Oct 19- Fitch Ratings has revised the Outlooks on Ukraine's Long-term foreign and local currency Issuer Default Ratings (IDRs) to Stable from Positive and affirmed the Long-term IDRs at 'B' and Short-term IDR at 'B'. Fitch has simultaneously affirmed Ukraine's Country Ceiling at 'B'.
"The balance of risks facing Ukraine is now better reflected by a Stable Outlook, following an increase in sovereign external borrowing costs and associated concerns about external financing, as well as the impact of a forecast slowdown in global growth," says Charles Seville, Director in Fitch’s Sovereign group.
The ratings were assigned a Positive Outlook in July 2011. Since then, the agency has revised down its forecasts for global growth and increased investor risk aversion has led many emerging market currencies to weaken against the US dollar.
Fitch has previously noted that Ukraine’s combination of exposure to the pro-cyclical steel industry, de facto pegged exchange rate and domestic policy risks make it more vulnerable than most emerging markets to a deterioration in the external environment. External financing risks weigh on the rating. Ukraine has a high gross external debt of 77% of GDP, and a large external financing requirement. Its programme with the IMF has remained off-track since March.
In September, international reserves at the National Bank of Ukraine (NBU) fell by 8%, or USD3bn, to USD35bn, slightly above where they ended 2010. Reserves have come under pressure from a widening current account deficit, which is forecast to reach 4.5% of GDP in 2011, and from a flight to foreign currency cash by the private sector. Intensification of these trends would increase the likelihood of depreciation in the hryvnia.
While greater exchange rate flexibility might be desirable, depreciation would worsen the country’s solvency ratio (up to 60% of sovereign debt is foreign currency denominated or linked). It would also make private sector debts more difficult to service and pose additional risks for the financial sector.
The government budget is performing ahead of target so far in 2011 and the deficit is on course to reach around 4.5% of GDP. The government intends to reduce the deficit further in 2012. However, the 2011 overall deficit exceeds the target of 3.5% of GDP set out in the standby arrangement with the IMF, mainly because state-owned oil and gas company Naftogaz is set to make losses equivalent to 1.5% of GDP in the absence of adjustment to natural gas tariffs to households. The IMF agreement is off-track largely because the government has not raised gas prices to households as agreed.
A resumption of IMF lending would help Ukraine meet external financing challenges in 2012, when it starts to face substantial repayments to the IMF of previous lending, and would underpin confidence ahead of the 2012 legislative elections. The agreement offers SDR10bn (USD15bn) in balance of payments support through 2012 conditional on a number of fiscal and structural reforms. Budget financing plans for next year assume access to external market borrowing.
The signing of a free trade agreement with the EU, which had been scheduled for December 2011 could well be delayed, with an associated cost in terms of investment and trade. Relations with the EU have soured since a Ukrainian court sentenced opposition party leader and former Prime Minister Yulia Tymoshenko to a prison term in October for exceeding her authority in negotiating a gas pricing and supply agreement with Russia.
Renewed pressure on the currency, a shortfall in external financing or a severe deterioration in the external environment could result in downward pressure on the rating. Positive rating action could result if sources of external financing are secured and confidence is maintained, which would favour sustained real GDP growth and narrowing of the fiscal deficit.
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