Fitch Ratings has downgraded Ukraine's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to 'C' from 'CCC', the rating agency said on its website.

"Fitch typically does not assign outlooks to sovereigns with a rating of 'CCC+' or below. Fitch has removed all of the ratings from Under Criteria Observation (UCO)," it said.

"On July 20, the Ukrainian government formally launched a consent solicitation to defer external debt repayments for 24 months. Fitch views this as the initiation of a distressed debt exchange (DDE) process, consistent with ratings of 'C' for both the LTFC IDR and affected securities. According to Fitch's Sovereign Criteria, a commercial debt restructuring that entails a material reduction in terms, such as the deferral of interest or principal, and is necessary to avoid a traditional payment default constitutes a DDE. The LTFC IDR would be downgraded to 'RD' (restricted default) and the affected instruments to 'D' following the consent solicitation "effective date" should it be accepted, which we view as likely," it said.

"Even if not accepted, Fitch considers that the risk of missed payments or initiation of an alternative DDE process is high as the government seeks to preserve liquidity in the face of acute military spending pressure. More generally, we expect a broader restructuring of the government's commercial debt will be required, although the timing remains uncertain. This reflects severe stresses to Ukraine's macro-financial position, public finances and external finances as a result of protracted war," Fitch said.

"Following Fitch's recent introduction of +/- modifiers in the 'CCC' category, we have downgraded Ukraine's Local-Currency IDR to 'CCC-', from 'CCC'. The lower default risk than on FC debt partly reflects the government's somewhat greater ability to service LC debt, and greater disincentives to restructure, given that 40% of domestic LC debt is held by banks (and 52% of the sector is state-owned) and a further 47% by the National Bank of Ukraine (NBU). The share of domestic government bonds held by non-residents has fallen to just 6%, and we do not expect strong international pressure for Ukraine to bring domestic debt into a broader restructuring process," the experts stated.

"The war looks set to continue well into next year, with the prospects of any negotiated political settlement weak. The Ukrainian government, reflecting overwhelming domestic public opinion, appears unlikely to cede any substantial territory lost to Russia, and we judge President Putin will continue to pursue an objective of undermining the sovereign independence of the Ukrainian state. At the same time, it is not clear either side will have sufficient military superiority to deliver on objectives, which could result in a long-drawn-out conflict. The attritional nature of Russian military tactics, which includes the widespread destruction of physical infrastructure, is resulting in huge economic as well as human cost," according to the document.

"Fitch forecasts the Ukrainian economy to contract 33% in 2022, with a shallow recovery of 4% in 2023 constrained by ongoing war that limits seaport access and prevents commencement of any large-scale reconstruction … Fitch forecasts a full-year current account surplus of 2% of GDP, returning to a deficit of 1.6% in 2023, which together with ongoing financial account outflows will put further downward pressure on FX reserves. The monthly fiscal deficit averaged $4 billion in 2Q22, driven by war-related expenditure, and we forecast a full year general government deficit of 29.1% of GDP, a record high for Ukraine. Given urgent spending pressures, we view the size of monthly expenditure as largely a function of available finance. We project the deficit to remain large in 2023, at 22.4% of GDP due to the ongoing need to fund the war and replace critical infrastructure," the report says.

"Fitch forecasts general government debt to rise 48 p.p. in 2022 to 92% of GDP, and to 103% at end-2023 (excluding government guarantees, of 8% of GDP on latest data). The rating is supported by strong multilateral and bilateral support, favorable human development indicators, and prior to the invasion a credible macro-policy framework. Set against these factors are heightened geopolitical and security risk, low and falling external buffers, very weak public finances, the huge economic and human cost of the war, high inflation and macro-volatility, which also complicates IMF-program support," Fitch said.