In August, Ukraine is likely to default on its Eurobonds worth about $20 billion. This in itself will not be a big problem – negotiations with creditors will continue. The problem is how to maintain investors' confidence in the Ukrainian economy, namely, creating a mechanism to guarantee new investments.
The top priority for recovery efforts is the reconstruction of the energy infrastructure, which has suffered damage estimated to be worth a minimum of $10 billion. According to some estimates, the operating power plants are generating only slightly more than half of the electricity Ukraine needs during winter. Additionally, the destruction of the energy sector is a reason for the slowdown in Ukraine's economic growth.
In order to attract private investment from outside Ukraine on a systematic basis, the West must develop a long-term financial strategy for Ukraine's recovery. Otherwise, if the country sinks into economic and then political collapse, military aid may be a waste of resources.
In turn, Ukraine urgently needs to focus on revitalising its financial system. According to experts, the first necessary step on this path is the creation of a 'bad debt bank'. The second step is the creation of a new development bank that would focus on attracting private foreign investments and providing financing to commercial banks inside the country. The third is the creation of a war risk insurance system.
The West, riven by electoral divisions, is unable to develop a coherent strategy for Ukraine at this point in time, not only with regard to sustainable military assistance mechanisms or a long-term strategy for reaching acceptable agreements, but also with regard to how to reconcile military and economic assistance. Without such a strategy, Ukraine will be unable to withstand destructive Russian aggression almost as much as if it were without missiles and air defence systems.
In the coming weeks, Ukraine may announce a default on external debt amounting to about $20 billion. The moratorium on Eurobond payments, which was introduced at the beginning of the war, expires on 1 August. These bonds were purchased by private Western financial companies. In June, the Ukrainian government, on the recommendation of one of its key creditors, the IMF, proposed to its partners a total debt write-off of approximately 60%. However, the Investors Committee, representing the interests of holders of 20% of the Eurobonds, agreed to a write-off of only 22.5%. Ukraine and the IMF did not agree to this. If a compromise is not found, Kyiv will have two options, The Economist concludes: negotiate an extension of the moratorium or declare default.
As dramatic as the word ‘default’ may sound, it will not be a catastrophe for Ukraine, explained Alexander Paraschiy, head of the analytical department at Concorde Capital, to Ukrainian Forbes. Negotiations with creditors will continue even after the default occurs. Moreover, even if the parties found a solution by 1 August, a default would likely still occur due to the lack of time for the legal formalisation of new payment terms.
The problem is not the default itself, but the step that follows it. Ukraine will certainly need to borrow heavily again, particularly to finance the rebuilding of its destroyed infrastructure. However, changing the terms of Eurobond repayments is unlikely to fill private investors with a desire to buy new debt securities without an understanding of the West's long-term strategy towards Ukraine. The Economist's sources in organisations that own Ukrainian Eurobonds are sceptical: in a normal situation, when agreeing to restructure debt, the creditor bets that the debtor will be able to improve their financial situation. In the case of Ukraine, another bet is required – that it will continue to exist.
Experts from the Atlantic Council and CEPR emphasise in recently published reports that the restoration of Ukraine needs to start now, without waiting for the end of the war. Otherwise, the funds spent on military aid may be wasted if the war-torn country falls into economic and political collapse. Specifically, investment in the expansion of construction material production is necessary immediately, as experts from the Kyiv School of Economics note. For example, they believe it will take at least two to three years to bring cement production to the required levels for reconstruction purposes. According to the European Investment Bank, almost $1 trillion will need to be spent over 15 years. Adjusted for inflation, this amount is five times the total budget of the Marshall Plan for all of Europe, according to calculations by Bloomberg.
However, Bloomberg's calculations appear speculative. Most of the funds allocated under the Marshall Plan served as guarantees for investors (→ Re: Russia: The Great Reconstruction). In the case of Ukraine's reconstruction, primary funding, as then, should come from private investors. This aspect is also emphasised by CEPR experts: allied governments should fund military aid, and international financial organisations should support the Ukrainian budget to maintain its stability. However, attracting private investors to finance the reconstruction of the Ukrainian economy requires a strategy of guarantees and debt settlement.
Furthermore, 'reconstruction' breaks down into two types of tasks. The Atlantic Council report prioritises the reconstruction of energy infrastructure, with damages estimated at a minimum of $10 billion. Since the war began, the potential capacity of Ukrainian power plants has been reduced almost threefold, to 20GW, as sources in the Ukrainian government told the Financial Times in June. Much of the damage has been caused by strikes in recent months. According to the Kyiv Post, based on power outage schedules, Ukraine can currently produce significantly less – only about 10 GW. In winter, it needs at least 18 GW, and in summer, 40-45% less. Before the war, Ukraine was one of the largest electricity producers in the world – now it is forced to import it. Problems with generation due to Russian strikes have worsened economic growth prospects this year. The National Bank of Ukraine lowered its GDP growth forecast from 3.6% to 3%, and the International Monetary Fund (IMF) from 4% to 2.5-3.5%. It is important to remember that last year, with the National Bank's initial forecast of 0.3% (the IMF expected changes in the range of -3 to +1%), Ukraine's GDP increased by more than 5% (→ Re:Russia: Adaptive Ukraine).
Foreign companies are already participating in the restoration of Ukrainian infrastructure, Bloomberg notes, but mainly in small projects that are essentially ‘patching holes’. For example, Turkish companies are repairing roads and bridges in Ukraine. Over two years, they have completed 70 projects with a total budget of $1 billion. Western companies are more cautious – so far they have mostly just declared their intentions.
To make attracting private investments systematically possible, the authors of the CEPR report suggest that Ukraine urgently needs to address the revitalisation of its financial system. The first condition is the creation of a state-owned 'bad debt bank'. CEPR estimates that 30% of loans in Ukraine are non-performing. To revive the lending market, the state must relieve banks of this burden by purchasing bad debts.
The second condition is the creation of a special infrastructure, the key element of which should be the Ukrainian Development Bank. This new state institution should be organised on the principle of the German Kreditanstalt für Wiederaufbau (KfW), which participated in the implementation of the Marshall Plan. The primary function of the development bank should be to attract private foreign investments and provide financing to commercial banks. It should serve as the main counterparty for foreign investors.
Finally, another prerequisite is the establishment of a war risk insurance system. At present, there are only isolated initiatives in this area. For example, the World Bank insures certain export operations and warehouse construction. However, there are no insurance products that would protect long-term investments. Western governments and international organisations need to create this system, CEPR experts warn. For private insurers, the risks of operating in a wartime environment are too high.
In any case, the continuation of military aid to Ukraine, which is still a matter of consensus among the major European governments, must involve the development of a strategy of economic and financial 'resistance' to support the country's infrastructure and economy in the face of massive aggression.