Fitch affirms Ukraine's ratings at 'B' with stable outlook

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July 10, 2012, 6:28 p.m. | Ukraine — by Interfax-Ukraine


Fitch Ratings on July 10, 2012, affirmed Ukraine's Long-term foreign currency and local currency Issuer Default Ratings (IDRs) at 'B' with a stable outlook, Fitch said in a statement.

The agency also affirmed the Short-term IDR at 'B' and the Country Ceiling at 'B'.

According to the statement, the affirmation reflects the finely poised external financing situation. The international reserves of the National Bank of Ukraine (NBU) were steady in January-April 2012 at around $31 billion (or three months of current account payments) before posting falls in May and June, partly because of large external debt repayments. Pressure on reserves could re-emerge from Q312.

Fitch says it expects the current account deficit to reach 6% of GDP in 2012, but the main stresses are on the capital account. Household demand for foreign currency - which led to reserve falls in Q411 - appears to have picked up in June, and could accelerate.

Ukraine's external liquidity ratio is one of the lowest among Fitch-rated sovereigns at a prospective 55% in 2012. Private sector external debt accounts for much of the debt service due, but on aggregate, rollover rates have been over 100% since the crisis. Ukraine's limited ability to refinance sovereign external debt obligations risks pressure on the exchange rate and a decline in reserves.

The sovereign faces $6.4 billion in repayments and interest to the IMF in 2013, combining payments due from the government and the NBU. Fitch believes the government will likely re-access eurobond markets and IMF funding in 2013, allowing it to refinance IMF repayments, but will need to take the unpopular step of raising household gas tariffs in order to do so. By comparison, external market debt maturities are relatively low, at $1 billion in the remainder of 2012 and $1 billion in 2013.

Fitch's end-year exchange rate forecast reflects devaluation risks, which could lead to overshooting, given the fragile confidence in the hryvnia. A weaker hryvnia would increase the burden of external debt, including sovereign debt. Fitch notes that a more flexible exchange rate would help Ukraine absorb external shocks and adjust to movements in trading partners' exchange rates. The exchange rate has shown greater flexibility since May, weakening slightly from its post-crisis anchor of UAH 8 against the U.S. dollar.

Fitch expects real GDP growth to slow to 2.4% in 2012 but recover to 3.5% in 2013. Economic performance is dependent on the highly cyclical steel sector, and growth is sensitive to a downturn in the global economy or a eurozone growth shock.

The government successfully narrowed the general government deficit to 4.2% of GDP in 2011 from 7.7% of GDP in 2010, but it will widen slightly in 2012. A supplementary budget in April 2012 lifted spending and may overestimate revenues, while losses at state-owned energy firm Naftogaz will increase.

The general government debt/GDP ratio fell in 2011, ending the year at 27% of GDP, not including NBU debt to the IMF. Including state-guaranteed debt, government debt was 36% of GDP. The future path of the debt ratio will depend partly on the exchange rate. The government has increasingly issued foreign currency bonds on the local market as it lost access to the eurobond market and faced high borrowing costs in local currency, but at shorter tenors and high rates. Fitch estimates that around 10% of the domestic debt stock is now in foreign currency.

Banks' fragile balance sheets make them vulnerable to any devaluation or renewed economic slowdown, with potential costs to the sovereign, which has already injected up to 9% in capital into banks since 2009. However, in view of declining loan dollarization and the decreasing importance of external funding, banks are less at risk from devaluation than in 2008.

The Party of the Regions-led government faces legislative elections on October 28, 2012 with its popularity reduced, but should still win a majority. This would pave the way for fiscal tightening and action on outstanding IMF commitments. An election outcome that reduced governability and the government's ability to take necessary policy steps could increase pressure on the sovereign rating.

Fitch says the immediate rating outlook is highly dependent on Ukraine's ability to weather external and domestic shocks and secure external financing. A failure to secure IMF financing by early 2013 or improve confidence sufficiently to regain sovereign external market access over a sustained period would lead to dwindling reserves and sharp hryvnia falls. In this case Fitch would likely downgrade the sovereign. Successful refinancing and further consolidation of the public finances could lead to a positive rating action.

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