TEXT-S&P summary: Ukraine
In our view, increased risk aversion toward Ukraine's funding needs has been fueled by the lack of clarity over the ultimate direction of government policy in relation to ongoing negotiations with the IMF and Russian gas company, OAO Gazprom (BBB/Stable/A-2). Currently, Ukraine is negotiating the resumption of the IMF's suspended lending program while talks with Gazprom are aimed at reducing the overall cost of gas supplied to Ukraine.
Boosting investor confidence, and thereby making debt refinancing more affordable, may require the government to make some politically difficult decisions. We think the burden of refinancing could be reduced:
-- If disbursements under Ukraine's roughly $16 billion (special drawing rights 10 billion, 8% of estimated 2012 GDP) IMF program, of which about 8 billion SDR remain undisbursed, were resumed. Further disbursements are conditional on the government increasing domestic gas prices by 50%, following an initial 50% price increase in August 2010, in order to phase out the annual deficit at state-owned utility, Naftogaz Ukrainy.
-- If the government's ongoing gas price and mandatory volume contract negotiations with Gazprom were to lead to the cost of gas imports decreasing, which would somewhat alleviate external accounts pressures.
In our opinion, the two are not mutually exclusive. A lower gas price contract with Gazprom could offset the need for domestically imposed gas price hikes and may result in the IMF resuming disbursements under the program. However, Ukraine's current relationship with Russia (BBB/Stable/A-3) is tense. It seems unlikely to us that a deal to lower the price of gas imports will be made without Ukraine giving up control of key energy infrastructure assets. Ukraine wants to cut its gas imports to 27 billion cubic meters in 2012 from an estimated 40 billion in 2011, and lower the price to around $250 per cubic meter from an expected average of over $400 in 2012. Gazprom has rejected these demands, arguing that the terms of the 2009 agreement must be honored.
So far, the Ukraine government has not clearly indicated its course of action. However, our base case reflects our expectation that domestic gas prices will be hiked to some extent in order to reduce the deficit at Naftogaz, once parliamentary elections have taken place on Oct. 28, 2012. As a result, we expect inflation to accelerate at the end of 2012 having decelerated sharply to average 1.7% in January-May 2012 from an average of 8% in 2011. We expect GDP growth and general government and current account deficits to average 4.0%, 3.5%, and 5.0% respectively over the period to 2015. At the same time, we expect foreign currency reserves to decline further as the central bank intervenes to prevent hryvnia depreciation. Meanwhile, the financial system continues to be vulnerable, with NPLs at around 40% of total loans.
In our view, the government is currently unwilling to pay the interest rates required to access international capital markets. At the same time, the government has found it necessary to diversify its debt issuance strategy in the domestic market away from straight hryvnia-denominated debt. Since the beginning of 2012 it has been issuing U.S.-dollar-denominated domestic T-bills, while there has been little demand for the government's other recent innovation (in December 2011) of hryvnia-denominated debt indexed to exchange-rate movements. At the same time, the interest rate to be paid on these government securities is increasing, highlighting the difficult financing environment the government is currently facing. The yield on government hryvnia-denominated T-bills placed on the primary market has risen to 13.7% in April 2012, up from 10.0% in December 2011.
We estimate the Ukrainian economy as a whole has around $50 billion in external debt due to be refinanced during 2012. Private sector companies other than banks hold the majority of Ukraine's external debt (51%), followed by the public sector (28%), and banks (21%). The government and National Bank of Ukraine (NBU) have around $2.6 billion in external debt to repay to the IMF and World Bank in the second half of 2012. At the same time, the government's external refinancing needs have been marginally eased by the renegotiation of its $2 billion loan from Russian bank VTB (BBB/Stable/A-3; see Fiscal Analysis section below).
The increased risk aversion to Ukrainian government securities has occurred despite the implementation of modest structural reforms of the tax code and pension system (see "Ukraine Long-Term Foreign-Currency Rating Affirmed At 'B+'; Local-Currency Rating Lowered To 'B+'; Outlook Stable," published Sept. 13, 2011), which we view as likely to improve economic growth prospects, while placing public finances on a more sustainable footing. Also, we estimate that the general government deficit including financial support for Naftogaz was reduced to 4.2% of GDP in 2011, from 6.5% in 2010, as the government curbed spending in light of tighter financing conditions.
The negative outlook reflects the likelihood that we could lower our long-term sovereign credit ratings on Ukraine if the country's external liquidity remains under pressure, as highlighted by the currently suspended IMF program, the government's (and other borrowers') lack of access to international capital markets, and sustained high current account deficits.
Conversely, we could revise the outlook back to stable if these indicators were to materially improve. In our view, such improvements could be brought about by a positive conclusion to the negotiations with Gazprom on Ukraine's gas contract and/or a resumption of disbursements under Ukraine's IMF program. We expect that such a resolution could take place in the months following the parliamentary elections in October 2012, at which time we expect to review the ratings again.
Related Criteria And Research
-- Sovereign Government Rating Methodology And Assumptions, June 30, 2011
-- Criteria For Determining Transfer And Convertibility Assessments, May 19, 2009
-- Introduction Of Sovereign Recovery Ratings, June 14, 2007
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