Debtors’ Prison

Ukraine Debt: Putin’s Trump Card

American retirees are inadvertently doing the Russian president’s dirty work.

The lavish lifestyle of Putin ally and deposed Ukrainian President Viktor Yanukovych was opulent even by kleptocrat standards. There was the private zoo complete with an African eland that gave milk Yanukovych allegedly believed could enhance his libido. Other perks of treating Ukraine’s budget like a personal ATM included a private casino on a galleon (a small ship); classic and high-tech car collections; and a sprawling marble-columned mansion on privatized national parkland. In all, it’s believed that Yanukovych and his cronies fled Ukraine with an estimated $70 billion in state funds.

Stealing over the years after coming to power in 2010, the Yanukovych government also borrowed billions from the American firm Franklin Templeton Investments. Their debt deal continues to bleed the country’s budget, leading one group of Ukrainian and Russian civic activists to launch a White House petition that called on the Obama administration to investigate corruption tied to the bonds.

“I really feel this huge difference in economic stability before and after [the] revolution,” says Andrii Chepurnyi, a software developer in Kiev. Unhappy with the Yanukovych regime, Chepurnyi volunteered on Maidan, Kiev’s Independence Square, helping build the barricades and donating food and medicine in the revolution. He lost one friend to the violence of Yanukovych’s riot police, and three of his friends were killed defending against Russia’s intensifying invasion of the east.

“Yanukovych and his team have stolen a lot from Ukraine’s treasury and now we have huge problems with paying our loans,” says Chepurnyi.

The problems compound a perfect storm, which includes a collapsed currency—the third worst performing in the world. Inflation is now around 55.3 percent. Ukraine’s average monthly salary has plummeted to $186. Pensions have been cut and taxes raised. While earning exceedingly less, Ukrainians are paying 450 percent more on household energy bills. The poverty rate hovers around 33 percent. What’s more, a fifth of the country’s productive capacity has been ravaged by the war and Russian trade sanctions.

The financial burdens will only increase. The war has created more than 2 million refugees and left more than 5 million people in need of humanitarian aid like health services and medicines. There are also the costs of reconciliation and rehabilitation programs, and PTSD services for veterans, as well as for widows and orphans. Rebuilding areas destroyed by the war could cost an estimated $1.5 billion or more.

In April, Ukraine received a $17 billion bailout from the IMF, but some of that money went to creditors, including Franklin Templeton. The asset management and mutual fund company owns more than $7 billion of the $9 billion of Ukraine’s public debt represented by an ad-hoc committee of creditors. Ukraine’s total public debt is now at $75 billion.

Michael Hasenstab, the superstar bond portfolio manager with Franklin Templeton, has earned a reputation taking high-risk, high-reward gambles. His bets on Irish and Hungarian debt paid off when the struggling EU countries received massive bailouts. Hasenstab placed a bet on Ukraine in 2010 when Yanukovych became president; so far his gamble has lost $3 billion. Having climbed Mount Everest and earning an average return of 10.2 percent since taking over his fund in 2002, Hasenstab doesn’t seem like the kind of guy who likes to lose. Considering that Ukraine isn’t going to get a bailout anywhere close to the billions pumped into Ireland and Hungary, he may have to. At least that’s what the IMF, U.S. Treasury, and leading economic experts want the creditors to do to help Ukraine limp onto the road to stability.

But the debt restructuring negotiations have ground to a stalemate with very little time remaining. Ukraine is faced with restructuring its debt to find $15.3 billion in savings over the next four years as part of a $40 billion IMF package. Being IMF-compliant provides a major seal of approval to reassure and attract foreign investments to help the country work toward stability. A deal has to be struck by the middle of August in order for Ukraine to avoid having to pay more than $500 million on September 23 on a maturing Eurobond; writing this check would mean Ukraine can’t make the savings targets required by the IMF. A deal means Ukraine avoids default that would drive up the cost of borrowing.

“Agreeing on a deal will be beneficial for the economy for the middle and long term,” Andy Hunder, president of the American Chamber of Commerce in Ukraine, told The Daily Beast. “The economy can have much more clarity and predictability. I think predictability is what investors want so that the economy can move forward.”

The creditors refused a government proposal to take a significant haircut: a 40 percent loss on the principal. Doing so would give Ukraine breathing room and put money back into much-needed services. It is believed that the creditors consider the haircut to be based on 2020 forecasts that they see as impossible to predict, especially given that the IMF has already been forced to revise its outlook in just three months.

On Wednesday, Natalie Jaresko, Ukraine’s minister of finance, will meet with Franklin Templeton and other representatives of the ad-hoc Committee of Bondholders to Ukraine. The meeting will take place in San Francisco, 20 miles from Franklin Templeton’s San Mateo, California, headquarters. In addition to Franklin Templeton, the committee is made up of the financial giants BTG Pactual, TCW, and T. Rowe Price, which together hold about $9 billion of Ukraine’s public debt, with Franklin Templeton owning the majority at more than $7 billion.

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“Ukraine finally has a government in place focusing on values of democracy and a free market. This is a very important time in Ukraine’s history,” said Hunder. “It’s about understanding the realities and the complexities of the country when these agreements were signed and where the country is today.”

Frustration with the slow pace of reforms that many Ukrainians gave their lives for on Maidan and in east Ukraine can lead to more political unrest. “Restructuring debt would buy Ukrainians more time for reforms,” Olena Tregub, director, International Technical Assistance Coordination and Cooperation with IFIs Ministry of Economic Development and Trade, wrote in a message. “There are no visible results yet, at the same time the mounting debt and looming default together with never ending war keep Ukrainians under pressure. There is a risk of radical forces and populists taking power with an unrealistic promise to change things overnight.”

The overthrown Yanukovych won the presidential election by running a populist campaign. The IMF knows that this is a critical moment, which is why managing director Christine Lagarde has made it clear that the IMF will continue to lend to Ukraine even if the country has to default. Besides the country’s economic hardships, 50,000 Russian troops and 30,000 militants are reportedly amassed at its border; the threat of a full-scale Russian invasion remains.

“Russia does not want to see Ukraine succeed,” said Hunder. He calls an economically strong Ukraine essential to Western security in the region.

Hasenstab has a controversial history of buying up bonds from governments with abysmal human-rights records, frustrating State Department officials. In response to one of many recent op-eds calling on the creditors to accept a deal that takes Ukraine’s crises into account, Hasenstab wrote a letter to the editor of The Washington Post that pointed out: “The majority of the private debt in the region is held by mutual funds that invest on behalf of millions of working Americans and retirees.”

A deal is also in the interest of Franklin Templeton, whose mom-and-pop customers would likely not support further weakening a country already severely weakened by Russia. A recent Pew poll found that nearly 70 percent of Americans view Russia unfavorably. Given that it has been widely reported that Putin seeks to keep Ukraine destabilized, it’s not difficult to imagine that Franklin Templeton’s pensioners would not want to assist Putin in his mission.