After Bailout, Ukraine Steps Closer to Default

Four years after Ukraine embraced the West with the election of President Viktor Yushchenko in the Orange Revolution, the former Soviet nation's economy is collapsing and investors expect the country to default.

Even with the International Monetary Fund's $16.5 billion bailout, Ukraine's finances are deteriorating as the country battles with Russia over natural gas prices and the cost of steel, its biggest export, sinks.

Yields on Ukraine's $105 billion of government and company debt are the highest of any country with dollar-denominated bonds except Ecuador, which defaulted in December. The currency, the hryvnia, weakened 40 percent in the past 12 months against the dollar. The benchmark stock index lost 85 percent, the biggest drop in the world after Iceland, Bloomberg data show.

"The market is telling us there is a high probability of a default," said Tom Fallon, head of emerging markets at La Francaise des Placements in Paris, which manages $11 billion and sold its Ukrainian holdings six months ago. "It's an advantage that the country is committed to policy measures that the IMF is prepared to back, but that is no guarantee it won't default."

The gap in yields between Ukraine's bonds and Treasuries tripled in the past four months to 25 percentage points. The country's bonds yield 9.5 percentage points more than debt sold by Argentina, which defaulted in 2001 and has yet to compensate all holders, according to JPMorgan Chase data.

Ukraine is getting battered after European steel prices plummeted 56 percent since August, according to data from Metal Bulletin. Industrial production fell 48 percent in November, the steepest decline in Europe, as the global economic slowdown cut international demand.

The crisis led the IMF to provide $4.5 billion of emergency loans in November. Conditions for the credit include moving toward a flexible exchange rate, tackling inflation and running a balanced budget even though Ukraine's parliament approved a 2009 deficit of 2.96 percent of gross national product.

The government will partly cover the shortfall by selling bonds, according to the plan reached last month. Ukraine's inflation rate is the highest in Europe at 22.3 percent.

An IMF mission is scheduled to visit Kiev this month before it provides a second payment in February.

Ukraine's economy, which expanded at an average annual rate of 7 percent since 2000, grew 2.1 percent last year. Gross domestic product may shrink 5 percent this year, Oleksandr Shlapak, the president's deputy chief of staff, said in November.

The slump coupled with the hryvnia's decline increased concern that the government and companies will default after a fourfold jump in foreign debt since January 2004, according to data on the central bank's web site.

While a default by Ukraine is "not impossible," it is not "imminent," said Dmitry Sentchoukov, an emerging-market strategist at Dresdner in London.