A Tale of Two Cities: Moscow and Kyiv. Kyiv's Debt Deal Changes the Game

Kyiv reached a debt agreement with its creditors on August 27, which was impressive in one respect, the relative ease with which it was concluded.  There was little of the drama of a Greek bailout.  The term “good will” might be a bit strong, but all the parties at the table seemed to recognize that a country in Ukraine’s unique circumstances needed a way out and an opportunity to rebuild its economy if it was to meet its financial obligations.  The deal includes a new security linked to Ukraine’s economic growth rate from 2021, an indication of hope at least that creditors expect Ukraine to return to a growth rate sufficient to reward patient debt holders.

On its merits the deal is equally good, including a 20% reduction in debt, a four-year extension on payments, and immediate debt relief of about $3.6b.  The deal avoids a default and will allow Ukraine to return to bond markets by 2017.  With a debt deal in place, Kyiv can reasonably focus on growing its economy. 

The moment of Ukraine’s return to the financial markets in 2017 may also be the moment that Russia departs the markets.  With little prospect that the conflict in eastern Ukraine will end, that sanctions will be lifted or that oil prices will rise soon, Russia is widely expected to run out of cash in 18 to 24 months.  Although its debt levels are low, its prospects are worsening.

Indeed, already in June the World Bank’s Global Economic Prospects projected Ukraine’s GDP to grow 2% in 2016 and 3% in 2017, while Russia was projected to grow only 0.7 and 2.5%, respectively.  The IMF has since reduced its 2016 projection for Russia to a negligible 0.2%.  In August the IMF projected Ukrainian growth higher in 2016 at 3.5% and 4% in the years thereafter, and this was before the debt deal was concluded.  Since then oil prices, upon which Russia is dependent but Ukraine is not, have continued to fall, putting additional pressure on Russian growth.

Already the economies of Ukraine and Russia are separating as war, sanctions and geopolitical tension reduce commercial interactions and cross border trade and drive them apart.

The two economies will continue to diverge, with Russia trapped in a downward spiral of economic mismanagement, under investment, falling productivity and corruption.

Ukraine is at the beginning of a perilous reform process that moves in fits and starts, but its finances are stabilizing and, with the debt deal, its prospects are improving.  Not “blessed” with huge oil and gas reserves, the Ukrainian economy has a more diverse base of agriculture, transportation, forestry and manufacturing upon which it can build.

No longer distorted by Soviet planning and post-Soviet political manipulation, Kyiv is freeing itself of policy deference to Russia and subservience to oligarchic interests. Kyiv has a wide-open, free-for-all political climate and open public debate about its future (in Moscow people are afraid to speak out or give their last names when they are interviewed).

All signs suggest that Kyiv is on the right path.