Fitch Downgrades Ukraine to 'CCC'

Fri Feb 7, 2014 11:43am EST

Link to Fitch Ratings' Report: Ukraine - Rating Action ReportLONDON, February 07 (Fitch) Fitch Ratings has downgraded Ukraine's Long-term foreign currency Issuer Default Rating (IDR) to 'CCC' from 'B-', and affirmed the Long-term local currency IDR at 'B-'. The Outlook on the local currency IDR is Negative. The issue ratings on Ukraine's senior unsecured foreign and local currency bonds are also downgraded to 'CCC' from 'B-' and affirmed at 'B-' respectively. The Country Ceiling is downgraded to 'CCC' from 'B-' and the Short-term foreign currency IDR is downgraded to 'C' from 'B'. Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch's sovereign rating on Ukraine was 28 February 2014, but Fitch believes that developments in Ukraine warrant such a deviation from the calendar and our rationale for this is laid out below. KEY RATING DRIVERS The downgrade of Ukraine's foreign-currency IDR reflects the following key rating drivers and their relative weights:- High -Political Risk/Uncertainty Political instability has increased markedly since Fitch's last rating review on 8 November 2013, adding to pressure on the sovereign credit profile. Street protests initially triggered at the end of November by the government's decision to reject an Association Agreement with the EU increased in scale and violence in mid-January, claiming several lives. The government response to the protests has weakened its popular legitimacy and put diplomatic ties under strain. Mykola Azarov resigned as Prime Minister at the end of January along with the rest of the government. Opposition leaders have rejected a power-sharing offer and demanded constitutional changes and early presidential elections in return for ending the protests, but talks between them and President Viktor Yanukovych have progressed slowly. This raises the risks of a prolonged impasse and renewed disorder, and increased policy uncertainty. Financing Flexibility/Market Access Sovereign access to external financing and the sovereign's ability to refinance a heavy external debt repayment schedule, have deteriorated. Russia lent Ukraine USD3bn of a USD15bn lending package agreed in December, but has put further disbursements on hold pending the formation of a new government. Fitch has previously warned that further Russian support is likely conditional on President Yanukovych's continued political survival. We no longer assume the Russian loan will be disbursed in full, while Ukraine has lost external market access. International reserves fell to USD17.8bn at the end of January from the already low level of USD20.4bn at end-2013, reducing the buffer available to the sovereign to service external debt. The NBU sold USD1.7bn in January to stabilise the hryvnia, and sales continued in the first week of February. Medium Economic Policy Coherence and Credibility Political uncertainty has contributed to a weakening in confidence in the Ukrainian hryvnia and in the exchange rate policy. The National Bank of Ukraine (NBU) is estimated to have sold at least USD2bn to support the currency since the beginning of January, and the hryvnia has depreciated 7% against the USD. While an orderly currency depreciation could aid external adjustment (the current account deficit reached 8.9% of GDP in 2013) and ration NBU reserves, there is a risk of a steep and uncontrolled depreciation, given the fragile confidence in the hryvnia. Political instability increases the risks of capital flight and financial instability. The NBU has also re-introduced capital controls effective 7 February 2014. These place a monthly limit on individuals' purchases of foreign currency, impose a five-day waiting period on corporates' purchases of foreign currency to service external debt and ban purchases of foreign exchange to make early repayments of external debt. The measures currently in force do not prevent corporates from servicing external debt, but given the fluid and uncertain state of affairs, there is a risk that controls could be tightened. Banking System Vulnerability Bank deposits have remained resilient and banks in Ukraine are fairly liquid. Fitch assumes that banks' balance sheets can withstand a depreciation of 10-15% in the hryvnia from the end-2013 level. However, there are emerging signs of stress in the banking system. Demand for foreign currency cash has risen, potentially leading to further steep exchange rate depreciation. These developments pose liquidity and asset quality risks, given the large amounts of foreign currency debt on private sector balance sheets. External Debt Sustainability The decline in reserves, weak outlook for the hryvnia and the reduced prospects of the sovereign accessing external funding undermine external debt servicing ability both at the sovereign and non-sovereign level. Similarly, a high share of foreign currency-denominated debt in public debt (57%) heightens the government's vulnerability to further sharp falls in the exchange rate. Ukraine's 'CCC' foreign-currency IDR also reflects the following key rating drivers:- -A weak business environment and poor governance indicators, even relative to the 'B' median. -GDP and inflation volatility are high, reflecting overheating before the global financial crisis and a deep recession in 2008-2009, followed by a slowdown and recession in 2012 and 2013, respectively. -The financial system remains fragile, burdened by non-performing loans (NPLs) of 30%, and represents a contingent liability to the sovereign, even after solvency support since 2008 worth 10% of GDP. -As a result of a weak monetary policy regime and fragile confidence in the hryvnia, dollarisation is high. However, high levels of dollarisation afford the sovereign some modest domestic financing flexibility in foreign currency. -Income per head is high (at purchasing power parity), and private sector estimates suggest that up to half of GDP is unrecorded. Human development indicators exceed 'B' median levels. RATING SENSITIVITIES The main factors that individually, or collectively, could trigger a downgrade: -Intensification of political and economic stress such that default on government debt becomes probable. -The main factors that individually, or collectively, could trigger an upgrade: -A return to political stability -Sovereign access to external financing, leading to reduced pressure on reserves -A return to sustainable growth and a moderation in fiscal and external imbalances KEY ASSUMPTIONS -Fitch assumes a prolonged period of political uncertainty and lack of clarity on the government's external financing plans. Contact: Primary Analyst Charles Seville Director +44 20 3530 1048 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Paul Rawkins Senior Director +44 20 3530 1046 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com; Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, ‘Sovereign Rating Criteria' dated 13 August 2012 and ‘Country Ceilings’ dated 9 August 2013, are available at www.fitchratings.com. Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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