Investors are hostage to politics in Ukraine

The Orange Revolution of 2004 was supposed to usher in new hope for Ukraine. But at the start of 2010, investors are paying more to insure Ukraine’s debt over one year than for any other country, even though default seems virtually impossible with just $400 million of foreign debt falling due this year and $26.5 billion in reserves.

Political risk continues to hold the economy in limbo. Sunday’s presidential election brings resolution one step closer, but the risk remains that even February’s run-off vote between Prime Minister Yulia Tymoshenko and Viktor Yanukovych, whose victory in 2004 was overturned after street protests, mightn’t generate needed political stability.

Whoever wins will face huge challenges. The priority is to persuade the International Monetary Fund to resume payments under a $16.4 billion program. Without IMF funds, Ukraine has had to use foreign-exchange reserves to pay its bills. Relations with international creditors have suffered.

IMF support will reassure markets that reserves can be preserved, easing pressure on the hryvnia and averting more trouble in the banking sector.

But the president will need political support to push through austerity measures. That might require parliamentary elections, causing further delay. And a close runoff vote could yet be contested by the loser. Investors will be watching. With one-year credit-default swaps at 13 percentage points, or $1.3 million per $10 million of debt insured, and bonds due 2011 yielding more than 11%, the potential returns are attractive, particularly as risk appetite has reduced yields elsewhere in emerging-market debt. But a flare-up in political instability would hit Ukraine and investors hard.

Credit: Richard Barley

Source: Reuters