Will the West let Ukraine default amid conflict with Russia?

Conflict puts Ukraine at risk of default

In late July, credit rating agency S&P Global Ratings downgraded Ukraine's long-term debt rating by three notches, saying that the country's recently announced plans to delay debt payments meant default was almost certain.

Ukrainian President Volodymyr Zelensky and ambassadors from G7 countries visit the port of Odessa – an important export hub for Ukraine's important agricultural products. Photo: EPA.

S&P downgraded Ukraine's rating from "CCC+" to "CC" after Kiev proposed a 24-month delay in payments on all of its foreign debt. S&P's view is that Ukraine must implement debt restructuring plans, which would amount to default.

Previously, Fitch Ratings also downgraded Ukraine's credit rating from CCC to C. The company said that the Ukrainian government's request to delay debt payments is a "default-like process."

In early July, Kiev formally requested a delay in bond payments, and Ukraine’s Finance Ministry said it had “received clear signs of support” for the plan from a group of its largest creditors, including BlackRock Inc., Fidelity International, Amia Capital and Gemsstock Ltd.

Ukraine is burning through money fast amid a five-month-long conflict with Russia. According to the International Monetary Fund, Ukraine’s GDP could shrink by 35% in 2022 as a result of the war. Inflation in Ukraine is forecast to hit 31% by the end of 2022, compared to 10% in 2021.

Ukraine’s grain exports have been severely affected, with a recent deal to resume grain exports only transferring a fraction of Ukraine’s existing stockpiles. In 2021, Ukraine exported $27.8bn (£22.6bn) of agricultural products to the world, accounting for 41% of its total exports.

It is no surprise that Ukraine’s public finances are in trouble. The Ukrainian Finance Ministry estimates that the country’s public sector deficit increased from $2 billion in March 2022 to $7 billion in May.

If Ukraine runs out of money, it would not only affect the ongoing war, but also leave the country unable to pay the salaries of nurses, teachers, police officers, and other essential workers. This would have a negative impact on the Ukrainian people, with vital services disrupted and households unable to pay bills and buy food. This is a concern, but some analysts say the situation is not dire.

Will the West help Ukraine avoid bankruptcy?

Ukraine has received funding from allies and more is still being promised. The United States, for example, has pledged about $5.3 billion in security assistance to Ukraine since President Biden took office, including about $4.6 billion since Russia launched its military campaign in its neighbor.

This is not the only support Ukraine is receiving. The G7 and the EU have announced official aid commitments to Ukraine worth $29.6 billion. EU leaders have also pledged up to $9.1 billion in additional support, on top of an earlier $1.2 billion emergency loan. This money from international partners will help Ukraine get through the short term. Interest payments on this debt will not be an immediate problem for Ukraine, although it remains a concern.

The more pressing challenge is to repay its outstanding foreign debt and bonds. With limited cash resources, Ukraine is unlikely to be able to meet its debt obligations on time. In fact, the country has requested permission to “freeze” some $20 billion of its foreign debt, a request that has been immediately accepted by Western governments, especially Germany.

Another challenge for Ukraine's economy is the ongoing conflict. A prolonged war will only bring more instability to the country's economy.

As a result of the conflict, Ukrainian cities have been repeatedly hit by rockets and critical infrastructure such as railways and ports has been severely damaged. The conflict has also not provided an incentive for investment in Ukraine at this stage, creating another long-term challenge for Ukraine’s economic prospects.

Ukraine did, in fact, default in 2020. This was not a catastrophic event, but it did raise interest rates on any new loans the country sought.

Creditors are generally reluctant to lend if there is a risk they will not get their money back. However, the political situation and statements of support from Western powers mean that Ukraine is more likely to receive money to prevent another default. Such public commitments suggest that Western governments may be willing to pay a high price to keep Ukraine afloat, both militarily and economically.