* Foreign investors look again at Ukraine post-elections
* Global interest in local debt set to revive
* Eurobond issue seen in second half
By Sebastian Tong
LONDON, March 11 (Reuters) - After months of fretting about sovereign default, foreign investors are giving Ukraine a second look, with some arguing that asset prices don't fully reflect the promise of political stability.
The domestic debt market where international participation has virtually dried up in the last two years could be the next beneficiary of renewed investor interest which has already pushed Ukraine's foreign bond prices higher and yields lower. Despite a severe 15-percent contraction last year, Ukraine's economic prospects are seen improving following the mid-February election of President Viktor Yanukovich.
"This is most likely the best political landscape we've had in some time," said Jeremy Brewin, emerging debt fund manager at Aviva Investors.
Yanukovich's election has kindled hopes for an end to the political feuding that has paralysed national decision-making for years, culminating in November when the International Monetary Fund suspended its $16.4-billion aid programme.
The new president, who has promised to heal bilateral relations with major trade partner Russia, this week formed a new coalition expected to work on a new 2010 budget that will meet the conditions of its multilateral lenders.
Yields on Ukraine's dollar bond maturing 2013 are at their lowest in nearly 20 months as investors shrug off lingering doubts over the country's ability to service its debt.
State-controlled firms such as utility provider Naftogaz, railway company Ukrzalyznitsya and telco Ukrtelekom are among those that have entered restructuring talks with their creditors.
Senior officials have warned that the IMF may not return to prop up state finances until the second half of the year and that the country needs to find $3-5 billion per quarter for its budget requirements. On Thursday, newly appointed Prime Minister Mykola Azarov pledged cooperation with the IMF, warning that state coffers were empty and the country had to repay $5.5 billion in domestic debt by the end of this year.
GO LOCAL?
Analysts say that Ukraine's refinancing schedule for its foreign currency sovereign debt is relatively light.
A Japanese yen-denominated bond is due in December and a dollar bond matures next March but following these, no foreign bond repayment is due until mid-2012. Even without the IMF, RBS head of emerging markets research Timothy Ash notes that Ukraine's sovereign debt obligations this year are manageable given its US$26 billion foreign exchange reserves and $2.5 billion fiscal reserves. The cost of insuring Ukrainian sovereign debt has reflected this, with five-year credit default swaps falling to around 770 bps compared with an all-time peak of 5,545 bps a year ago.
Despite the increasing volume of Ukraine's short-term domestic debt and widening yields, "the chances of a domestic debt default are low because Ukrainian banks are pretty liquid and will continue to buy local currency debt issued by the state that is offering yields of around 20 percent," Ash said.
On Tuesday, Ukraine repaid in full and on time maturing treasury bills worth 596 million hryvnias ($75 million).
Local currency debt could start looking more attractive to offshore investors after the rally in Ukraine's foreign bonds.
Before the global financial crisis, non-resident holders of domestic securities accounted for nearly quarter of the market. A mere 0.7 percent of local government debt issued was bought by offshore investors last year, but latest central bank figures show non-residents holding 1.3 percent of government securities issued in the year to date.
"There should be further pick-up in foreign interest," said UniCredit analyst Dmitry Gourov in Vienna, recommending local currency government debt and short positions on dollar/hryvnia non-deliverable forwards in anticipation of an appreciation in the spot rate.
"Restored confidence is likely to move the dollar/hryvnia NDFs lower, thus NDFs at current levels should present a good opportunity with six-month/nine-month/12-month maturities implying around 10 percent yields," he said.
The central bank -- which has been intervening to stop the exchange rate strengthening below 7.98 to the dollar -- is likely to allow the currency to appreciate further after IMF funds are unlocked.
The resumption of the IMF programme coupled with benign global market conditions and newfound domestic political stability is also seen setting the stage for Ukraine to issue its first sovereign Eurobond since 2007.
In January, Kiev said it had begun talks with foreign banks in the hope of obtaining a bilateral loan or selling a publicly traded bond by May.
"Most managers are probably overweight their benchmark in Ukraine (foreign bonds) ... But if Ukraine came out with a new debt issue now, it would probably do quite well," said Nick Brown, emerging debt manager at Schroders. (Reporting by Sebastian Tong; Editing by Ruth Pitchford)