Banks will expand the purchase of domestic bonds, while foreigners are likely to keep portfolios unchanged in 2021, according to Konstantin Stetsenko, Co-Founder of ICU, the leading asset management and investment advisory firm in Ukraine.
This year, demand from foreigners for Ukraine debt was in line with other emerging countries, which also saw a decline in foreigners’ portfolios. Ukraine fared better than some peers; nonetheless, the government’s ability to borrow in local currency has been greatly constrained. During February -August, foreigners decreased their portfolios by 32%, taking redemptions and selling bonds in the secondary market. “We expect they will continue to decrease portfolios to at least US$2.7bn by the end of this year,” says Mr Stetsenko.
Low demand for domestic bonds during the lockdown induced the National Bank of Ukraine (NBU) to change some regulations such as the rules for refinancing loans for banks. This resulted in stronger interest to short-term bills from banks. But this demand from banks was not sufficient to completely cover Ukraine’s Ministry of Finance’s liquidity needs, and they had to increase borrowings via FX-denominated bills. “Looking ahead, we expect banks to play a key role in budget financing from domestic sources. Meanwhile, the amount of Government bonds held by non-residents should stabilize during 2021 as rather high yields and fading devaluation expectations will make the carry trade attractive again. As a result, the share of non-residents in Government bonds should fall to 9% by the end of 2021, from 16% in February 2020,” predicts Mr Stetsenko.
In April 2020, Ukraine’s government announced plans to increase fiscal stimulus via expanding the budget deficit and raising more debt. Mr Stetsenko expects that government will provide a fiscal boost by accelerating spending before year end. However, the uncertainty over official financing will act as a restraint. “We maintain our forecast for a budget deficit around 6% of GDP, lower than that planned by the state budget. Moreover, the government submitted to the parliament the draft budget for next year with the same deficit level of 6% of GDP, as a sharp increase of the minimum wage will sizably push expenditures on wages in the public sector”, Mr Stetsenko said. “However, since authorities also want to boost capital expenditures, they will have to find corresponding compensators in revenues and reliable financing,” he added.
Along with the IMF Stand-By Programme, the government expected to receive loans from the World Bank and EU, but this has not materialised yet. Mr Stetsenko expects that the government will eventually receive the first tranche from the EU COVID-19 programme this year. Nevertheless, sizable financing needs will force Ukrainian authorities to speed up negotiations and reach an agreement with the IMF early next year. That will allow funds to be freed up from the World Bank and EU and facilitate access to market financing. Mr Stetsenko believes the government will try to tap international capital markets again this year to borrow up to US$1bn and another US$3bn next year. “Taking into account planned official financing and assuming 100% rollover of domestic FX bonds, financing needs will be covered to the end of 2021,” he said.
Commenting the balance of payments flows and highlighting pandemic-induced gains for current account, Mr Stetsenko expects to see a gradual and uneven recovery of capital inflows. Debt borrowings are positive again, while capital outflows and decline in foreign direct investment persist. “As we forecast in June, capital outflows induced by the pandemic were quite short-lived and moderate in scale. Both government and the private sector switched again to net borrowing of foreign capital after the net repayment in March–April (government had a large repayment of US-backed Eurobonds in May as well). For the full year 2020, we project net capital outflows to amount to US$5bn,” says Mr Stetsenko. A large contribution to that outflow comes from a decline of foreign direct investment, mostly related to losses sustained by companies with foreign capital and their reflection in reinvested earnings. Mr Stetsenko also projects marginal positive net borrowings of the public sector, assuming one tranche under the EU COVID programme and one more Eurobond placement by the end of 2020. He thinks net debt flows of the private sector will be close to zero.
In 2021, Mr Stetsenko expects that the government will continue to tap international capital markets and receive new tranches from the World Bank and EU. In addition, the private sector will once again become a net recipient of capital flows, both foreign direct investment and debt. Also, an increase in foreign assets will slow sharply as the accumulated amounts will be spent actively. As a result, net capital inflows will become positive again and reach US$7bn, close to the average level in 2016-19.
Commenting on the soundness of Ukrainian banking system Konstantin Stetsenko mentioned that bad debt write-offs by state-owned banks can significantly lower the non-performing loan (NPL) ratios. “The high share of NPLs is one of the most serious impediments for a recovery in lending,” says Mr Stetsenko. Four state-owned banks jointly are responsible for 77% of total NPLs in the corporate sector. One of them, commenced the write-down of NPLs from its balance sheet after the government clarified the procedure. “Despite the likelihood of additional NPLs as a result of coronacrisis, we expect the NPL ratio to continue declining due to write-offs,” adds Mr Stetsenko.
Unlike in the corporate sector, consumer lending has flourished in the past several years. However, the pandemic put an abrupt end to the immense expansion of retail loan portfolios. Most banks’ loan portfolios are around where they were at the beginning of the year. “We expect the NPL ratio in consumer lending to increase significantly when 1) banks recognize part of currently restructured loans as NPLs and 2) new lending does not increase significantly enough to build a higher denominator for the ratio,” says Mr Stetsenko.
The Ukraine government’s 5-7-9 programme was initially designed to reduce the cost of borrowing to SMEs in order to create additional jobs, however Mr Stetsenko believes that it has now turned into an economic stimulus to tackle the pandemic. “The 5-7-9 programme transformed into one of relatively few government support measures for the business during the COVID-19 crisis. It allows SMEs to avoid defaults throughout the period when their revenues are likely to dwindle. While banks with private capital are tending to include their existing borrowers in the programme, four state-owned banks do the opposite; only a third of their loans are refinancings with the rest being newly issued loans,” explains Mr Stetsenko. He does not expect that government will discontinue the programme, but instead will try changing the model to include more new loans. One of the possible solutions might be portfolio guarantees from the government. “These should facilitate credit to borrowers that lack proper collateral and, therefore, cannot get loans from banks,” Mr Stetsenko added.
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