Ukraine Fans Default Risk in Russia Bet as Vote Molds Policy

Ukraine’s efforts to seek cheaper natural gas from Russia rather than comply with the terms of a bailout have alarmed investors, propelling the former Soviet republic’s credit risk above Argentina’s for the first time in two years.

The government is shunning the International Monetary Fund as it struggles to agree on discounted fuel imports from Russia, with whom clashes halted European gas transit twice since 2006. That’s fanned concern over its ability to meet $11.9 billion in debt costs this year, with default risk rising more than any country Bloomberg tracks except Greece in the last six months.

While Ukraine faces a widening current-account gap, slowing economic growth and limited access to global capital markets, President Viktor Yanukovych has refused to raise household gas tariffs to restart a $15.6 billion IMF aid package as support for his ruling party ebbs before October elections.

“It’s a question of willingness to pay a political price,” Ronald Schneider, who helps manage about $1 billion in emerging-market debt at Raiffeisen Kapitalanlage GmbH in Vienna, said Jan. 31 by phone. “Skepticism for Ukraine will increase” without a resumption in IMF disbursements.

The cost of insuring Ukrainian state debt against non- payment for five years using credit-default swaps rose 254 basis points in the last six months to 780 today, according to CMA, which is owned by CME Group Inc. and compiles prices from dealers in the privately-negotiated market. That compares with 768 yesterday for Argentina, which the gauge surpassed Jan. 13.

Ukraine’s CDS price fell this month after peaking at 930 basis points on Jan. 17. A basis point is 0.01 percentage point.

“The improvement in Ukrainian debt spreads is a mere consequence of the risk rally we’re now seeing in the markets,” Luis Costa, an emerging-market strategist at Citigroup Inc. in London, said today by e-mail. “The macro story in Ukraine still points to very dangerous imbalances in the local economy.”

Economic growth may slow to 3.9 percent this year from about 5 percent in 2011, the government estimates, as the euro- region turmoil threatens its steel exports and cold weather curbs the grain harvest.

Pressure on the hryvnia has intensified in recent months while dwindling trust in the authorities has halted capital inflows and investment, the IMF’s Ukraine representative, Max Alier, warned former First Deputy Prime Minister Andriy Klyuev in a Jan. 31 letter, the Kommersant-Ukraine newspaper reported Feb. 13.

The hryvnia has declined to 8.0138 per U.S. dollar from 7.9550 a year ago. Ukraine’s gold and foreign-currency reserves fell $3.3 billion to $31.8 billion in 2011 as the hryvnia weakened and its current-account deficit widened to 5.5 percent of gross domestic product from 2.2 percent.

The former Soviet state’s credit-rating outlook was cut to stable from positive at Fitch Ratings in October, while Moody’s Investors Service lowered it to negative in December, citing risks to funding, liquidity and political stability. They both rate Ukraine five levels below investment grade.

The yield on the government’s Eurobond due 2016 has jumped to 8.587 percent from 6.265 percent when it was issued last June. Foreign investors have cut hryvnia-debt holdings to 4.26 billion hryvnia ($532 million) as of yesterday from 11.26 billion hryvnia last January, central bank data show.

Ukraine’s IMF loan, obtained in 2010, has been frozen since last March because the government won’t approve a one-third increase in consumer energy costs, a move the Washington-based fund has demanded to trim losses at state energy company NAK Naftogaz Ukrainy.

“We can’t burden the citizens,” Yanukovych, whose ruling Party of Regions has 14 percent backing before this year’s parliamentary vote, said Feb. 16 in comments published on his website.

Instead, he wants to wipe a third off his country’s gas bill by seeking a discount on its Russian imports to $250 per 1,000 cubic meters from the $416 average price assumed in this year’s budget. The bill came to about $12 billion last year.

While the two neighbors have been negotiating for months, no agreement has been reached. Ukrainian officials say Russia wants control of the transit pipelines OAO Gazprom uses to ship gas to Europe, a similar deal to one Belarus accepted last year.

Ukraine is unwilling to sanction the sale and Prime Minister Mykola Azarov reiterated Feb. 11 that there are no plans to join a Russia-led customs union of which Belarus is also a member.

“Russia will demand a very high price in terms of sovereignty and getting control of key economic assets,” Ariel Cohen, a senior fellow at the Heritage Foundation in Washington, said Feb. 8 by phone.

Gazprom’s press service declined to comment yesterday when asked about the negotiations with Ukraine and what the company is seeking in return for potential price discounts.

Russia, which supplies Ukraine with more than 70 percent of its gas needs, agreed to cut prices in April 2010 in exchange for a 25-year extension on its lease of the Black Sea port of Sevastopol, where it has a naval base.