Fitch Affirms Ukraine at 'B-'; Outlook Stable
Oct. 27, 2017
(The following statement was released by the rating agency)
Fitch Ratings-London-27 October 2017: Fitch Ratings has affirmed Ukraine's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B-' with a Stable Outlook.
KEY RATING DRIVERS
Ukraine's ratings reflect weak external liquidity, a high public debt burden and structural weaknesses, in terms of a weak banking sector, institutional constraints and geopolitical and political risks. These factors are balanced against improved policy credibility and coherence, the sovereign's near-term manageable debt repayment profile and a track record of bilateral and multilateral support.
International reserves continue to increase reaching USD18.5 billion in September, the highest level since the end of 2013, driven by external disbursements and residents' use of FX assets. Ukraine's external buffers remain weaker than 'B' peers (3.5 months of CXP). Increased exchange rate flexibility, manageable foreign-currency commitments and moderate external imbalances mitigate near-term pressures on international reserves. FX controls still cushion external liquidity, although they continue to be gradually eased.
Near-term financing risks are limited, as sovereign debt repayments remain manageable due to the 2015 debt restructuring, the high proportion of domestic debt held by public sector institutions and multilateral support. USD1.59 billion in cash in Ukraine's treasury and domestic FX liquidity provides the sovereign with space to bridge gaps in external disbursements in the short term. Ukraine has also actively pursued liability management operations, mostly with the central bank, to ease its debt repayment profile and extend maturities over coming years.
Ukraine returned to international debt markets for the first time since 2013 placing USD3 billion Eurobonds (net USD1.3 billion financing after repurchasing USD1.7 billion securities, 44% participation rate, coming due in 2019-2020). The breathing space provided by the 2015 restructuring ends in September 2019, as Ukraine faces USD1.6 billion in external amortisations. External bond amortisations average USD2.3 billion in 2020 and 2021. In additional to market sentiment, Fitch believes that continued engagement with the IMF and multilateral partners is fundamental to maintain access to external markets.
As with previous reviews, the completion of the fourth review under the IMF EFF has been delayed. Although pension reform (a key condition) was approved and signed into law in early October, the heavily amended version has yet to be signed-off by multilateral partners. In addition, the government needs to put in place legislation on privatisation and the fight against corruption. Fitch expects the next programme tranche (possibly USD1.9 billion) next year after the approval of the 2018 budget and an agreement between the IMF and the government regarding changes to the formula to adjust household heating tariffs. Further disbursements from the IMF and other international partners will depend on progress in the structural reform agenda, most notably land reform and delivering results in terms of privatisation and the fight against corruption, which is subject to delays and execution risks as the 2019 electoral season picks up pace.
Gross external financing needs (current account balance plus public and private sector maturities) have eased but will average a high 70% of international reserves in 2018-2019. Fitch expects the current account deficit to increase to 4.1% of GDP in 2017 and average 4% in 2018-2019. In the short term, material net external borrowing by the private sector and a strong pick-up in FDI are unlikely, meaning borrowing by the public sector will provide the bulk of external financing.
Inflation will average 12.9% and finish 2017 above the National Bank of Ukraine's (NBU) target band of 8%-2% due to supply shocks (food prices). However, it is likely to decline gradually over the forecast period and average 7.8% in 2019, still above the 5% 'B' median. Ukraine's strengthened policy framework is underpinned by increased exchange rate flexibility, the NBU's commitment to sustainably lowering inflation, and moderate fiscal imbalances. The delay in the appointment of a new NBU governor has not led to policy uncertainty due to improved institutional capacity, recovering domestic confidence and favourable external environment.
Growth will likely remain weaker than 'B' rated peers, despite a forecast recovery. Fitch forecast growth at 2% for 2017 and expects Ukraine to accelerate to 3.2% and 3.7% in 2018 and 2019, respectively, driven by domestic demand. Private consumption benefits from improvement in real incomes and increased access to credit. Investment (21.4% of GDP) is experiencing a cyclical recovery, but it will remain below 'B' peers (24%).
Ukraine will record a lower general government deficit (2.7% of GDP) than peers (4.7%) in 2017. Expenditure pressures from wages and benefits, and potential fiscal loosening before elections create risks for the government's deficit target of 2.2% in 2019. Fitch expects deficits to average 2.8% of GDP in 2018-2019. On the back of primary surpluses, reduced financial sector outlays and moderate FX depreciation, Fitch forecasts general government debt to peak at 71.5% of GDP (83.3% including guarantees) this year, and to decline, for the first time since 2007, to 67.3% in 2018, still above the 58.5% 'B' median. Debt dynamics remain subject to currency risks (68% FX denominated).
The financial system is stable but weak. It continues to represent a contingent liability for the sovereign due to the large state presence (56% of total assets after the nationalisation of Privatbank). Total bank recapitalisation and clean-up costs between 2013 and 2017 are estimated at UAH401 billion (14.3% of 2017 GDP). Loan portfolio quality is weak, as NPLs account for 57% of total loans. NPLs net of provisions equalled 13% of total loans in H117. Deposit and credit dollarisation have declined to 42% (from 46.9% end-2016) and 44% (from 49.3%), respectively.
Despite significant progress in macro stabilisation, energy, pensions and the fight against corruption, political risks for the reform agenda stem from powerful vested interests, fragmented political forces, rising populist voices and the slow recovery after a deep crisis. Presidential and parliamentary elections are scheduled for 2019, increasing the political cost of reforms.
The unresolved conflict in eastern Ukraine remains a risk for overall macroeconomic performance and stability. There are constant clashes along the contact line, but a material escalation of hostilities is not part of our base case scenario. The USD3 billion outstanding debt dispute with Russia is in the English Court of Appeals. Fitch does not expect the resolution of the debt dispute to impair Ukraine's capacity to access external financing and meet external debt service.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Ukraine a score equivalent to a rating of 'CCC' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Macro: +1 notch, to reflect Ukraine's strengthened monetary and exchange rate policy which will support improved macroeconomic performance and domestic confidence. Increased exchange rate flexibility allows the economy to absorb shocks without depleting reserves
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, the following risk factors could, individually or collectively, trigger negative rating action:
- Re-emergence of external financing pressures and increased macroeconomic instability, for example stemming from delays to disbursements from, or the collapse of, the IMF programme.
- External or political/geopolitical shock that weakens macroeconomic performance and Ukraine's fiscal and external position.
The main factors that, individually or collectively, could trigger positive rating action are:
- Increased external liquidity and external financing flexibility.
- Improved macroeconomic performance and sustained fiscal consolidation leading to improved debt dynamics.
Fitch expects neither resolution of the conflict in eastern Ukraine nor escalation of the conflict to the point of compromising overall macroeconomic performance.
Fitch assumes that the debt dispute with Russia will not impair Ukraine's ability to access external financing and meet external debt service commitments.