Ukraine’s debt is hitting all-time highs. Nevertheless, we can cope with it.

According to IMF estimates, Ukraine’s state debt by the end of the year could reach a record 100% of the GDP. What does this mean, and what is the way out of this situation?

During 2015-2021, Ukraine pursued a prudent debt policy, maintaining a budget deficit below 3% of the GDP and striving to retain a primary budget surplus (before interest payments). This allowed the government to reduce the debt burden from 79% to 49% of the GDP.

However, the situation drastically changed with the start of the full-scale invasion and increased defence spending. As a result, the budget deficit rose from 3.6% of the GDP in 2021 to 16.3% in 2022.

Throughout 2022, the total amount of state and state-guaranteed debt increased to $120 billion. Ukraine couldn’t borrow money from the foreign commercial market due to high risks for investors, and the internal resources were insufficient to cover all needs.

The National Bank of Ukraine’s involvement in purchasing government bonds amounted to UAH 400 billion. Assistance from allied countries’ governments (mainly in the form of credits rather than grants) contributed to a significant increase in external debt, which rose from $48 billion in 2021 to $71 billion by March 2023.

Managing state debt: global experience for Ukraine

Moreover, the country’s economy shrank by almost one-third, with a loss of 12% (20% at the peak of the invasion) of territories controlled by Ukraine as of 2021, mass population migration, city and energy infrastructure shelling, and a manifold increase in business risks, resulting in a 29% GDP decline in 2022.

The devaluation of the hryvnia led to a reevaluation of foreign currency-denominated debt. As a result, by the end of 2022, the state and state-guaranteed debt-to-GDP ratio reached 78.5%.

Without nearly $18 billion in grant support (in 2022 and spring 2023), this figure would have increased to 86%.

As of the end of April 2023, external debt accounted for about 67% of the state and state-guaranteed debt. Over half of it consists of concessional long-term loans from donors and foreign countries (the largest creditors being the EU, IMF, Canada, and EIB) with repayment terms of up to 35 years, grace periods for principal repayment of up to 10 years, and low-interest rates (amounting to $32.9 billion in total).

There are also Eurobond obligations ($24.3 billion) and commercial loans from banks and other foreign financial institutions ($2.7 billion). As for the internal debt, the National Bank is the largest creditor of the government, which holds almost half of the domestic state loan bonds, while around 30% is owned by state banks, and the rest is distributed among private commercial banks, companies, non-residents, and the population.

According to the IMF’s estimates, by the end of 2023, the state debt-to-GDP ratio may rise to 98.3%.

This is due to the continued need to spend on defence and social expenditures and the modest economic growth of 1-3%, according to the IMF’s estimates, or up to 2%, according to the NBU’s April macro foresight.

What to do next?

Our research thoroughly examined the best global practices in managing countries’ debts during and after wars. Below, we briefly outline the situation Ukraine finds itself in.

Until the end of the war, the debt will continue to grow, but its cost will be essential. Currently, it is crucial for Ukraine to attract as many grants and cheap, long-term loans as possible from our partners to finance not only the budget deficit but also the recovery.

The standstill agreement on freezing payments for private external obligations will last until 2024. If the war does not end by then, the debt will need to be restructured (i.e., deferred payments for a longer term, possibly reducing interest rates or writing off part of the debt).

If Ukraine wins the war, the government and creditors will have various options to consider. The best course of action will depend on the prevailing market conditions in Ukraine. One option could be to continue servicing the debt under the existing terms used to borrow funds.

At the same time, some steps must be taken to manage the external debt properly. First and foremost, these are negotiations regarding interest rates and commissions favouring the IMF. They amount to $3.25 billion over the next five years. Similar steps should be discussed with other creditors-MFOs.

Definitely, it is not worth refusing debt. Such a move could cut off the country from private debt markets, lead to a loss of investor confidence, and increase interest rates.

Ultimately, the best solution for Ukraine may be to approve preferential terms until the economy regains growth.

Additionally, it is essential to remember internal debt, the main creditors of which are the National Bank, state banks, and, to a lesser extent, private players. Restructuring it makes little sense since the consequences will fall on the state budget anyway. However, partial or complete refinancing may be expected.

We should already be actively working on confiscating russian assets in Ukraine and abroad to cover our financial expenses. Experts suggest several options for receiving compensation from the aggressor.

For example, the head of the analytical department at Concorde Capital, Olexandr Paraschii, suggests attracting loans from partners at low-interest rates with the condition that we repay them through reparations from the Russians.

In this way, we will encourage our partners to be more proactive in recovering reparations from Russia. Bluebay Asset Management strategist Timothy Ash suggests using the interest accruing on frozen russian central bank assets to purchase Ukrainian Eurobonds.

This way, the money will automatically be transferred to Ukraine, and Western countries will demonstrate that they do not infringe on Russia’s rights. In fact, Russia will continue to own the assets, but the funds will be automatically transferred to Ukraine.

Material was published in Ukrainian by Ekonomichna Pravda.