Public Debt Management in Wartime: Interview with Ukraine’s Yuriy Butsa with OECD

Even in normal times, meeting a government’s funding needs through borrowing can be challenging. Wartime conditions – including suddenly increased borrowing needs, a loss of market confidence and operational difficulties – make it even harder. In this interview, Yuriy Butsa, Ukraine’s Government Commissioner for Public Debt Management, answers questions from Fatos Koc, Head of the OECD Public Debt Management Unit, about the challenges Ukraine has faced to date as a result of Russia’s large-scale aggression and about his near-term expectations.

What was the level of public debt before your country was invaded on 24 February 2022? What was your assessment of the government’s borrowing outlook?

Pre-war conditions were rosy for us. First, on the fiscal side, Ukraine recorded a low budget deficit in 2021 of 3.6% of GDP, which was expected to decline further to 3% of GDP in 2022. Ukraine’s government debt-to-GDP ratio was below 50%, down from about 80% in 2016. Second, Ukraine’s economy was recovering from the COVID-19 pandemic, with an annual growth rate that reached 3.4% in 2021. In view of this strong recovery, our central bank was already tightening monetary policy in 2021 to keep rising inflation under control.

Against this favourable background, government funding needs for 2022 were not challenging from a debt-management perspective. We were planning to meet the government’s financing needs through domestic debt (around two-thirds) and loan disbursements from international financial institutions such as the IMF and World Bank. We were expecting more non-resident flows to domestic markets with our first bond inclusion into the JPM GBI-EM Index starting from 2022. The key issue for us was whether to borrow from external commercial sources or, anticipating the external market backdrop, concentrate on maximising domestic market resources.

How has the war affected your borrowing needs and funding conditions?

The war completely changed the rosy picture that I just described. First and foremost, it deteriorated investor sentiments. We faced a panic sell-off in the market due to the fear and extraordinary uncertainty caused by the invasion, significantly impacting the yield curve. In particular, yields on our FX-denominated bonds surged to levels that restricted our access to international capital markets. What we were left with was the domestic market, in particular domestic financial institutions, and external support from donors.

At the same time, the war caused extreme uncertainty in the government’s cash flows. We lost visibility in terms of cash management as our pre-war estimates suddenly became irrelevant. We had to take into account the impact of the war on fiscal revenues and expenditures. The borrowing needs related to military expenses became the main question. In addition, we had to consider revenue losses from the territories under Russian invasion. In view of these considerations, we revised our cash forecasting model with new figures and shortened its horizon. We came up with some sort of a framework for three months of cash needs, roughly USD 5 billion per month. We assessed that USD 1 billion could be raised through domestic bond auctions, and the rest from IFIs and other bilateral sources. We also had to rely on the central bank as a lender of last resort.

At a time when our government needed cash the most, we had to adapt our financing plans quickly to meet this need on time and under the most favourable conditions. It was also important to avoid putting additional pressure on domestic banks. Hence, we made some changes to attract further demand from retail investors. We first re-labelled our bonds as ‘war bonds’. Then we reduced the minimum purchase amounts to 1 thousand Ukrainian Hryvnia (approximately USD 34). Finally, we asked the Ukrainian commercial banks for help with launching mobile applications and other web-based solutions to enable individuals to participate in our bond auctions. Our efforts paid off. So far, ninety thousand retail and business investors have invested in the war bonds.

In addition to the changes in borrowing techniques, we adjusted the borrowing maturity of our bonds, shortening the maximum maturity from 5 years to 1.5 years. This decision was made at the request of the Primary Dealers as the war and inflation trajectories make the pricing long-term bonds more difficult.

I should also mention that our government has continued with social spending in full, thereby increasing liquidity in the banking system. Thanks to this improved liquidity, there have been no bank runs. On the contrary, bank deposits increased, which has helped support the demand for government bonds.

How has the war changed your operational environment, including the morale of your staff, communication with investors and the debt issuance procedure? How did you manage to hold bond auctions under such extreme conditions?

We were evacuated from the office following the invasion of our country on 24 February 2022 when a missile exploded 200 metres away that very same day. At the beginning, we had limited access to the office and mainly operated from the western part of Ukraine.

We held the first auction on the sixth day of the invasion. I should note that our experience during the COVID-19 pandemic helped us a lot in terms of learning how to work remotely. Everyone, including our staff, investors and traders were already used to operating remotely. However, we faced a technical challenge for running auctions: the Bloomberg set-up of our primary auctions was not designed for remote access. We reached out to the Bloomberg team over that weekend. They were very supportive and we managed to have the system ready for a remote auction. This also required high-level cooperation with Primary Dealers and other investors.

Now we have a new normal. We have returned to our offices in Kyiv, which is now relatively safe. This is also good for staff morale. However, we remain prepared to switch to the remote working environment if necessary without any disruption in business continuity.

You have managed to weather the storm since the beginning of this year. What is your assessment of debt management preparedness to help respond to the operational, liquidity and funding challenges critical to support the effectiveness of a government’s emergency response and to calm the markets?

In terms of local bond market operations, we had to adapt some aspects of our business and borrowing instruments as I explained. One of our biggest operational challenges has been to run all the bilateral official loan negotiations, mostly with G20 countries. We have never had to engage in bilateral loans before. This requires additional capacity so we had to beef this up and establish a separate office for official funding activities.

We also had liquidity buffers in place before the war, with pre-financing and Special Drawing Rights allocation in 2021, which helped during January and mid-February (covering 3 months of spending). Ukraine as an emerging market country is subject to market sentiment so the liquidity buffer was helpful at the beginning.

Is there anything you want to add in terms of the lessons learned from this crisis so far? Do you envisage making any changes in operational aspects of your debt management when you return to normal?

Preparedness is the key word. An important element of business continuity is to have all the infrastructure solutions in place. For example, we – not just debt management but all government offices – should move to a cloud-based system. Our goal is not to be tied to any physical location.

Clearly, Ukraine will need enormous resources going forward, first to finance the resistance and support its people and economy, and then for the transformation and reconstruction of the country. How can this huge funding problem be overcome by a relatively small economy like Ukraine? What are the funding options and risks going forward?

This issue is high on our agenda. Until now, we relied on domestic market sources to the extent possible. Donor funding is also helpful, but it has limitations. However, going forward we cannot rely on domestic funding to meet our enormous financing needs. We are trying to solve this puzzle in a way that encourages private investors to invest in Ukraine, thereby contributing to the Ukrainian recovery. The question is how to improve the credit quality of Ukrainian bonds so that they can be attractive to institutional investors such as pension funds. In the past, the US government guaranteed Ukraine’s bonds as a credit enhancement facility. Having such official guarantees would decrease the risk for investors and reduce the costs of rebuilding our country.

Finally, we foresee plenty of environmental, social and governance (ESG)-related spending in the rebuilding phase. Once such a credit enhancement facility is put in place with the help of official partners, we may consider issuing ESG-labelled sovereign bonds to attract ESG-sensitive investors.