How green is this debt?

How green is this debt?

On November 3, 2021, Ukraine’s state-owned power company, Ukrenergo, issued a $825 million green bond, backed by the full faith and credit of the Ukrainian sovereign. The declared purpose of this green bond was to repay the debt incurred by Ukrenergo and passed on to the state-owned Guaranteed Buyer – the only entity paying Ukraine’s renewable energy source (RES) electricity producers. The European Bank for Reconstruction and Development (EBRD) invested $75 million in the green bond.

Prof. Willem Buiter

The events leading up to and following this debt issuance provide painful reminders that Ukraine’s government institutions are weak and unable to fulfill the fundamental economic responsibilities of the state. Among these are the rule of law and the imposition and enforcement of laws, rules and regulations that support a competitive, dynamic, innovative and entrepreneurial economy and equality of opportunity; the provision of public goods and services and a fair and effective social safety net; and raising the necessary tax revenues in a fair and efficient manner. For Ukraine’s energy sector, policies are required to advance the synchronization with the EU and to put Ukraine on a path to meet its nationally determined contribution to the Paris Agreement on climate change.

Four things were wrong with this debt.

First, the debt was expensive. The yield on the 5-year green bond was 6.875%. The yield that same day on the US 5-year Treasury was 1.19%. Clearly, all is not well with the creditworthiness of the Ukrainian state, which is junk-rated – no higher than B – by the three leading rating agencies. The reason for this poor credit rating is a history of fiscal failure. Public expenditure is high for a country with the per capita GDP of Ukraine: Total general government expenditure was 41.4% of GDP in 2019 and (a somewhat Covid-inflated) 46.0% of GDP in 2020. Too little is spent on infrastructure and on targeted income support for low-income households. The tax system is poorly designed and administered; what should be the most efficient tax – the land tax - is not based on the value of the land but on the size of the plot. Land tax revenues are negligible. There is a very large informal or shadow economy, much of which escapes the fiscal and regulatory nets. Estimates of the size of the informal sector vary widely, with the 45% of GDP number produced by the World Bank at the low end of the range.

Second, the debt of the Guaranteed buyer to the RES producers should never have been there. It arose because the generous electricity prices guaranteed to RES producers by the feed-in tariffs established in 2008 were much higher than the extremely low electricity prices charged to households. Even though the government imposed a reduction of the feed-in tariffs from August 1, 2020, the rapid expansion of renewable energy production that started in 2019 – the result of an investment boom driven by the original feed-in tariffs - meant massive losses for Ukrenergo. Ukraine should charge all users of electricity, including households, its full long-run social marginal cost (including any climate change externalities) and address the inevitable adverse impact on low-income households with targeted fiscal support measures. Any resulting debt would, appropriately, be general government debt, held by the public, to be serviced out of general government revenues.

Third, not enough debt was issued. The domestic currency value of the green bond was around UAH 21.6 billion. The total debt owed to the RES producers is estimated at UAH 28 billion at the beginning of November 2021. More could easily have been borrowed as the issue was three times oversubscribed. In fact, no more than UAH 19.3 billion was transferred by Ukrenergo to the Guaranteed Buyer, of which only UAH 16.3 billion was allocated to RES producers.

Finally, according to the rules, all RES producers should have been paid the same proportion of the arrears owed to them. This did not happen. The UAH 3 billion that should have gone to the largest RES producer remained unpaid. The Director of the Guaranteed Buyer was summarily dismissed by the government when he refused to go along with this manifest violation of the rules. This must have given the EBRD second thoughts about the wisdom of its investment in Ukrenergo’s debt. It is incomprehensible why the IMF agreed, on November 22, 2021, knowing all this, to provide Ukraine, following the first revision of the current stand-by arrangement, with a loan tranche of $699mn.

Ukraine has made four commitments as regards climate change. President Volodomyr Zelenskiy pledged at the recent United Nations climate summit, COP26, to reduce emissions of greenhouse gases by 65% below their 1990 level by 2030 and to aim for carbon neutrality (zero net emissions) by 2060. Ukraine also joined the Powering Past Coal Alliance at COP26 and is committed to ending coal-fired power generation by 2035. Finally, Ukraine supports the Declaration on Forest and Land Use. The first of these objectives is not particularly ambitious, as Ukraine had already achieved a 62.4% decrease from Soviet era 1990 emission levels in 2019. The second and third objectives are challenging – Ukraine’s greenhouse gas emissions amounted to 332.11 Mt CO2 equivalent in 2019 and Ukraine currently is Europe’s third largest coal-fired power generator, after Germany and Poland.

Realizing these objectives will require massive investment in renewable energy power generation, storage and distribution. Ukraine’s track record on investment has been dismal, both in the private and public sectors. Investment in the private sector and FDI – a key contributor to innovation –have been discouraged by arbitrary and at times predatory behavior of the government The green debt saga is just one example. Public sector investment, including infrastructure, has also been inadequate. The business climate is dire. The 2019 Global Competitiveness Index of the World Economic Forum ranks Ukraine 85 out of 141 countries, with Bosnia and Herzegovina the only European country ranked lower (at 92). The 2021 IMD World Competitiveness Ranking has Ukraine ranked 54 out of 64. Of the European countries only Croatia does worse (59th). Transparency International’s Corruption Perceptions Index has Ukraine ranked no 117 out of 180 countries in 2020 – the worst of any European country and only slightly ahead of Russia (129). In the 2021 Index of Economic Freedom published by the Heritage Foundation, which covers rule of law, regulatory efficiency, government size and open markets, Ukraine is ranked 127 out of 169 countries and assigned to the “Mostly Unfree” category. It is ranked last of the 45 countries in the Europe region. It is high time for a radical change.

Prof. Willem Buiter

Visiting Professor of International and Public Affairs at Columbia University and an Adjunct Senior Fellow at the Council of Foreign Relations