Despite an ostensible ceasefire between Ukraine and Russia, low level fighting continues between the Eurasian rivals. But Ukraine is about to open up a second, potentially more dangerous, front in this conflict–this time with its foreign creditors.
On Tuesday, the Ukrainian Parliament passed a bill that would allow the government to default on payments to foreign creditors, amid negotiations to restructure its increasingly unsustainable debt.
So, does this mean that the Ukraine is going bankrupt? Most outside analysts agree that Ukraine can’t pay back what it owes. But as we know from the situation in Greece, just because everyone agrees a country can’t make good on their debts doesn’t mean it will default.
Take, for instance, the example of Mexico. In 1995, the U.S. government, in conjunction with the IMF, the Bank of International Settlements, and private banks, orchestrated a $50 billion bailout for Mexico, which was undergoing a severe recession as well as a debt and currency crisis. Then Treasury Secretary Robert Rubin worried that letting Mexico default would spark a financial crisis that could spread to other nations. Other supporters of the bailout pointed to the deep economic ties between the United States and Mexico, arguing that hundreds of thousands of U.S. jobs could be lost if Mexico were allowed to default.
When it comes to the Ukraine, people like financier George Soros have argued that the international community, and specifically Europe, should invest at least $50 billion on top of the $17 billion the IMF has already offered to help the nation stabilize its economy and reform its bureaucracy. If Ukraine were able to successfully go through with such reforms, such as radically reducing the size of its public sector, it could very well lead to the sort of economic growth that would enable it to pay back its benefactors. But as Soros admits, Ukraine’s track record of using international loans to spur reform is spotty. And unlike in the case of Mexico, Ukraine doesn’t have large deposits of oil to use as collateral.
Another option to saving Ukraine from financial ruin would be to force private creditors to forgive its outstanding debt. That’s the approach former Treasury Secretary Larry Summers advocated in an op-ed published on Monday. “The case for debt reduction is as strong as any that I have encountered over the past quarter century,” Summers writes.
Summers argues that Ukraine cannot possibly pay what it owes, and that its troubles are not just a result of creditors over-lending and Ukraine over-borrowing. Instead, Russian aggression is also to blame. Finally, Summers writes, “[Ukraine] has shown real political courage in combating corruption and moving aggressively to curb energy subsidies that generated vast waste. Ukraine has done more in the past 12 months to reform its subsidies than most nations do in 12 years.”
But how exactly will the international community force private creditors, composed mostly of large investment companies like Franklin Templeton, to accept losses on Ukrainian sovereign debt? Summers is less specific on this question, but he more or less suggests that the international community support Ukraine in a high-stakes game of chicken:
It should be unacceptable to taxpayers around the world that their money be put at risk on loans to Ukraine in order that plans be made to pay back creditors in full. The IMF and national authorities should call out the recalcitrant creditors on their irresponsible behaviour. If necessary, Ukraine should be prepared to go into default and not meet its obligations, while at the same time the international community should make clear that it will continue to provide support to Kiev. In the context of these steps, creditors will have little choice but to accept the economic reality of the situation.
The vote taken in the Ukrainian parliament on Tuesday is the first step in initiating this process. But will Ukraine’s creditors budge? The recent drama over Argentina’s debt restructuring, in which a group of bondholders used the U.S. court system to block a restructuring deal and insisted on being paid in full, casts doubt on this scheme.
Ukraine’s creditors surely realize that they have more leverage in Eastern Europe than they’d have even in a place like Argentina. There’s support on both sides of the aisle here in America for standing tall against Russia. Meanwhile, the U.S. hasn’t thought twice about spending an estimated $8.6 million per day—more than $2 billion total so far—in its fight against ISIS. That’s money it has no chance of being repaid, whereas any loans it makes to Ukraine very likely could be. Ukraine’s lenders are certainly paying close attention to America’s willingness to spend big to project its power in strategically important corners of the globe.
Meanwhile, even Summers’ hardball strategy would require the international community to prop up Ukraine while it negotiates with creditors. The international community may be able to shame lenders into taking losses in order to support Western values. But Big Finance hasn’t proven too susceptible to public shaming lately, so taxpayers in the U.S. and Europe shouldn’t be surprised if they are forced to swerve first.