On August 1 a debt restructuring deal expires and the government will have to pay back all the suspended interest payments for the last three years in one go. If forced to pay the whole amount, it will result in an unprecedented increase in public debt servicing costs to 6.3% of GDP, or almost $12bn in 2024.

That is a payment the government cannot afford to make. A lack money is one of the three M problems – men, money and materiel – Ukraine is facing, as recently detailed by bne IntelliNews. Ukraine once again passed a 2024 budget with a whopping $43bn deficit that will be two-thirds funded by Western donors and one third with expensive short-term domestic treasury bill issues (OVDPs).

Taken together, if the bond interest payments resume, then together with payments on Ukraine’s GDP warrants and servicing its growing IMF debt, then almost half of the money donors have promised for Ukraine’s budget this year will disappear, going on debt servicing payments.

MinFin says it needs at least $3bn of international grants and loans a month to cover the spending, but even MinFin admits that Western funding is likely to halve over the next two years, making it increasingly difficult to pay for the war with Russia. Resuming debt payments now will only accelerate that process.

A default is not a given as the $3.5bn Eurobond interest payment is included in this year’s budget. But clearly the government would rather spend the money on guns and civil servant salaries.

Ukraine’s domestic and foreign debt, 2021-2025

The government is scrambling to cut a new restructuring deal and asking for investors to take a 60% haircut, as the state can barely afford to run the war-time economy, let alone repay its pre-war borrowing obligations.

The talks are not going well. Ministry of Finance (MinFin) has already been forced to drop the haircut demand to 40%, but bondholders are digging their heels in and offering no more than 22%.

Before the war, Ukraine has a healthy debt-to-GDP ratio of 48.9% at the end of 2021. The average rate of debt service was about 9% per annum on domestic debt and 4% on foreign debts. The total cost of debt service was equal to 2.9% of GDP.

But that has all changed since the war started. Debt-to-GDP was 80% at the end of 2023 and is already an estimated 97.6% this year, according to the Wilson Center, as more of Ukraine’s donors switch from grants (that don’t have to be repaid) to loans (that do).

And a lot of money is at stake. The deferred bond payments amount to 15% of Ukraine's GDP annually. If the payments were to resume they would become the government’s second largest budgetary expenditure after defence.

The IMF is pushing the government to persuade the investors to agree to a haircut, but it looks increasingly unlike an agreement with the investors can be struck in time. If Ukraine is forced to declare a default, it will indicate an alarming lack of faith among private investors in the West's commitments to continue to support Ukraine.

And Ukraine already has to pay about $900mn in interest to service the IMF debts this year, but after receiving $5.4bn in loans from the IMF in 2024, Ukraine will need to increase IMF debt service payments in 2025 up to $1.1–1.2bn.

Without an agreement, Ukraine has two options. One of them is to agree on extending the moratorium, as has been done with official creditors, until 2027. Another option is to declare a default.

Bondholders are sceptical of Ukraine's long-term recovery plans. Ukraine has a mountain to climb to rebuild its country. A report released by the Center for European Policy Analysis (CEPA) estimates the total damages from the Ukraine war at between $485bn and $1 trillion and notes that Western aid delivered thus far has been woefully inadequate for genuine reconstruction. Moreover, in assessing where the money will come from to rebuild, the authors estimated the international community and international financial institutions (IFIs) would come up with some $75bn, but unless the $300bn of Central Bank of Russia (CBR) reserves assets is seized the amount available for reconstruction falls far short of what is needed.

Investors are afraid that the proposed restructuring of their debt will be the first of many attempts by Ukraine's allies to shift the financial burden of the war and the costs of reconstruction to the private sector.

Warrants

The talks have been complicated as in addition to the bonds, Ukraine is scheduled to pay $210mn to the owners of GDP warrants, a special kind of bond that has payouts linked to GDP growth rates that were offered as part of a previous debt restructuring deal in 2015 and which are valid until 2041, following an economic shock caused by the 2014 EuroMaidan revolution that ousted former President Viktor Yanukovych.

In theory the warrants should be a good bet as they payout if GDP growth after 2019 exceeds 3%. After the economic dislocation of the overturn of the government the economy should bounce back potentially handing the holders of the warrants huge profits.

In 2023 the economy grew by 5.3%, which means the warrants should already be paying out some $700mn-$800mn to warrant holders. Taken together with the bondholders and the IMF payments, then half of the donor money slated to arrive in Ukraine in 2024 could be needed just to pay off creditors.

Under conditions of post-war reconstruction, payments on these obligations could reach $1bn-$2bn per year or more, with a nominal volume of securities of $3.2bn, estimates the Wilson Center.

Ukrainian Eurobonds holders are still determining the fate of their GDP warrants, the total nominal value of which is $3.2bn. On August 1, in addition to the payment for Eurobonds maturing in 2026, Ukraine must pay holders of GDP warrants about $210mn. This payment includes the amount that Ukraine had to pay at the end of 2021 and a 5% commission to warrant holders for agreeing to a two-year pause in debt service.

During the restructuring negotiations, the Ukrainian side tried to advance the concept that a default on GDP warrants would not cause a cross-default on Eurobonds.

Different from Eurobonds, GDP warrants are much more difficult to restructure, reports UBN. In order to make significant changes to the covenants, the terms of their circulation, it is necessary to secure the support of 75% of warrant holders, while for Eurobonds a consent of 66.6% of the owners of all bond issues is needed, and 50% for each of the 13 issues is sufficient.

Some of the holders of Ukrainian GDP warrants are planning to create a group that will represent their interests in restructuring sovereign debt, UBN reports. Warrant holders include both investment funds and hedge funds.

The activity began after Ukraine announced on July 1 during an investor call that it plans to restructure its sovereign Eurobonds and GDP warrants and intends to complete the process by September 1.

This was unexpected news for investors, who had not been expecting the warrant issue to be raised until 2025 at the earliest.

Rothschild, Ukraine's financial adviser, said that a two-level restructuring would be "suboptimal" for Ukraine. Ukrainian officials, in turn, reported that negotiations with creditors are ongoing and there are good chances of reaching an agreement. Two arguments against another pause, given by the Ukrainian side during the call, were as follows: the IMF requires restructuring to be completed, and this will benefit Ukraine's recovery by stimulating private capital.