Comment: Debt at the heart of Ukraine’s woes

QUITE the scariest troubles are those that bubble up from nowhere. Those elaborate statistical models predicting how stock markets were likely to behave this year could now be facing a demolition ball.

Bill Jamieson. Picture: Ian Rutherford

Few of the stock market’s star-gazers at the start of the year listed “Ukraine crisis” as a potential de-stabiliser. But today, just over two months into 2014, and this country, convulsed by a bloody overthrow of its president, stands on the brink of a major military confrontation with Russia.

Markets in Europe and America seemed sanguine at all this last week. But events are moving swiftly. Do not expect this to last.

Ukraine now poses a direct threat to peace in Europe. Since markets closed on Friday it has ordered a full military mobilisation in response to Russia’s build-up of forces in Crimea. Acting president Olexander Turchynov has described Russia’s actions as “a declaration of war” and ordered the closure of airspace to all non-civilian aircraft. US President Barack Obama has called Russian troop deployments a “violation of Ukrainian sovereignty”. And with every hour, the Russian military build-up intensifies.

Why should these events, – “a quarrel in a far away country between people of whom we know nothing” – be of concern to western investors?

It is because, even if the military build-up stopped tomorrow, Ukraine’s most intractable problem is debt, masses of it, and with a stricken economy totally reliant on continuing supplies of Russian oil and gas.

Ukraine shows every sign of being a failed state. Its debt currently stands at 80 per cent of GDP and with foreign exchange reserves reckoned at just $15 billion (£9bn). Its debt obligations are closely intertwined with agreements it has made with Russia to ensure continuity of gas supplies, without which the country’s economy would be in an ever greater state of collapse.

All this will unnerve bond markets, with Russia, Ukraine’s principal creditor, in the firing line. Putin has moved to protect not only his political and military interests in Ukraine but also the substantial amounts Russia has extended to the country.

Just before Christmas Russia agreed to provide a $15bn aid package together with cheaper natural gas and “gas debt forgiveness” estimated to be worth $7bn a year for Kiev. But that package was already conditional, not just on Ukraine’s continuing loyalty to Moscow, but also on Ukraine complying with previous longstanding commitments to repay gas debts reaching as far back as the early 1990s. The aid required Ukraine to address the issue of outstanding non-payments of gas running, on Russian estimates, at more than $2bn a year since 2010. The country, even before the balloon went up in Kiev, is in no position to repay.

Last week, the financial guru George Soros argued that Ukraine needs a modern equivalent of the Marshall Plan. This, he pointed out, aided western Europe’s recovery from the ravages of the Second World War but did not include the Soviet bloc, thus reinforcing the Cold War division of Europe.

Today Ukraine desperately needs a gas debt payment plan.

Thus, even if a military conflagration can be avoided, Ukraine, and those western leaders who have rushed forward with offers of financial aid, have to arrive at a credible arrangement to honour debts even before direct economic assistance can begin. It is the complexity and depth of Ukraine’s problems as much as the immediate military flashpoints, that looks set to give bond and equity markets cause for serious reflection in the days ahead.

RBS presents a bonus payments paradox

A CURIOUS paradox lies at the heart of the latest bonus payments proposal at stricken RBS. Why, given its commitment to running down its investment banking division, should it feel the need to pay bonuses at all?

According to last week’s announcement of full-year figures showing a further loss in 2013 of £8.2 billion, a total of £567 million is to be paid in bonuses. Of this bonus total, £237m, or almost half, is accounted for by bonuses to investment bankers.

The argument is – as it has always been – that RBS needs to pay hefty bonuses in this division as staff are constantly being tapped to go and work for rival banks. But central to its plans for the next five years is a very substantial reduction in the size of its investment banking division.

If investment banking operations are to be reduced, why pay bonuses to retain staff, when RBS already looks all too keen to be shot of them?