Default or deal? Ukraine scrambles to avoid $3.5 billion in overdue payments

Ukraine is on the brink of defaulting on $3.5 billion in interest payments.

With an August 1 deadline looming amid its ongoing war with Russia, the government is racing to restructure the debt, which could determine its ability to continue funding defense efforts.

The debt in question stems from Eurobond interest payments suspended for the past three years due to the ongoing conflict.

Ukraine's Ministry of Finance initially proposed a 40% "haircut" on the debt—a term referring to a reduction in the amount owed to creditors. This proposal was later reduced to 35%.

However, bondholders are resisting, offering no more than a 22% reduction. If there's no deal by August 1, Ukraine faces two options: seek an extension of the debt moratorium or declare a default.

War pushes debt-to-GDP ratio to nearly 100%

Ukraine's debt-to-GDP ratio has doubled since the war began, surging from 48.9% before the conflict to an estimated 97.6% this year.

Ukraine's 2024 budget, which includes a $43 billion deficit, accounted for the $3.5 billion debt payment. However, as you can guess, they’d probably rather spend that money elsewhere right now.

The Ministry of Finance says it needs at least $3 billion of international grants and loans monthly to cover spending, but even they admit that Western funding is likely to halve over the next two years.

The negotiations are further complicated by an additional $210 million payment due to holders of GDP warrants, a special type of bond linked to economic growth.

These warrants, issued as part of a previous debt restructuring in 2015, add another layer of complexity to Ukraine's financial obligations.

With a total nominal value of $3.2 billion, these warrants could lead to payments of $1-2 billion per year under conditions of post-war reconstruction.

Investors worry whether asset seizure will delay repayment

Investors fear the proposed restructuring may be the first of many attempts to shift war and reconstruction costs to the private sector.

According to the Center for European Policy Analysis estimates, Ukraine's war damages are between $485 billion and $1 trillion, far exceeding current aid commitments.

This massive funding gap puts bondholders on edge. They're concerned that if Ukraine gets its hands on this Russian cash, it might not be as motivated to pay back the money it already owes.

The International Monetary Fund is pushing for a resolution, urging bondholders to agree to some level of debt reduction. However, some investors express skepticism about Ukraine's long-term recovery prospects, complicating negotiations.

The debt crisis is exacerbated by Ukraine's growing IMF obligations.

The country is set to pay about $900 million in interest to service IMF debts this year, with payments expected to increase to $1.1-1.2 billion in 2025 after receiving $5.4 billion in IMF loans in 2024.