorest countries, chiefly in Africa, revealed a divide in outside government approaches. Under the framework, Paris and non-Paris Club lenders were to provide “comparable relief”, but the latter delivered less than half the amount expected and 40% did not participate at all. Anticipating a Ukraine-type experience, the arrears rethink also was guided by a scenario of single or multiple Paris Club holdouts, unlike the virtual unanimity in low-income economy workouts.

The revisions would establish a precedent for lending into official arrears only under strict criteria, including the need for the IMF to act fast in a country following sound policies and conducting “good faith” negotiations with bilateral creditors. The IMF board would decide these factors and previous description of the constructive talk test included regular economic and financial information-sharing and dialogue, but the concept will be further elaborated in another paper due out this year. This engagement requirement could be waived in contingencies like natural disasters, and implies a loophole for Ukraine’s war circumstances, as both sides now prepare to face off in the foreign courts in the absence of direct talks. The IMF otherwise encourages non-Paris Club members to organize their own forum and coordinate with the Paris Club, but as China’s founding of the Asian Infrastructure Bank shows, it prefers to go its own way rather than align more closely with a Western-dominated body.

Central Asian countries, including Mongolia, Tajikistan and Uzbekistan, reviewed in a companion IMF-World Bank report on low-income borrower vulnerability, increasingly receive non-concessional terms from China with average interest rates above 2% in 2014.

Mongolia’s risk rating from the assessment is “medium to high” debt distress, reflected also in Standard & Poor’s November downgrade to ‘B’ junk status. Economic growth is projected at only 1% next year even with the next phase of the giant Oyu Tolgoi copper-gold mine due to begin operation, and with over $1.5bn in external bond issuance this year, its debt/GDP ratio is now 70%. China recently expanded a central bank swap line to $2.5bn and its Export-Import Bank extended another $1bn loan. With large repayments looming in 2017, Mongolian Prime Minister Chimed Saikhanbileg broached the possibility of an IMF programme, where the new arrears formula could short-change China and prompt a pre-emptive pullback of the current lifeline needed to fund the budget and current account deficits.

The updated arrears plan further inflames the Russia-Ukraine impasse and is backfiring on neighbours, and the IMF should go back to the drawing board to more explicitly incorporate BRIC creditor reaction to spreading fragile state debt sagas.