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Don't Pop That Cork Yet...
Rumor: Ukraine Debt Deal To Be Signed Tomorrow?

The rumor mill is churning away as the September deadline approaches for Kiev to cough up the dough for a massive sovereign debt repayment to a team of international creditors led by Franklin Templeton. The latest news, Bloomberg reports, has Ukrainian bond valuations soaring on the rumor that a deal to restructure the debt under terms reasonably favorable to Kiev is set to come out tomorrow:

The nation’s $2.6 billion of notes maturing in July 2017 gained 2.16 cents to 55.54 cents on the dollar at 7 p.m. in Kiev, headed for the biggest daily gain since July 2. Ukraine’s Novoye Vremya magazine reported Wednesday that a debt deal will be signed tomorrow, citing an unnamed source in Ukraine’s Finance Ministry. “There is no deal yet,” Finance Ministry spokeswoman Daria Marchak said by phone from Kiev. A spokesman for the creditor committee declined to comment.

A deal would end five months of negotiations between the war-torn nation and a creditor group led by Franklin Templeton. The sides appeared to come closer to reaching an agreement this week when a person with knowledge of the negotiations said they are considering a 20 percent cut to face value, half of what Ukraine was originally demanding of bondholders.

Across the hall at Bloomberg View, however, expert commentator on all things Ukraine and Russia Leonid Bershidsky, whose coverage of the ongoing crises has been quite solid, puts things in grim perspective, arguing Ukraine is too corrupt for the rumored debt deal to affect Kiev’s bottom line very much. After running through the results of a series of Bloomberg’s own analyses and surveys that lay out a much more pessimistic economic forecast for Ukraine than even the IMF is projecting, Bershidsky gets to what he identifies as the real insurmountable obstacle: the untaxability and unchangeability of Ukraine’s corrupt “shadow economy”.

Ukraine does have one reliable growth engine: its shadow economy. According to a recent paper from the economy ministry, in the first quarter of 2015, when the official economy was in freefall, the shadow sector increased its share of official GDP by 5 percentage points year-on-year, to 47 percent. That is a modest estimate based on an average from several methods, some of which are not particularly relevant to Ukraine. Measured by consumer spending and retail trade, the informal sector has swelled to 56 percent of GDP.

The two reasons for this expansion are corruption and tax evasion. The Ukrainian government is making a visible effort to combat graft — many official agencies have switched to transparent electronic procurement systems, and the newly formed National Anti-Corruption Bureau promises to send its first cases to court by the end of this year. Even so, businesses still complain of bureaucrats’ depredations, the national prosecutor’s office is locked up in a struggle between reformers and veterans used to the old ways, and the country’s notorious judicial system remains unreformed. Changes to the tax code are in the works, but these are insufficient to induce businesses to start paying payroll taxes instead of offering employees unofficial cash salaries.

Bringing the shadow sector into the reportable, taxable economy would be far more important to growth than the proposed debt write-off. Given the nominal first-quarter GDP of $15.7 billion, the unofficial turnover (assuming a 47 percent shadow economy) reached $7.4 billion in those three months alone. Even the war in eastern Ukraine, the government’s perpetual excuse, means less to the nation’s future than this, much quieter war with the sizable part of the country’s population that cannot imagine living by the rules.

The rumored deal would certainly be at least a bit of welcome relief in Kiev—among all the other challenges it faces, Ukraine has to pay back a $3 billion Eurobond to Moscow due at the end of the year. But if Bloomberg’s (and Bershidsky’s) analyses are right, the kind of hole Ukraine finds itself is too deep for any kind of one-time haircut to fully address. In other words, a deal tomorrow would at best loosen the noose a tiny bit.

And let’s not forget: at time of writing, we’re still just talking about rumors here.

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