November 18, 2015 / 10:38 PM / 4 years ago

Fitch Upgrades Ukraine's Foreign Currency IDR to 'CCC'

(The following statement was released by the rating agency) NEW YORK/LONDON, November 18 (Fitch) Fitch Ratings has upgraded Ukraine's Long-term foreign currency Issuer Default Rating (IDR) to 'CCC' from 'RD' (Restricted Default) and affirmed the Long-term local currency IDR at 'CCC'. The Short-term foreign-currency IDR is upgraded to 'C' from 'RD'. The Country Ceiling is affirmed at 'CCC'. Senior unsecured local-currency debt ratings are affirmed at 'CCC'. Fitch has assigned 'CCC' ratings to the eurobonds issued on 12 November and withdrawn ratings on those securities tendered in the debt exchange. KEY RATING DRIVERS The upgrade of Ukraine's IDRs reflects the following key rating drivers and their relative weights: High The country has emerged from default on commercial external debt, issuing new bonds on 12 November to holders of USD15bn in defaulted eurobonds. The restructuring pushes out maturities to 2019-2027 and reduces the debt stock by USD3bn (3.4% of GDP). Public debt sustainability has improved. Reduced refinancing needs and a pipeline of official financing give the public and external finances some breathing room and lower the risk of a sovereign debt crisis over the short- to medium-term. The rating level also reflects the following factors: Although real output has stabilised, with a 0.7% qoq seasonally adjusted rise in real GDP in 3Q, the economy will still contract on an annual basis by 11.6% in 2015, led by a 20% fall in consumption. Fitch believes a swift recovery is unlikely, projecting growth of 1% in 2016, compared with the government assumption of 2.4%. In 2017, we project growth could reach 2%-3%. The same factors that led to the deep recession in 2014 and 2015 continue to constrain growth prospects. Exporters face a permanent loss of Russian demand (its share of Ukraine's exports has shrunk to just 12% in 2015 to date from 24% in 2013), while military conflict in the east has damaged the industrial base and supply chains. Geopolitical risks will weigh on investor confidence. Banks are focused on repairing balance sheets and both the supply of and demand for credit will be constrained. Although Ukraine's economy is energy-intensive and will benefit from lower energy prices, the share of commodities (grain and steel) in exports means that low commodity prices are a net negative. The hryvnia has stabilised in a range between UAH22-24 to 1 USD. The National Bank of Ukraine floated the hryvnia in 1Q and was able to cut its policy rate to 22% in August. Energy tariff rises and currency depreciation led to a burst of inflation but this is now subsiding. Annual inflation fell to 46.4% in October. Prices declined 2.4% month-on-month, largely driven by a 13.8% fall in energy prices as the statistics authority included subsidised energy prices in the index for the first time. In May-September, monthly inflation averaged 0.6%, or 7.4% at an annualised rate. A further gas tariff adjustment in 2016 will push up prices again but Fitch believes that the National Bank's 12% inflation target for 2016 is within reach, provided further exchange rate instability is avoided. The government led by Prime Minister Arseniy Yatsenyuk has shown commitment to an ambitious package of reforms agreed with the IMF in return for USD17.5bn in financing under a three-year Extended Fund Facility (EFF), plus other official financing. Reforms include cleaning up the commercial banking system, introducing a free float of the currency, and removing fiscally costly distortions in the domestic gas market. The National Bank of Ukraine (NBU) has been granted a new mandate and will pursue inflation-targeting. Government indebtedness is high, exceeding 80% of GDP, including sovereign and sovereign- guaranteed debt. Fitch expects the government debt ratio to fall from 2016, but there is uncertainty over Ukraine's ability to generate the combination of GDP growth and primary fiscal surpluses that would reduce the debt/GDP ratio (including sovereign and sovereign-guaranteed debt) to the government's target of 71% of GDP by 2020. The government has kept a tight rein on public spending in 2015, freezing public sector wages and social benefits in nominal terms despite high inflation, and imposing wide-ranging cuts to make room for higher defence spending. Revenues have been boosted in 2015 by one-off sources: exceptional transfers of NBU profits to the budget (UAH61.8bn or 3.3% of GDP), and a temporary import surcharge (2.2% of GDP). The authorities will face a challenge in shrinking the consolidated budget deficit (including losses at Naftogaz) in 2016. However, without improvement in tax compliance, a proposed tax reform may do little to boost revenue. Governance indicators are weak. The conflict in parts of two eastern provinces, Donetsk and Lugansk, has subsided although it could flare up again. Russia and Ukraine agreed in October to continue to work to implement the Minsk II peace accords beyond the previous deadline of December 2015. This process should contain hostilities even if the agreement is not fully implemented. Ukraine has increased defence spending to 5% of GDP. The pro-reform ruling coalition continues to enjoy a majority in the Rada, but the government's popularity has declined and passing reforms is likely to remain difficult. This has already led to delays to measures required to pass the second review of the IMF programme due in September 2015, and decentralisation reforms related to Minsk II. One party left the coalition in September. Fitch believes that the result of local elections held on 25 October 2015 reduces the risk of early elections. Rival parties failed to make decisive gains and will not have been emboldened to try to overturn the existing majority. The banking system is fragile in the wake of the severe recession and currency depreciation and the conflict in the east of Ukraine. Non-performing loans, on a broad definition, as published by the IMF, are 44% of total loans, and provisions are 68% of total NPLs. On aggregate, the system lost UAH52bn in 9M15, or 35% of bank equity at the start of 2015. Banks have restructured external debts. The NBU has liquidated 58 banks since 2014, reducing the number of banks to 122. Bank recapitalisation and deposit insurance costs weigh on public finances. Steep exchange rate depreciation and a collapse in trade and domestic demand have led the current account back to balance, and Fitch expects a current account deficit of below 1% of GDP in 2015. Private sector capital flows have been negative as foreign direct investment (except that related to recapitalisation of foreign-owned banks) is muted and corporates make net repayments on (or default on) external debt. These outflows have been more than balanced by large-scale inflows of official financing. External liquidity measures are weak but have improved. Gross reserves have increased but are expected to remain low at USD15bn at end-2015 (end-October 2015: USD13bn). Capital controls remain in place to curb foreign exchange demand but will be progressively lifted. RATING SENSITIVITIES The following factors could individually or collectively lead to positive rating action: -Formal decision by the IMF to change its policy on 'lending into arrears' and willingness to disburse the tranche linked to the delayed second review of the EFF programme. The following factors could individually or collectively lead to negative rating action: -A change in the nature and status of the USD3bn bond maturing on 20 December (see assumptions below). -Substantial delays to disbursements by the IMF and other official creditors that lead to a deterioration in confidence and macro stability. -External or political/geopolitical shock. KEY ASSUMPTIONS Fitch assumes that the conflict in eastern Ukraine does not intensify. Fitch assumes that non-payment of the USD3bn bond maturing on 20 December 2015, which is held by Russia's National Wealth Fund, would not constitute a default under Fitch's Sovereign rating criteria. Fitch also assumes that any legal action resulting from non-payment of this debt does not hinder the servicing of newly issued external debt. Contact: Primary Analyst Charles Seville Senior Director +1 212 908 0277 Fitch Ratings Inc. 33 Whitehall Street New York Secondary Analyst Carmen Altenkirch Director +44 20 3530 1511 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country Ceilings (pub. 20 Aug 2015) here Sovereign Rating Criteria (pub. 12 Aug 2014) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=994362 Solicitation Status here Endorsement Policy here ail=31 ALL 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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