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Russia tensions could hit Ukraine banks - S&P

LONDON (Reuters) - The refinancing of the debt of Ukraine’s highly leveraged banks is at risk if foreign investors take fright from worsening relations between the country and Russia, Standard & Poor’s said on Monday.

The ratings agency also said an escalation in tensions between Ukraine and Russia would lead to a drop in foreign direct investment into Ukraine, shutting down a key source of funding to cover the country’s widening current account deficit.

“Ukraine’s banking sector is highly leveraged and dependent on foreign investors to refinance existing debt. Western investors already have less appetite for Ukrainian risk than they did two weeks ago,” Frank Gill, S&P director of European sovereign ratings, told Reuters.

S&P estimates that foreign debt of Ukrainian banks reached more than $35 billion as at mid-2008, representing 28 percent of the banking sector’s total liabilities.

As a row continues over the use of a Ukrainian Black Sea port by Russian warships, the cost of insuring Ukraine’s debt against restructuring or default rose on Monday to its highest levels since Ukraine’s “Orange Revolution” of 2004. For more see [nLI728791].

Russia’s military intervention in Georgia’s breakaway region of South Ossetia has inflamed tensions among former Soviet countries, with Russia seen to be taking a harder stance against neighbours such as Ukraine and Georgia which aspire to NATO membership.

PARTY POLITICS

Gill said the Georgian crisis would probably lead to further political polarisation in Ukraine, cementing divisions between existing political parties, such as the pro-Russian Party of Regions and pro-Western parties associated with President Viktor Yushchenko and Prime Minister Yulia Tymoshenko.

“Those opposed to NATO entry will be more vehemently so, while the pro-Western side will redouble efforts to gain membership to NATO and other Western multilateral organisations,” Gill said.

Earlier in the day, Yushchenko’s office accused Tymoshenko of betraying national interests by not backing Georgia in its conflict with Russia. [nLI81850]

Gill said Ukraine’s “B+” credit rating was not under pressure as the ratings agency had already taken into account Ukrainian political risk arising from Russia’s tendency to intervene in the politics of its neighbours.

“There is a recognition among Ukrainian leaders of Russia’s importance to its economy. In terms of trade flows, Ukraine’s economy is more integrated into Russia’s versus Georgia,” Gill said, adding that Tymoshenko has shifted to a “more nuanced and pragmatic approach” towards Russia.

“There is always a risk of some kind of conflict between the two countries, but this is not part of our core expectations at this moment,” he said.

Ratings agency Moody’s also said the tensions were not likely to have an immediate impact on Ukraine’s B1 rating with positive outlook.

“Geopolitical issues are among the things we look at,” said New York-based Ukraine analyst Jonathan Schiffer. “We would probably wait and see what Ukraine’s response is, what the EU, U.S. and NATO’s response is. Then we would try to draw up a new balance sheet which takes these things into consideration.”

Schiffer said the risks of an overheating economy in Ukraine were hindering the country’s chances of a near-term ratings upgrade.

Ratings agency Fitch said last week that Ukraine faced greater risks to its BB- debt rating from the current account deficit, rising external debt levels and inflation than from tensions with Russia.

Ukrainian annual consumer price inflation stood at 26.8 percent in July.

Additional reporting by Carolyn Cohn; Editing by James Dalgleish

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