About the authors: Daleep Singh is the chief global economist at PGIM Fixed Income. Giancarlo Perasso is the company’s lead economist for Africa and the former Soviet Union.
While Russia‘s ongoing barrage of missiles into Ukraine keeps the end of the war far from sight, it’s not too early to envision a brighter future. Ukraine can and must re-emerge as a successful economic alternative to Putin-style kleptocracy but, for that to occur, it must overcome a mounting debt burden that could cripple the country’s recovery. A bold plan to swap existing obligations for new debt—let’s call them Ukrainian “freedom bonds”—would help.
Prior to the invasion, Ukraine was making tangible progress to integrate its economy with the European Union and reform its institutions, including the establishment of an independent central bank, enhanced oversight of the banking sector, and an anticorruption drive. Its debt owed to external lenders was comparable to that of peer countries. But the economic damage from Russia’s invasion will quickly make that debt burden unsustainable, threatening Ukraine’s war effort and economic reforms. Our proposal is to entice a voluntary restructuring of Ukraine’s private-sector debt obligations with a modified version of the Brady Plan—named after former Treasury Secretary Nicholas Brady—that compels Russia’s participation. For Ukraine, it is an economic and national security imperative to redouble its integration and reform drive in order to shore up support from Western partners and—most importantly—to restore a path toward prosperity for the Ukrainian people.
The Group of Seven advanced democracies and international financial institutions such as the International Monetary Fund and the World Bank will provide financial support to secure macroeconomic stability and create breathing space for much needed reforms. However, Ukraine’s reconstruction needs will likely be several multiples larger than what the official sector can reasonably provide. Creative solutions must fill the gap. Any just peace arrangement must include sizable financial contributions from Russia, but Ukraine can’t wait and hope for a voluntary settlement. Might financing from the private sector suffice? Perhaps, but Ukraine’s stock of debt continues to cast doubt on the sustainability of its debt servicing capacity, keeping private investors at bay. Currently, Ukraine has agreed to pause servicing its external debt obligations owed to private creditors until August 2024. In our view, extending this pause is not enough. A large-scale debt restructuring, including deep haircuts of principal, is necessary to decisively restore sustainability.
Why? The debt Ukraine owes to external lenders was about $60 billion as of September 2022, corresponding to almost 30% of its pre-invasion gross domestic product. That is about the same as the average debt burden of an emerging economy. Due to the devastating effects of the war, however, Ukraine’s GDP has collapsed by as much as 40% this year alone, which means Ukraine’s external debt-to-GDP ratio will very likely balloon next year, making it an unfavorable outlier among emerging economies. More to the point, Ukraine’s current stock of liabilities to external creditors amounts to $22 billion, and its total external debt service obligations (excluding IFIs) over the next five years is almost $18 billion, over 70% of its foreign exchange reserves. This is not a sustainable trajectory.
The Brady Plan was launched in March 1989 with the recognition that developing countries’ external debt burden was too high and required reduction in order for countries to regain access to private-sector financing. With the leadership of the U.S. Treasury, it was agreed that creditors (mostly commercial banks) would be better off if they collectively swapped existing claims, at some loss, in exchange for new instruments with a higher probability of being repaid, thus avoiding far worse—and possibly systemic—consequences. As a sweetener, U.S. Treasury bonds were offered as the guarantee. If a Brady Plan beneficiary defaulted on the newly issued debt, creditors would receive U.S. Treasury bonds.
We recommend a similar enticement for restructuring Ukraine’s external debt into new financing, but with a twist. This iteration involves using frozen Russian reserves—which mostly consists of U.S., U.K., European, and Japanese government debt—as collateral. The details of the restructuring offer, such as the coupon and maturity of the new bonds, would be negotiated between the Ukrainian authorities and a committee of creditors, within the framework of an IMF program.
The benefits of a successful restructuring and issuance of new debt would be immediate, substantial, and broad-based. Most importantly, it would lower the debt overhang for Ukraine, providing much needed fiscal space for the continuation of Ukraine’s war efforts, the country’s reconstruction, and its sustainable economic recovery. At the same time, it would lower the probability of a disorderly restructuring for private creditors and increase the probability of their repayment, thereby accelerating Ukraine’s return to international capital markets. Donor countries and the IFIs would benefit from bearing less of the financing burden than would otherwise be the case without new private-sector financing for Ukraine. And, crucially, the plan would involve Russia via its currently immobilized hard currency reserves serving as collateral against Ukraine’s newly issued debt. As a minimum condition—and subject to the approval of Ukraine’s leaders—the return of Russia’s reserves could be made contingent upon Ukraine’s full repayment of the newly issued debt. Kyiv could set other conditions if it chose to pursue a negotiated settlement with Moscow.
We believe this proposal for Ukrainian freedom bonds would give Kyiv its best chance of regaining the positive dynamic between stability, reform, financing, and growth that had just started to take root before the invasion. The bottom line is the official sector can’t and shouldn’t bear this burden by itself. The private sector, too, has a stake and a responsibility to advance the core principles that underpin peace and security across the world.
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