A Warning for Investors Rushing Into Ukraine

(Bloomberg) --

Foreign investors piling into one of this year’s most lucrative emerging-market trades may be sleepwalking into trouble.

An underdeveloped secondary market means buyers of Ukraine’s local debt may be unable to sell their holdings if global risk sentiment sours. Even if they find a buyer for the bonds, an illiquid foreign-exchange market might mean further losses on potential depreciation in the hryvnia, which is the world’s best-performing currency this year.

“It could be a problem to sell bonds to locals with an attractive price in a short period of time,” said Taras Kotovych, an analyst at the ICU investment bank in Kyiv.

Those risks haven’t deterred most investors though, lured by one of the highest real interest rates in the world and policy momentum from the election of a new president. Ukraine is in the early stages of building its domestic debt market, as its economy recovers from a devaluation and war with Russian-backed separatists. The share of the nation’s hryvnia bonds held by non-resident investors has risen to 15%, from near zero at the beginning of the year.

Foreign investors have bought $4.1 billion worth of hryvnia-denominated government bonds this year, helped by smoother access since the country joined the Clearstream International SA network in May. Officials have also cut back capital controls that were put in place during the 2015 currency crisis.

Speaking in London on Friday, Ukraine’s Prime Minister Oleksiy Honcharuk urged foreigners to invest more in the country. Ukraine is committed to the rule of law and fighting corruption, and “is now very open for private investments,” he said at the European Bank of Reconstruction and Development’s Eastern Partnership Investment Summit.

While the inflows may be big for Ukraine, they are less than a third of the money poured into larger emerging markets such as Russia and Brazil.

What may be a risk to investors could be a boon for Ukraine, as foreigners opt to wait out any potential turmoil, as opposed to rushing for the exits.

The underdeveloped secondary market is “a kind of safety net,” for the country, said Mykhailo Rebryk, a senior analyst at Raiffeisen Bank Aval in Kyiv. Selling between 200 million and-500 million hryvnia ($8.3 million-$20.7 million) of bonds isn’t usually a problem, but if non-residents decide to get rid of their positions, that would impact yields, he said.

--With assistance from Daryna Krasnolutska.

To contact the reporter on this story: Áine Quinn in Moscow at aquinn38@bloomberg.net

To contact the editors responsible for this story: Alex Nicholson at anicholson6@bloomberg.net, Marton Eder, Justin Carrigan

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