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18 July, 2016  ▪  Lyubomyr Shavalyuk,  Vitalii Melnychuk

Putin on the squeeze: The Yanukovych debt

The anatomy of Yanukovych’s “loan” from Putin. Should Ukraine repay it?

Breaking up the European Union, playing like equals with the US, and destroying Ukraine as a sovereign state—these are the prime geopolitical objectives of the Kremlin that Putin’s Russia is spending enormous resources on. And not just on acquiring modern weaponry, maintaining an army that is 800,000 strong, waging a massive information war, annexing Crimea and occupying Ukrainian soil in Donbas. The other major expenditure in the Kremlin budget is for “friends of Putin,” for bribes and pay-offs that Moscow figures will bring it geopolitical and strategic dividends. Ukraine is no exception there.

The Kremlin’s financial deals

Russia has been giving illegal financial support to extreme right and left parties in Europe in order to get them to set in motion the process of breaking up the European Union. It keeps the two pseudo republics in occupied Donbas, DNR and LNR, afloat and finances its fifth column in Ukraine to destabilize the situation and help anti-Ukrainian forces get to power. It was caught bribing top officials in FIFA in order to be given the World Cup championship games. Russia both legally and illegally buys off high-profile politicians and community activists in other countries in order to have leverage over both domestic and foreign policy there.

Not long ago, the US announced the start of a massive investigation into the Kremlin’s financing of parties and politicians outside of Russia, which the Congress delegated to the CIA, according to an article in The Telegraph. The leading position in this investigation could well involve financial and political deals that the Kremlin cut in Ukraine, on of which is the subject of this article.

Yanukovych’s debt

At the end of November 2013, Russian President Vladimir Putin and Ukraine’s Viktor Yanukovych cut a deal where Russia would lend Ukraine US $15 billion at 5% pa. The way the deal was set up, Yanukovych was to order the Azarov Government to agree to issue external government bonds worth US $15bn and place them on the Irish exchange in Dublin in several tranches. That is when the term “Ukrainian Eurobonds” first was used, meaning that Ukrainian government bonds were placed and sold on one of the European stock exchanges and were denominated in dollars, euros or another foreign currency.

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Russia, in return, promised to completely buy up the Ukrainian Eurobonds on the Irish exchange, tranche by tranche.

On Dec. 24, 2013, Ukraine’s Eurobonds—or, more accurately the “Yanukovych-Azarov bonds” were placed on the Irish stock exchange and immediately purchased by the Russian side. The very next day, the first tranche of US $3bn was placed on the account of the State Treasury of Ukraine. Insofar as Yanukovych left Kyiv on February 20 and shortly made his way to Russia, that tranche was the first and last.

Ordinary Ukrainians call this US $3bn loan “Yanukovych’s debt.” In essence, that’s what it is, but formally and legally, the money was received by the government of Ukraine and its ultimate beneficiary was supposedly the state budget, completely controlled by Yanukovych’s ally, Mykola Azarov, his son Oleksandr Yanukovych, the then-Governor of the National Bank of Ukraine Serhiy Arbuzov, Yuriy Kolobov, Oleksandr Klymenko and a number of others, all of whom belonged to the “Family.”

This means that the debt officially has to be repaid by the Hroysman Government today, out of the public purse, meaning out of the pockets of Ukrainian taxpayers. Whether it’s the right thing for Ukraine’s Government to do, to return this money from public funds to Putin, who is waging war against Ukraine, moreover money that was borrowed for Yanukovych’s private interests, a man whom the people pushed off his throne and chased off to Russia? There are a number of nuances.

Putin insisted on the loan

Our administrative audit and analysis shows that Russia gave Yanukovych this loan against all economic logic, common sense and a sober evaluation of the situation. The impression is that Putin for some reason really wanted to give this money to Yanukovych, based on a number of facts:

First. Russia had no spare cash at the time and its economic situation was not especially positive. Moreover, the budget year was just ending and there were severe limits on granting foreign credits that had already been reached.

The necessary funds were “found” in the Russian Federation’s sovereign National Welfare Fund (FNB), which accumulates surplus petrodollars that were earned when oil prices were high to cover pensions for Russian citizens. Then, with the go-ahead “from the highest level,” the funds for the future loan to Yanukovych were reserved in the FNB and the first trance of US $3bn was “invested” in “Ukrainian Eurobonds.”

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Second. According to Russian law at the time, the Fund was allowed to invest abroad only in government bonds with the highest rating, AAA, which meant only 14 countries at the time, including the US, Germany and the UK. Ukraine, meanwhile, was five positions down at B- in investment ratings. And in order to give this deal the veneer of legitimacy, the Russian Government effectively superseded the law and, in the best traditions of hand-managed governments, approved a special resolution on Dec. 23, 2013, one day before the Ukrainian emission was scheduled, that allowed itself to invest in the bonds of countries that were considered risky “based on individual Government resolutions.” Immediately after this, a second resolution was issued that allowed the RF to invest in those same “Ukrainian Eurobonds.”

Third. From the start, the Yanukovych loan had absolutely no investment appeal. From the outside, it looked like a waste of Russians’ money that had been accumulated for their pensions. At 5, the interest rate on the loan was not market-based, given that Ukraine was paying 8-10% on global financial markets for credit at that time.

Fourth. In 2013, Ukraine’s economy was stagnating and slowly slipping into recession. The current account deficit at the end of the year was US $16.5bn. The NBU’s gold and currency reserves had shrunk by US $7.1bn, not including, of course the money that came in as Yanukovych’s loan, and these holes needed to be patched.

All other factors being equal, the US $15bn that Ukraine was supposed to pay off within two years after receiving the first tranche would have simply been buried in the sand to support “stability” under Yanukovych. As it turned out, the money was spent much sooner than that: we now know that in 2014 global prices for raw materials began to fall sharply and that, after Ukraine received the US $3bn, the financial markets where the Yanukovych regime had been drawing liquidity over 2011-2013 closed their doors on Ukraine completely.

In short, the Yanukovych regime could not have repaid that loan.

Ulterior motives

Why, then, given all these facts, would the pragmatic and extremely cool-headed Putin—as authoritative experts assess him and have so far proved to be quite right—offer a reduced, non-market and economically and investment-wise foolish “credit” to Ukraine’s president? It would seem that the Russian president knew perfectly well that Viktor Yanukovych would never return the money—and he was not even counting on that: he was betting on something much more valuable than US $15bn of pension money that belonged to Russians.

What exactly might this something have been?

First. On November 27, 2013, two days after meeting with Putin in Sochi, Yanukovych refused to sign the Association Agreement with the EU at the Eastern Partnership Summit in Vilnius. Clearly, this refusal was one of the conditions for getting the loan from Russia. The first tranche of US $3bn was nothing more than Putin’s little “gift” for turning down Eurointegration and crushing the Euromaidan (which had begun on November 21 after then-Premier Azarov announced suspension of preparation for the signing of the Association Agreement with the EU). In short, a bribe, as President Poroshenko has referred to it.

If Ukraine’s rejection of Eurointegration had not been on the agenda in this one-on-one meeting between Putin and Yanukovych, there would have been no purpose for Yanukovych to fly to Sochi for urgently organized negotiations over “strategic cooperation” a day before the Vilnius Summit. Official meetings at that level are normally organized months in advance and never take place the way this one did.

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Second. There is little doubt about the second geopolitical condition for the provision of this credit. As of January 1, 2014, Ukraine was committed to joining the Customs Union and the Eurasian Economic Community (EAEC), a pseudo-economic international organization with little economic purpose—certainly for Ukraine—, but one that gave Russia considerable political and strategic leverage over the members.

This condition was evident in the hyperactivity of the Kremlin’s lackeys in 2013, such as Putin’s personal assistant Glaziev, and their counterparts in Ukraine. One of their tasks was preparing the falsified “academic” calculations that supposedly provided concrete numbers and illustrated the scale of the advantages for Ukraine that membership in the EAEC would bring and the losses that its economy would suffer from Eurointegration.

Third. Experts confirm that one of the other conditions was handing over companies in Ukraine’s military-industrial complex (MIC) to Russia and effective full-scale integration. Confirmation of this came in an urgent visit by the Russian Deputy Premier in charge of the RF MIC during that time to Dnipro, Zaporizhzhia and Kharkiv. Sevodnia, a Ukrainian paper, reported on Dec. 3, 2013:

“Today, the Russian Federation’s Deputy Premier Dmitri Rogozin arrived for a working visit in Dnipropetrovsk. He visited enterprises in the missile and space sector: the Pivdenniy Construction Bureau and Pivdenmash, the machine-building plant. ‘We are prepared to go as far as you are prepared to go,’ said Rogozin.”

Building the Kerch bridge, which is now on hold for lack of funding, was one of the points in the agreement, indicating that the active integrate Crimea into the Russian Federation was on the cards.

Fourth. At the end of February 2014, the Yanukovych regime was supposed to receive a second tranche of US $2bn from Russia. The prospectus for the issue of “Ukrainian Eurobonds” had already even appeared at the Irish stock exchange, waiting for their buyer. As events turned out, Russia never bought these bonds from the Government of Ukraine.

What went wrong? Plenty. Yanukovych’s ignominious zigzag from Kyiv to Kharkiv, then to Crimea and finally to Rostov-on-Don meant that all the secret deals between him and Putin with their ulterior motives lost meaning—and so the need for a “sweetener” for carrying them out disappeared as well. Had this debt been a genuinely financial one, nothing should have stood in the way of delivering the second and further tranches of the loan.

Toss the suckers”

But Putin would not have been Putin if he had not clearly planned out how he intended to toss the “khakhol suckers,” including in his understanding both “president” Yanukovych and Ukraine. He was confident of returning the principle with considerable interest, and Ukraine thrown in to the bargain—as events have shown.

First. The “loan agreement” included Russia’s unique right to present the bonds for redemption should Ukraine’s public debt rise above 60% of nominal GDP. This would have made the holders of Yanukovych’s debt preferential among all other holders of Ukrainian Eurobonds and all of the country’s other creditors. Given that Ukraine’s total external debt guaranteed by the state at the end of 2014 was US $70bn, that made Russia, which held only 4.3% of Ukraine’s debt, more influential than those creditors who held the remaining 95.7%.

This placed an instrument that afforded enormous financial pressure in Putin’s hands and an effective noose around Yanukovych’s neck. Facing international isolation after rejecting the Association Agreement and a coward by nature, he would simply have betrayed Ukraine’s interests, one by one.

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Second. One of the conditions of the “loan” was that Ukraine would not issue creditor counterclaims as a way of refusing to service the debt. In other words, if Russia had owed Ukraine anything, the Ukrainian Government would nevertheless have to pay interest and cover the principle of this “loan.” This is very similar to the situation now, where Ukraine is refusing to pay Yanukovych’s debt, arguing that the Kremlin illegally annexed Crimea and expropriated many Ukrainian assets. Russia claims that, according to the agreement, Ukraine has no right to do this.

And so, was Russia was already preparing to annex Crimea and anticipated the consequences by including the necessary conditions in the prospectus for the Eurobond issues? And so the very handy Yanukovych really did hand everything over to Putin.

Third. By its nature, the “loan” was an inter-state loan, but in its form was strictly commercial because it involved Eurobonds that were listed on the Irish stock exchange and could have been bought by anyone, whether an individual or a corporation. The fact that the RF Fund bought these “Ukrainian Eurobonds” that returned only 5% per annum, with dividends paid out twice a year, it could have sold them on to anyone, both in Russia and beyond it. That is, the Yanukovych debt is not inter-state. It’s the debt of Ukraine specifically, even though held by a state entity in Russia.

Fourth. Another aspect of this “loan” was provisions that allowed its status to be abused by playing both sides against the middle. International financial experts say that Russia refused to restructure this debt through the Paris Club, which handles issues with inter-state debts, arguing that the “loan” was private. At the same time, Moscow refused to restructure Ukraine’s external state debt held by private creditors, arguing that it was an official, therefore inter-state “loan.”

See you in court”

Russia has filed suit against Ukraine in a London court to recover the Yanukovych debt. The case is currently being considered.

Why did Russia not exercise its right to call in the US $3bn debt after Ukraine’s public debt passed 60% of GDP? The answer is very obvious: Firstly, with the changed circumstances, it would not have received what it had planned on from the very start, that is, the fulfillment of the hidden provisions of the agreement and the acquisition of parts of Ukraine in one form or another. Secondly, at that point negotiations over restructuring had already begun with private creditors, so Russia would not have been able to arrange an artificial storm on the Ukrainian Eurobond market. Moreover, no matter what anyone says, but the financial, organizational and verbal support of the West would have been enough to localize any such storm.

Given that Ukraine enjoyed the support of the EU and US, Russia was unable to make use of the Yanukovych debt as a lever to pressure Ukraine and gain dividends, so it went for principles instead, treating Ukraine as a sucker who’s not going to make you lose, no matter what. Moscow still expects to get back its US $3bn in full and so it’s gone to court to do so.

Sucker’s defense or sucker punch?

Ukraine’s arguments for not honoring Russia’s “loan” are based on four key points:

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First, the “loan” agreement was illegal because it did not come within the caps established by the Law on the State Budget. That 2013 Budget Law was only amended by the Azarov Government after the money had arrived from Russia, not prior to the agreement, as the Russians had done. The ceiling increase was backdated specially to match the amount coming in from Russia. This haste suggests that there were secret conditions for the issuing of this “loan” to Yanukovych.

Second, the Yanukovych regime, however odious it may have been, was operating under duress from repeated threats on the part of Russia and its lackeys, and trade restrictions that Russia tended to institute from time to time starting in 2012.

Third, there were secret, covert provisions that were not written into any of the agreements, as we discussed above, as well as a commitment to pay off debts to Gazprom. Possibly Ukraine’s lawyers will be able to expand the list and evidence of such hidden conditions prior to the case being heard in court.

Fourth, the annexation of Crimea and Russia’s expropriation of considerable Ukrainian assets, both state-owned and private, are self-evident. These actions by the Russian Federation not only resulted in enormous material losses for Ukraine and forced the country to increase spending to defend itself at a time when the destruction in Donbas and the annexation of a chunk of territory have resulted in a significant loss of revenues.

Premier Groisman has singled out this particular line of defense. According to Bloomberg, international lawyers say that this is the most persuasive angle. There’s no question that this approach to the defense is seen as promising by the Ukrainian side as well.

Odious debt: illegal and unenforceable

International law has a concept called “odious debt” that refers to national debt incurred by a regime for purposes that did not serve the best interests of the nation but was used for personal enrichment or to finance personal interests. And when such a regime is overthrown, the new government can abandon old obligations, which are considered the debts of that regime.

There’s no doubt that the Yanukovych debt qualifies as an odious one, because this money bought the rejection of Eurointegration and the acceptance of the Eurasian Economic Community against the will of the Ukrainian people. Furthermore, the Yanukovych regime was kleptocratic and criminal to the core. For them, the difference between the EU and the EAEC was not substantive or civilizational as many Ukrainians consider it. It was simply a matter that whoever was prepared to pay more, that’s with whom they would play ball. What’s more, at least half of the amount coming in was earmarked for the pockets of the Family and people connected to it. According to The Ukrainian Week’s sources, audits of state procurements during the Yanukovych Administration have shown that up to 50% of the amounts allocated from the state budget, especially for Euro 2012, went to companies owned or controlled by the Family.

In short, they traded Ukraine’s prospects like whitebait at the Odesa market. By 2013, this approach had taken on especially vivid forms. In mid-year, the regime had organized a huge investment conference involving business representatives from over 80 countries at which, like boxers in a ring, supporters of integration with the EU and EAEC were sicced on each other, raising the bets in the fight for Ukraine.

Not long ago, the black books of the Party of the Regions were published, testifying to the scale of personal enrichment of the Yanukovych regime, which far outstripped the first tranche of the Russian “loan.” If US $2bn was handed out as bribes and every amount backed in this book by authentic signatures of specific individuals, then at least as much again remained in the hands of those in power, who were none too generous and never ever forgot about their cut.

And so it was that the US $3bn donated by Putin passed through a state budget completely controlled by the Yanukovych clique and at least half of it was “detached” for the benefit of the Family. This was a kind of personal bribe that Yanukovych took for himself and shared with his henchmen (and henchwomen) as payment for services rendered to Putin.

A rigged regime, after all

The other aspect that is being raised more and more often, not only by civil society but also by some politicians, is the legitimacy of the Yanukovych regime. It is now apparent that Yanukovych came to power illegally and exercised his powers of government through intimidation, stupefaction, persecution, bribery, and threats to accomplish everything it wanted, from selling a plot of land to the right person to changing the Constitution. Evidence is also mounting that the presidential election of 2010 was rigged, just like the second round of the 2004 election, which led to the first Maidan.

Ukrainians can only hope that, sooner or later, the lion’s share of crimes of this regime will be brought to light and lead to court sentences and the incarceration of those who are guilty. If we think in terms of odious debt, then it’s possible to conclude that all of the debt incurred by Ukraine during the Yanukovych years qualifies as odious. The net growth of state debt and debt guaranteed by the state grew from February 2010 to February 2014, the period Yanukovych was in power, was US $30.5 bn. Most of this has nothing to do with Russia at all. It all went into the pockets of Ukrainian kleptocrats running entirely democratic and market institutions.

If Ukraine can prove the scale of theft of the Yanukovych regime over the four years it was in power to be on a similar scale as this figure—and it’s not at all unrealistic—then it can easily defend its right not to pay off any debts or to demand that all credits, not just those from Russia, but also market lenders, be restructured on far better terms. After all, they knew with whom they were dealing and they anyway kept giving Yanukovych money.

For Ukraine to successfully apply the concept of “odious debt” in court, it will have to have impeccable legal representation to prepare and execute this assignment. Ideally, Ukraine’s judiciary should show up in court in London with hundreds of volumes of cases describing the corruption of various members of the Yanukovych regime, complete with consolidated figures reflecting their theft, and a long list of those serving time. Prominent among them should be the case of the Yanukovych debt.

What have we instead? Prior to the release of the black books, there was nearly nothing, and even since the publication, the entire process could once again be stopped Under these circumstances and with the current state of Ukraine’s judiciary, to bring this case to a successful end will be difficult. With the necessary public pressure, however, it should be eminently doable.

Translated by Lidia Wolanskyj

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