In 2019, Ukraine pursues a rather active policy of attracting financial resources through the mechanism of government bonds. A significant portion of the bonds were bought by non-residents. For the first time in Ukraine, foreign investments in domestic government bonds (government bonds) exceeded UAH 100 billion (USD 4.06 billion). This policy made it possible to finance the budget deficit in the absence of financial resources. However, this policy is actively criticized by some experts for its possible negative consequences, including the promotion of excessive strengthening of the hryvnia, the high cost of attracting funds, the possible increase in inflationary trends.
During 2019 Ukraine sells tens of billions of hryvnias of government bonds on a monthly basis. A considerable share of the bonds was bought by non-residents. As of mid-November, the government bonds portfolio reached UAH 816 billion. Over 12% of the portfolio is owned by non-residents. The popularity of government transactions among investors was preceded by certain changes in currency laws that made it easier to buy bonds for non-residents and Ukrainian banks, as well as an active promotional campaign aimed at popularizing government bonds among Ukrainian citizens. The main purpose of the PR campaign was to make the Ukrainian population aware of a financial instrument with the opportunity to invest in government bonds as an alternative to deposits. Investing in T-bills is completely secure because the state guarantees full payment of the nominal value of the bonds and interest income.
The state has decided to use a good time to close the budget deficit, while not inflating the national debt. The state budget deficit in the first nine months of 2019 amounted to UAH 20.7 billion, or 0.7% of GDP. The main component of its financing were domestic bonds – UAH 79.2 billion. At the same time, the amount of gross domestic borrowing reached UAH 296 billion. However, according to some experts, such an active sale of bonds to finance the budget deficit has a number of negative aspects.
In particular, large amounts of domestic government loans were not used to pay off debt or finance budget expenditures. They settled on a single treasury account. As of October 1, 2019, a record amount of UAH 61.6 billion was accumulated at the single treasury account. On the one hand, it increases the liquidity of the government, but on the other – it indicates inefficient management of cash flows.
The dangerous result of the formation of the balance of such funds is the emergence of additional budget expenditures for servicing government loans. With the current level of interest rates on government bonds for each of the 1 billion UAH attracted from their sale, which settles on the single treasury account and is not directed to financing budget expenditures, the Ministry of Finance accrues monthly 12.5 million UAH of interest payments.
Also, given the significant strengthening of the hryvnia exchange rate observed over the last few months and the corresponding hryvnia starvation, the accumulation of a substantial level of single treasury account balances by the end of the year may play a “bad trick” on the hryvnia exchange rate when the government starts to squeeze balances out of the state budget. year. An increase in the hryvnia supply at the end of the year can greatly weaken the hryvnia and significantly strengthen inflationary processes. We had the opportunity to observe something similar at the end of 2017, when active spending of the budget “under the Christmas tree” became the sole reason for the temporary collapse of the hryvnia exchange rate.
Significant expenditures of the budget for debt servicing limit the ability of the state to provide quality public goods to citizens, support vulnerable categories of the population and stimulate economic development.
Overall, the volume of placement of government bonds on the primary market for the nine months of 2019 increased four times relative to the same period in 2018 and 20 times – compared to the same period in 2017. This was an indication of the increased dependence of public finances and the volatility of the government’s financial position.
At the same time, nominal interest rates on government bonds remained excessively high – the average weighted nominal yield of hryvnia government bonds in the third quarter of this year was 15.3%.
The high level of interest rates on government bonds reflected the consequences of the NBU’s tight monetary policy and the deliberate policy of the Ministry of Finance to hold high yields of bonds, even in the conditions of large-scale inflow of foreign speculative capital.
In September 2019, the real yield of hryvnia government bonds was about 8% per annum. Such a high level of real interest rates on government bonds is unprecedented both in terms of Ukraine’s international comparisons and in terms of timely comparisons of the value of government borrowing in Ukraine.
On the one hand, the Ministry of Finance’s steps to reduce the nominal and real interest rates of government bonds in 2019 should be positively assessed. But on the other hand, given the massive inflow of foreign capital into the T-bond market after Ukraine’s accession to the Clearstream system, the Ministry of Finance of Ukraine had every opportunity for a more drastic reduction in interest rates on T-bonds. Moreover, in the context of the actual delimitation of the government bonds market (due to unimpeded access by non-residents) from the domestic money market, the cost of resources on which correlates with the NBU discount rate.
Today, among the 35 emerging markets, Ukraine has one of the highest nominal yields on domestic bonds and is ranked third in the rating list. Only Egypt (15.3%) and Argentina (35%) are ahead of the nominal interest rates on one-year bonds (15.2%). For comparison, in Bulgaria, Slovakia, Hungary and Slovenia, nominal rates are negative, while in Croatia, the Czech Republic, Poland, Chile and Thailand they do not exceed 2% per annum. In Morocco, China, Serbia, Chile, Malaysia, Philippines, Romania, Vietnam, nominal rates are in the range of 2-4% per annum.
Significantly, in terms of real interest rates on domestic government bonds, Ukraine ranks first in the world, with real yields at 8% per annum. The closest neighbors to Ukraine in the ranking of the most expensive borrowers are Uganda (with a real yield of 6.5%) and Egypt (5.9). It is noticeable that among 35 countries with emerging markets, 12 countries have negative real interest rates on one-year government bonds. These are the new members of the EU, as well as Chile, Vietnam, Turkey and Argentina
In January-October the portfolio of government bonds owned by non-residents increased by UAH 93.3 billion. As a result, as a part of hryvnia government bonds in circulation, the share of non-residents increased from 1 to 13.7%. If we calculate this share in the amount of hryvnia government bonds owned by ordinary investors (except the NBU), we will see an increase in the share of non-residents from 2.3 to 26.4%. Such changes in the composition of the investor base in government securities increase the risk of sovereign debt refinancing, increase the outflow of funds under the item “income” of the current account of the balance of payments, and increase the risks of exchange rate volatility of the hryvnia.
The Ministry of Finance declares a reduction in the currency risks of public debt as a result of an increase in the share of hryvnia government bonds in the debt structure and the attraction of non-residents to this market segment. But such statements are not entirely correct because, according to the international standards of the GFS and the PSDS, the debt of the state to non-residents is considered an external debt. And any external debt generates currency risks for the country’s balance of payments, even if they do not directly relate to the state budget.
Thus, currency and refinancing risks inherent in Ukraine’s public debt structure remain critically high. Although the substitution of external commercial loans by internal ones and the maturity of the latter have had a positive effect on the debt risk profile for the public finance sector.
It is dangerous that, while facing a sharp “money hunger” in the economy, the government bonds market absorbs more and more of the available money supply, exacerbating the liquidity shortage in the real sector. The level of bank loans to the corporate sector relative to GDP at the end of the third quarter of 2008 was 24%. Today, in the Czech Republic, Poland, Slovakia and Croatia, the level of bank loans relative to GDP is twice higher than in Ukraine.
The level of monetization of the Ukrainian economy (the ratio of money to GDP) is extremely low and continues to decline. According to forecasts, at the end of the year it will make up 33% of GDP.
Thus, the active sale of government bonds to finance the budget deficit causes the following unfavorable trends:
- More than double growth of government loans and the amount of repayment of public debt in January-October of this year increased the debt dependence of public finances and increased fiscal risks.
- Growth of the presence of foreign portfolio investors in the government bonds market increased the liquidity risks for the government and the risks of balance of payments volatility.
- High interest rates on hryvnia government bonds led to the diversion of budget funds for unproductive needs and led to the poor financing of education, culture and health care.
- Attracting domestic and external government loans at high rates has also led to an increase in the share of debt payments in budget expenditures.
- The government borrowed money in the domestic market partly deposited in the single treasury account and generated additional interest payments from the budget.
- An increase in the debt-to-cash ratio deepened the real-sector monetary deficit and exacerbated the distortions of the national monetary market.