Nation’s capital pipeline dries up amid global market turbulence

With Ukraine’s government and companies both in dire need of fresh capital, a new phase of the global economic crisis could hardly have hit a worse time.

Ukraine’s economic growth prospects appear relatively good, with the International Monetary Fund expecting 4.7 percent gross domestic product growth in 2011.

However, as the tumultuous markets drive investors away from risk, Ukraine will find it increasingly difficult to raise capital on international markets.

While this year’s budget revenues have substantially improved, the budget deficit is worrying. Yet with relatively easy financing conditions in 2011, the situation looks manageable, a leading Western bank wrote in a September research note to investors.

“Next year, however, the situation changes abruptly with the fiscal deficit likely to contract sharply, but public sector redemptions set to jump on Eurobond repayments and the start of the IMF repayment schedule,” the bank added.

Yet already the state faces rising interest rates on its upcoming bond issues. While the $2.75 billion issued earlier this year received a favorable interest rate, future conditions seem significantly tougher.

Reflecting the current market aversion to Ukrainian sovereign debt yields on Eurobonds due in 2012 rose 3.5 percent over the previous week.

Nonetheless, the government is now eying a $2.5 billion Eurobond issue to repay a $2 billion moving loan from Russia’s VTB bank.

“Given turbulent global credit markets, we think it will be quite difficult for the authorities to raise the planned Eurobond volume,” Dragon Capital wrote in a note to investors, arguing that under current conditions the VTB loan rate is no longer expensive, and may hence be rolled over until 2012.

Such a decision, however, will increase the need for external debt borrowings in 2012 by $2 billion, with $3.5 billion already to come from the Eurobond market, according to Dragon Capital.

This pushes total 2012 domestic and foreign borrowings to around $13 billion, up 17 percent from last year and 42 percent above the government’s current target.

Given turbulent global credit markets, we think it will be quite difficult for the authorities to raise the planned Eurobond volume.

- Dragon Capital wrote in a note to investors

This, in turn, places doubt upon the government’s ability to rely on the Eurobond market, and increases the appeal of an IMF loan, which would require a politically difficult increase of household utility fees.

Ultimately, Kyiv’s chances of landing an IMF loan depend on its willingness to reduce the deficit of financially-stretched state gas company Naftogaz – either by convincing Russia to lower its asking price or raising domestic fees – thus completing the IMF’s to-do list.

President Viktor Yanukovych noted progress in talks in Moscow on a new gas contract on Sept. 24, but no concrete agreements were announced.

An increase in gas fees for households is a risky option in light of the upcoming parliamentary elections in Oct. 2012.

Meanwhile, in terms of capital-raising ability, Ukraine’s weakest companies are also being affected.

Ukraine’s state railway monopoly Ukrzaliznytsia, known for its past difficulties in securing proper financing, is now considering Chinese locomotive producers for its fleet-modernization program, rather than the previously announced domestic provider Luhanskteplovoz.

"The ability to finance locomotive orders could tip Ukrzaliznytsia toward a deal with the Chinese producer," said Alexander Paraschiy, head of research at BG Capital, a Kyiv-based investment bank.

Yet nowhere are the worsening prospects for raising capital more visible than in the drastic reduction in public placement plans. While the past two years saw a surge of initial public offerings by Ukraine-based companies on foreign exchanges, the trend is fizzing out.

The last initial public offering was that of Coal Energy, a coal producer based in Donetsk Oblast. It placed a 25 percent stake on the Warsaw Stock Exchange in August. Its success, however, was limited as the company only attracted $81 million, rather than the $130 million it had initially hoped for.

Brian Best, head of investment banking at Dragon Capital, which acted as lead manager on the IPO, told the Kyiv Post that in the final stages of the IPO process the company found itself at a crossroads, knowing that better market conditions would allow it to raise more money. In retrospect, however, the company was satisfied it hadn’t stalled, he added.

The satisfaction is certainly justified.

August was the worst month for equity markets in 2011, with Ukraine’s stock index down by a quarter and no light at the end of the tunnel. With copper prices, a lead indicator of where the global economy is going, at a 10-month low, shares of Ukrainian basic material producers have been hit hard, as in the case of London-listed iron pellet producer Ferrexpo. It lost a whopping 21 percent over the previous week.

Unsurprisingly, Dragon Capital’s Best is hardly upbeat about short term prospects.

“Certainly, in the short term, staging an IPO would be very difficult – investors are sitting on the sidelines, looking at what will be happening in the Eurozone and globally,” he said

“I don’t expect any improvement until the end of the year, no IPOs. Before the end of the first quarter of 2012 we may see some activity, though,” he added.

But while Coal Energy went ahead with its IPO despite deteriorating market conditions, many companies have postponed them altogether.

Already in July, before the brunt of the crisis had hit, ViOil, a major Ukrainian sunflower oil producer, and Valinor, an agro company with massive land holdings in Russia and Ukraine, decided to delay their public placements citing “unfavorable market conditions.”

Investors are sitting on the sidelines, looking at what will be happening in the Eurozone and globally.

- Brian Best, head of investment banking at Dragon Capital

According to the PBN IPO tracker, which monitors IPO announcements by companies based out of Ukraine, Russia and Kazakhstan, over the past two years only 31 IPOs out of a total 215 announced have been completed, while 17 have been canceled outright and deadlines for the others are constantly pushed back.

Other companies, like cash-rich domestic poultry giant MHP, have decided to turn crisis into opportunity.

The company plans to consider a share buyback program at its upcoming general shareholder meeting, hoping to buy up the shares, which have lost 20 percent since the beginning of the year. The plan is to resell them once the price recovers, according to BG Capital.

The turmoil on the world’s capital markets has also impacted debt issuance among Ukrainian corporations. Over the past weeks yields on Ukrainian companies’ Eurobonds rose significantly as risk-averse investors sold their positions.

With external debt set to spike in upcoming years and a bleak outlook for global economic recovery, the country will face pressure on the hryvnia and rising challenges to maintain growth.

If all of the central bank’s $37 billion in foreign currency reserves are liquid, the situation will be manageable.

Even so, fresh foreign currency borrowings, from the IMF for example, will still be key to shoring up confidence to prevent a worse-case scenario.