Bloomberg News

Putin Bets $15 Billion to Capture Junk-Rated Ukraine Vassal (2)

December 19, 2013

Russian President Putin and Ukrainian President Yanukovych

Russian President Vladimir Putin, left, greets President of Ukraine Viktor Yanukovych during their meeting in Moscow on Dec. 17, 2013. Photographer: Sasha Mordovets/Getty Images

Vladimir Putin got what he wanted by anchoring Ukraine to Russia and pushing the European Union back from his borders. The cost is yet to be tallied.

The Russian leader is lending $15 billion to a junk-rated borrower and offering a 33 percent gas-price cut on a gamble that Ukraine will become a permanent ally and President Viktor Yanukovych will hold off a surging protest movement in the 2015 election. The prize is a crucial step in his crusade to halt what he sees as the West’s relentless encroachment on Russian interests since the end of the Cold War.

Putin closes the year on a high note. He cemented Russia’s foothold in the Middle East by bolstering President Bashar al-Assad, a Soviet-era ally and buyer of Russian weapons, with a deal over Syria’s chemical weapons and encouraging the West to make concessions to Iran over its nuclear program. He focused on his backyard with a single stroke that ended Ukraine’s quest for financial assistance.

“The risk is that Ukraine is right now an economic black hole,” said Ariel Cohen, a senior fellow for Russian and Eurasian studies at the Heritage Foundation, a policy institute in Washington. “The EU and the U.S. have suffered a major geopolitical setback. The danger for Russia is taking upon itself a huge financial commitment.”

Merkel, Demonstrators

The deal unveiled two days ago in Moscow jolted Ukrainian bonds. It also gave coherence to Yanukovych’s decision to pull out of an EU free-trade pact last month, which had left the 28-nation bloc’s leaders frustrated. German Chancellor Angela Merkel on Dec. 16 gave voice to her dismay over the competition with Russia, saying “that’s not the way I want the neighborhood to look.”

That same emotion, compounded with the anger over a violent police crackdown, has kept thousands of Ukrainians protesting against Yanukovych and Russia in central Kiev for four weeks. The demonstrations got new impetus as activists and opposition leaders questioned whether part of arrangement hasn’t yet been announced -- what Ukraine has to give up.

“Victory will not happen soon,” Arseniy Yatsenyuk, the head of jailed ex-Prime Minister Yulia Tymoshenko’s party, told a crowd of pro-EU demonstrators in Kiev’s Independence Square last night as he vowed to continue the demonstrations. “But we will have victory because we are following the right path.”

For the Russian leader, the pact signed in a gold-plated Kremlin stateroom as the two countries’ entire cabinets looked on, is the high point of one of Putin’s overarching ambitions since he first became president on New Year’s Eve 1999.

Putin’s Push

Russia went to war in 2008 with another former Soviet republic, Georgia, as the Caucasus nation was strengthening its ties with NATO. Putin has also championed the Customs Union, an economic bloc that includes Kazakhstan and Belarus, with Armenia on its way to join.

Putin sees Ukraine, the second-most-populous ex-Soviet nation and an essential transit route for westbound gas, as essential to make the alliance a serious rival to the EU, according to Alexander Rahr, an analyst at the German-Russian Forum who wrote a biography of the Russian leader.

While Putin and Yanukovych insisted that they hadn’t discussed the Moscow-based trading bloc, “without Ukraine, the Customs Union will be on paper, it will be nothing, not serious,” Rahr said by phone from Berlin.

Russia will probably “have had to extract some unofficial reassurances” on future membership of its rival customs bloc as part of the deal, according to Nomura International Plc.

Bonds Rally

Part of the price is committing about 17 percent of Russia’s $88 billion National Wellbeing Fund, one of two sovereign wealth funds, to buying Ukrainian Eurobonds.

Ukrainian assets rallied, with the yield on Ukraine’s dollar denominated bonds due 2023 falling to a six-month low of 8.85 percent on Dec. 17. It traded at 8.94 percent at 10:09 a.m. in Kiev. The cost to insure Ukraine’s debt against non-payment with five-year credit default swaps also dropped for a seventh day today, decreasing a combined 404 basis points to 770, according to prices of data provider CMA.

For Russia, investors are increasingly focusing on the risk. Extending credit to Ukraine, rated the same level at Moody’s Investors Service as Egypt and Pakistan, is becoming a concern for investors, Goldman Sachs (GS:US) chief economist in Russia, Clemens Grafe, said by phone yesterday.

Forecast Cut

“The numbers aren’t insignificant anymore, as they are of comparable magnitude to Russia’s overall sovereign debt,” he said. “If the bet goes wrong, it will be seen on the balance sheet.”

Putin said today that while Ukraine’s credit rating isn’t high, Russia believes in the fundamentals of the country’s economy and its competitiveness.

The $15 billion of Ukrainian Eurobonds is “money that is that returnable,” he told his annual news conference in Moscow. “I don’t see that we are squandering anything.”

The gas price discount is temporary and can be extended if the two countries reach a long-term arrangement, Putin said.

The ruble closed at 32.9490 per dollar on Dec. 17 and gained less than 0.1 percent yesterday as Goldman and UniCredit SpA (UCG) said the Ukrainian deal may hurt finances.

UBS AG (UBSN) lowered its forecast for Russian state gas exporter OAO Gazprom’s earnings in 2014 by 6 percent, saying it doesn’t expect Russia to compensate the company for the discount.

‘Endless Turmoil’

“I don’t think that anybody can expect to win in the Ukrainian situation because it is an absolutely hopeless country with permanent and endless turmoil,” Fyodor Lukyanov, head of the Moscow-based Council on Foreign and Defense Policy, said in a phone interview. “This is very much a short-term solution.”

Ukraine, suffering its third recession since 2008 with foreign-currency reserves at a seven-year low, achieved financial stability with the Russian deal, Prime Minister Mykola Azarov said yesterday in Kiev. He also announced that his government would boost pay for teachers, doctors and other state workers from Jan. 1, and would propose a corporate income tax cut of one percentage point from 19 percent next year.

Yanukovych, who has started to lose support from some of the richest Ukrainians who were counting on integration with the EU, can now focus on solidifying his position ahead of presidential elections scheduled for the first quarter of 2015.

“From Putin’s point of view, he cannot trust any Ukrainian leader. He must realize that in a year or so, the situation could so much change that a new president will lead Ukraine, a more pro-Western president and he will have to start from scratch,” said Rahr. “There is a huge risk that the money will be lost.”

To contact the reporters on this story: Henry Meyer in Moscow at hmeyer4@bloomberg.net; Ilya Arkhipov in Moscow at iarkhipov@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net


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