Bonds: Weak activity on the bond market
Despite the increase in borrowings at the primary auction, activity on the secondary bond market remains weak, particularly in the military bond segment.
At the auction last Tuesday (September 13), the Ministry of Finance sold a new 1.5-year bond issue for Hr 166 million ($4.5 million). This amount is quite large compared to previous auctions, but very low to cover budgetary needs or even roll over ongoing debt repayments. Since the beginning of the year, the volume of local currency debt that the government has been unable to refinance has exceeded 88 billion HR ($2.4 billion). That excludes National Bank lending, which rose by 15 billion hrs ($0.4 billion) to 315 billion hrs ($8.6 billion) last week.
Currency-denominated bonds helped attract more funds last week, especially euro-denominated bonds with a put option. In total, the state budget received 1.43 billion Hr (39 million dollars), of which the equivalent of 1.25 billion Hr in euros (33.9 million EUR). See details in the auction review.
Larger borrowings did not improve secondary market activity. Total trading volume with Hr bonds fell to Hr2bn ($55m) due to reduced activity with ordinary (non-military) bonds to Hr1.9bn ($52m) , while activity with the good military remained at the usual level of Hr 120 million ($3.3 million).
ICU view: The Ministry of Finance continues to rely more on assistance from international partners and loans from the NBU, attracting small amounts in local currency and a little more in hard currency in the domestic bond market. Low interest rates on military bills do not contribute to secondary market activity where individuals and foreign investors are the main players. Individuals continue to buy mainly military bills in small quantities, while foreigners are interested in ordinary (non-military) instruments that have not been offered for more than six months. The choice of instruments for foreigners is shrinking, as old issues are gradually redeemed and new issues from the Ministry of Finance include only military bonds. At the same time, foreigners may find it beneficial to purchase new securities maturing soon after April 1, 2023, when they can repatriate the funds received (under current NBU regulations).
Bonds: investors hail the military successes of the Ukrainian army
Investors positively assessed the Ukrainian army’s successful counter-offensive actions and Eurobond prices rose.
Over the past week, Eurobond prices have risen substantially by 2‒4 cents to 23‒28 cents on the dollar and VRIs by almost three cents to 33 cents on the dollar of notional value. At the same time, Ukrainian Eurobond spreads tightened significantly against the benchmark by 200 to 500 basis points. This happened due to both a decline in Ukrainian bond yields and an increase in US Treasury yields.
ICU view: Price moves show investors are pricing battleground news positively, but prices haven’t even reached the levels of mid-August when Ukraine completed its Eurobond restructuring and sentiment bearishness in global markets had not yet intensified. The low interest rate for emerging market debt is not contributing to further price growth. The successes of the Ukrainian army in liberating the territories occupied by Russia have increased the optimism of investors, but at the moment they are convinced that the war can go on for a long time and should not be expected payments on Eurobonds in the near future.
FX: Hryvnia exchange rate weakens again
Last week, the hryvnia weakened again despite the NBU’s efforts to reduce the cash deficit.
After several auctions for the sale of cash in hard currency, the exchange rate of the hryvnia against the US dollar in major retail banks weakened from 39.3-40.3 Hr/US$ to 39.4-40.4 Hr/US$. Therefore, the NBU had to announce an auction for the sale of 100 million dollars and 100 million euros for today.
The interbank market has not experienced any major changes. Demand for hard currency from bank customers far exceeds supply, and the NBU sold about $0.5 billion through interventions last week.
ICU view: The shortage of hard currency liquidity remains a key factor in the weakening of the hryvnia. Contrary to our expectations, the NBU supply of hard currency cash to banks in previous weeks did not help to stabilize the hryvnia exchange rate. The NBU will therefore offer more FX liquidity this week, as it believes that the current exchange rate is too high. But strong demand for hard currency will continue to put pressure on the hryvnia’s exchange rate, and is unlikely to allow it to strengthen even a little in the near future.
Economy: The government submits the draft 2023 budget to Parliament
Last week, the Ukrainian government submitted to parliament a draft budget for 2023, a budget deficit estimated at 20% of GDP.
The document forecasts a state budget deficit equal to its projected revenues at Hr280 billion ($30.3 billion at the government’s projected Hr/USD year-average exchange rate). This represents about 20% of 2023F GDP according to government estimates. The deficit is expected to be covered by net external borrowing of $35.5 billion, while net local debt repayment will be $5.3 billion. The officials further noted that the government does not plan to rely on direct funding from the NBU next year.
ICU view: The submitted document should be treated as reflecting the government’s best-case scenario, whereby Ukraine’s international partners are ready to provide as much funding as the government has foreseen in the document. This scenario seems optimistic, in our opinion, and we believe that foreign financial assistance from IFIs and foreign governments is going to be significantly lower. We therefore expect the actual composition of fiscal funding sources to be different, with the NBU still playing an important role in closing the fiscal gap, even though the volumes of government debt purchases by the NBU will more than halve compared to compared to 2022 (expected 500 billion hours).
RESEARCH TEAM: Vitaliy Vavryshchuk, Alexander Martynenko, Taras Kotovych.
See the full report here.