The victory of a TV comedian with scant political experience in Ukraine’s general election could have unnerved investors. But after his landslide victory, new president Volodymyr Zelensky has pursued a pro-reform, anti-corruption agenda backed by an experienced team.
“Investors have bought into the story,” said Oliver Williams, emerging market debt portfolio manager at Insight Investment, which is one of a number of global asset managers that have increased exposure to Ukrainian sovereign debt this year, attracted by double-digit yields.
Zelensky won 73% of the vote in April’s vote over rival Petro Poroshenko, who was elected in 2014 following the Euromaidan Revolution and subsequent Russian military intervention in Crimea. Poroshenko’s reform-friendly agenda, however, was overshadowed by allegations of nepotism and corruption.
“The Ukrainian public have become fed-up at the slow pace of reform,” Williams added. “There is a deep-seated dissatisfaction with the existing political class.”
Zelensky, 41, starred in a hit TV show about a teacher who unexpectedly wins the Ukrainian presidency after a viral video shows him angrily ranting against government corruption. The name of the show, Servant of the People, is the name of Zelensky’s party.
“There is an expectation of a smoother maturity profile for the Ukrainian sovereign over the medium term.”
IMF-supported reforms
Ukraine relies on International Monetary Fund (IMF) loans to service its external debt, which amounts to about 60% of gross domestic product. In October, the IMF agreed a new $3.9bn assistance package and Ukraine and Zelensky’s administration is expected to sign up to another three-year programme.
Parliamentary elections, scheduled for July 21, should provide a further indication on the extent to which the new administration can facilitate change. Zelensky’s Servant of the People party may not secure an outright majority in the Rada but is expected to gain enough seats to successfully pass IMF-led reforms with the support of minor parties.
“Investors have been encouraged that the reform path Ukraine is on is going to accelerate over the next few years,” Williams said. “The debt repayment profile over the medium-term should be fully covered and investors have faith in the Ukrainian authorities to pay it back.”
US asset manager Neuberger Berman increased its Ukrainian sovereign debt holdings this year. “We increased our overweight in Ukraine since the presidential run-off as the incoming administration has so far taken the right steps in demonstrating commitment to anti-corruption reforms and a new IMF programme,” said Rob Drijkoningen, co-head of emerging market debt at Neuberger Berman.
This month, Ukraine issued €1bn in euro-denominated bonds offering a yield of 6.75% per annum.
Improved fundamentals
Following Zelensky’s election, Insight Investment increased its Ukrainian sovereign debt holdings to include 10-year sovereign debt as well as three-year and five-year bonds.
Insight’s Investment’s flagship portfolios exposure to Ukrainian sovereign debt has jumped to 3-4% this year. (Overall, the groups’s total EMD AUM stands at €4.8bn.)
Williams said: “There is an expectation of a smoother maturity profile for the Ukrainian sovereign over the medium term. We’re long on Ukrainian sovereign bonds at the moment, and have extended our exposure, from bonds that mature in 2022 and 2023, to bonds that will mature in 2026 and 2028.”
Yields on 10-year Ukrainian government bonds stood at 12.7% on Tuesday and were rated B-, according to Standard & Poor’s. The yield on a three-year sovereign stood at 17.5%.
“Compared to other kind of single-B rated EM sovereign names, we still think there’s room for another 40-50 basis points contraction,” Williams said.
“As investors in sovereign debt, you need to be confident that you’re going to get paid back enough of a risk premium to buy into the story.”
Ukraine’s foreign exchange reserves are close to an all-time high – about US$20bn – which further bolsters market sentiment that there is a high probability that longer-term bonds will get paid back.
“You should see an FX profile that continues to increase at the same time as debt-to-GDP ratios continue to decline fairly steadily,” Williams said.
Drijkoningen added: “The relatively comfortable reserve position and increased foreign inflows mitigates any risks ahead of the parliamentary vote in July.”
Ukraine vs Russian debt
Zelensky has also prioritised talks with Russia with the aim of achieving a ceasefire in the Crimea. As a point of comparison, the yield on 10-year Russian sovereign debt stood at 7.4% on Tuesday, with an investment grade rating of BBB-, according to Standard & Poor’s.
“The credit profiles are very different. But Ukrainian ten-year bonds offer a lot more yield, so investors certainly feel like they are getting paid for any increased risk,” Williams said.
“Zelensky still remains something of an unknown quantity for investors. He doesn’t have political acumen or experience and there’s always the risk he could say something clumsy or get advised by the wrong person. But all the communication so far points to a reform-friendly IMF-funded policy agenda.”
