ICU Weekly Insight, August 15, 2022: Ukraine Postpones Eurobond Payments – KyivPost

Bonds: the bond market seeks to establish a balance

After all domestic bonds were released, the market split into two parts – one for military bonds and another for bonds issued before the Russian invasion. Two independent yield curves are emerging, even if they have the prospect of converging.

The Ministry of Finance has shown little reaction to high yields in the secondary market after the removal of most restrictions on bond exchanges, and it continues to offer military bonds in primary auctions, mainly at interest rates. interest unchanged. An exception last week was the placement of five-month paper at a new rate of 12%, 200 basis points higher than before. See details in the auction review.

The secondary market, surprisingly, was less active than before the lifting of trading restrictions. A total of 4,121 transactions were concluded with UAH invoices worth 2.3 billion UAH ($62 million), which is lower than the 4,841 transactions worth 3.6 billion of UAH ($99 million) the previous week. But last week, the market clearly split into two segments: one for bonds issued before the large-scale invasion, and the other for military bonds issued after it.

In the secondary market, military notes are traded at yields close to those at primary auctions. But in the regular bond segment, returns are very volatile for each issue because the number of transactions is currently minimal and the market has low liquidity.

In general, the activity broke down as follows: with military bills, 3,777 agreements for 674 million UAH (18 million dollars) were concluded, and with “pre-war” bonds, it there were only 353 deals, but for 1.7 billion UAH ($46 million). ). Each of these segments currently forms its own independent yield curve: 10‒16% for military bonds and within a range of 14‒25% for common local currency securities.

The military bill curve has the normal shape, where shorter maturities have lower yields and longer ones have higher yields. For regular bonds, the shape of the curve is not yet fully formed, but there are already visible signs of an inverted yield curve with higher rates for shorter maturities and lower rates for longer ones. long.

ICU view: The lifting of restrictions on domestic bond trading should lead to more active trading, but due to segmentation, activity has not increased so far. Yields in the secondary market for common (non-military) securities will remain volatile for some time, as it will take several weeks to find equilibrium levels in a low trading environment. Currently, market participants are trading in small volumes to explore the market mood and expectations. Thus, the military bond segment should dominate in the coming weeks, but it will certainly be influenced by the performance indicators of the regular bond segment. We continue to expect a gradual increase in yields at primary auctions as, at current levels, the Ministry of Finance cannot generate significant and stable demand for bonds from banks.

Bonds: Ukraine postpones Eurobond payments

On August 10, the results of the investor vote were made public: 75% supported postponing Ukrainian Eurobond redemptions for two years. The debts of Ukrenergo and Ukravtodor were also restructured under the same conditions.

Ukraine received significantly more investor support than was needed to approve the restructuring. Thus, the maturity of all issues has been extended by two years, coupons will continue to run and interest will also be accrued on unpaid coupons. Accumulated coupons can be paid in part or in full at any time. The Ministry of Finance also managed to reserve the right to convert all accrued interest into new bonds of the same maturity as the Eurobond after the end of the two-year period.

Ukraine also received permission to change the terms of the VRIs. According to the amendments, the payment which was to take place in May 2023 is postponed for one year until May 2024 and is limited to 0.5% of GDP, instead of 1% previously, and the maturity of the VRIs is also extended one year. . The issuer’s right to redeem the VRIs over the period 2024‒27 at their notional value has also been added.

After the announcement of the vote results, the prices of Eurobonds and VRIs rose slightly. As a result, over the week, Eurobond prices rose 2-7 cents to 20-35 cents. Eurobonds due this year, now postponed to 2024, remain the most expensive at 35 cents on the dollar. VRIs rose 6 cents to 33 cents per dollar of notional value.

ICU view: The restructuring of the Eurobonds went smoothly and without unpleasant surprises. The conditions were rather favorable to investors. Investors confirmed that they fully appreciate the economic and fiscal difficulties Ukraine is facing due to Russian aggression. Ukraine has certainly managed to maintain constructive relations with the vast majority of Eurobond holders. In general, the market expects the government to be forced to review the terms of the Eurobonds after the end of the two-year period, when there is a better understanding of the medium-term macroeconomic outlook and that a debt sustainability analysis will be possible. So far, timely restructuring has allowed Ukraine to avoid default risks, and thus one of the factors of uncertainty for investors has disappeared. Therefore, Ukrainian Eurobond prices may still rise moderately because of this. In the medium term, they will be mainly determined by Ukraine’s successes on the battlefield and the prospects for ending the war.

FX: FX Market Broadly Unchanged

The foreign exchange market has essentially stabilized; nevertheless, the NBU had to carry out sales interventions in large volumes.

Last week, the NBU sold hard currency from reserves, satisfying excess demand in the interbank market. It was only Tuesday that the National Bank was a net buyer. We believe that the NBU’s buy intervention was due to MinFin selling currency from its FX account at Ukreximbank. In just one week, the NBU bought $93 million on the market and sold $522 million in hard currency.

The spot market remains volatile. Over the past week, the local bank exchange rate has weakened again, but not as significantly as at the end of July: at 38.5 ‒39.5 UAH/US$ last Friday against 38.1 ‒39.3 UAH/US$ the previous week.

ICU view: The interbank market remains under pressure from the demand side, which is already becoming a systemic factor despite a significant depreciation of the hryvnia. The supply of foreign currencies from exporters remains insufficient while demand has proven to be solidly high. Therefore, we expect the NBU to maintain large and regular currency selling interventions in the future.

Economy: Inflation accelerates to 22.2% in July

Monthly inflation stood at 0.7% in July, which is generally a deflationary month. Annual CPI rose further to 22.2% from 21.5% in June. Core CPI accelerated even more dramatically to 16.7% year-on-year from 15.2% in June.

Prices accelerated across the board, with the one notable exception being gasoline, whose price growth slowed to 78% year-on-year in July from 91% in June, bringing substantial relief to households and businesses. The situation has improved, first and foremost, thanks to the saturation of the local market with imported fuels and in a context of falling world energy prices. Utility prices rose slightly by 0.5% month on month and only 3.6% year on year, as the government and local authorities decided to postpone the revision of natural gas and electricity tariffs until less until 2023.

ICU view: Data for July show that inflationary pressures remain strong as the economy continues to adjust to the weaker hryvnia and the rising cost of goods and services. We reiterate our projection that the CPI at the end of 2022 will reach almost 30% and will slow down to almost 25% in 2023. The main price drivers will be the continued gradual depreciation of the hryvnia against major global currencies and a state-regulated local power upgrade. prices that seem inevitable in 2023.

Economy: Ukrainian public debt growth is accelerating

Ukraine’s public debt rose 3.9% in June to $105.4 billion.

Almost two-thirds of the increase was driven by domestic borrowing, mainly NBU purchases of government debt, which totaled UAH 105 billion ($3.6 billion at June exchange rates) . External borrowing was driven by loans from Canada and the World Bank.

ICU view: In May and June, Ukraine’s public debt growth was mainly driven by the direct sale of government bonds to the NBU, rather than external borrowing. The composition of new borrowing could shift for some time and become dominated by foreign lending in the coming months as Ukraine’s international partners increase their support. However, there is a growing risk that money printing by the NBU will remain the main source of financing the budget deficit for the whole of 2022. Any further upward revision in government spending will likely involve further debt monetization by the NBU. We maintain our projection of the public debt-to-GDP ratio at the end of 2022 above 90%.

RESEARCH TEAM: Vitaliy Vavryshchuk, Alexander Martynenko, Taras Kotovych.

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