17:38 22.10.2018

S&P affirms ratings on Ukraine at 'B-/B', outlook remains stable

7 min read
S&P affirms ratings on Ukraine at 'B-/B', outlook remains stable

S&P Global Ratings affirmed its 'B-/B' long- and short-term foreign and local currency sovereign credit ratings on Ukraine. The outlook is stable, S&P has reported.

"We expect the new arrangement will aid Ukraine's efforts to cover sizable external debt obligations maturing next year, and also help to anchor macroeconomic policies through the 2019 presidential and parliamentary elections (2019)," S&P said.

S&P anticipates that a new program announced by the IMF will be approved by the end of 2018.

S&P also reaffirmed its 'B-/B' global scale ratings on Ukraine and 'uaBBB' Ukraine national scale ratings. The outlook remains stable.

"While Ukraine has not received a disbursement under its IMF program since March 2017, we anticipate that a new program announced by the IMF will be approved by the end of 2018. We expect the new arrangement will aid Ukraine's efforts to cover sizable external debt obligations maturing next year, and also help to anchor macroeconomic policies through the 2019 presidential and parliamentary elections. We are therefore affirming our 'B-/B' global scale ratings on Ukraine and 'uaBBB' Ukraine national scale ratings. The outlook remains stable," according to a report on the agency's website.

"The stable outlook reflects our expectation that Ukraine's existing extended fund facility (EFF) program with the International Monetary Fund (IMF) will be terminated early but a new 14-month program will be secured in its place. This will help anchor macroeconomic policymaking through Ukraine's 2019 presidential and parliamentary elections. We also expect that, as Ukraine makes some progress with conditionality under the new arrangement, it will be eligible for additional disbursements from international donors. This concessional funding will aid Ukraine in issuing additional commercial debt to meet its external repayments coming due over the next 12 months. Ratings pressure could build if disruptions to funding from external donors and/or the government's inability to tap capital markets over the next few months called into question Ukraine's ability to meet large external repayments over 2019," according to the document.

"Additionally, an adverse ruling in Ukraine's legal battle with Russia over a eurobond issued in December 2013, and held by Russia, could have fiscal implications for Ukraine, in our opinion. In a worst-case scenario, it might create technical constraints for Ukraine's ability to repay its commercial debt, which would pressure the ratings. We anticipate there will be appeals to the Supreme Court in the U.K. following the recent Court of Appeal decision in London to allow a full trial of the case, further prolonging the overall proceedings. We note that the government believes there is no potential for technical constraints on debt service, even in the case of an adverse ruling in the future," it says.

"We could consider a positive rating action if economic growth significantly outperforms our expectations, alongside improvements in fiscal and external imbalances that would allow the National Bank of Ukraine (NBU) to continue easing its capital account restrictions, and if we conclude that the security situation in the non-government-controlled areas in Ukraine's east has stabilized and a further escalation is unlikely," the experts said.

"Our ratings on Ukraine reflect the country's weak economy in terms of per capita income and its challenging institutional and political environment, which remains heavily exposed to a lack of transparency at various government levels. Moreover, our ratings are constrained by Ukraine's large external refinancing risks, which necessitate continued compliance with its IMF program. Despite fiscal consolidation efforts, the stock of public debt is still large. It stems from costs associated with the cleanup of Ukraine's banking sector and only gradual progress in reducing the large pension fund deficit. Ukraine's high consumer price inflation is another rating weakness. Despite declining in recent months, it remains outside the NBU's target. The monetary policy transmission mechanism is also still weak because of the very high share of nonperforming loans (NPLs) in the banking sector," they stated.

"A new $3.9 billion IMF program with a less demanding structural reform agenda is slated to replace the existing program domestic demand continues to drive Ukraine's economic recovery. We project real GDP growth of 2.8% on average over 2019-2021. The slow pace of reform implementation is likely to result in the early termination of the existing IMF EFF program, but we anticipate another program, with a lighter emphasis on structural reforms, will be in place to see Ukraine through the 2019 election cycle. The likely outcome of the two elections next year is still unclear, a large part of the electorate remains undecided," the report says.

"Ukraine is in its third year of economic recovery after real GDP contracted by 16% over 2013-2015. Domestic demand remains the main growth driver. In particular, household consumption has benefited from strong wage growth, falling unemployment, and significant remittance inflows from abroad. Investments, supported by government capital expenditure, are also growing by double digits. Over 2013-2015, real investments contracted cumulatively by over 41%, but have since rebounded, spurred by the improved macroeconomic environment and higher global commodity prices. The recovery in gross fixed capital formation has led to a rebound in imports. Moreover, rising oil and gas prices have increased Ukraine's import bill and the contribution from net exports to growth remains negative. We note that Ukraine's industrial producers, particularly in steel and aluminum, continue to partially rely on coal imports due to the suspension of trade with the separatist-controlled areas in eastern Ukraine since early 2017," it states.

"Ukrainian per capita wealth is low. Notwithstanding the nearly 20% average increase in nominal GDP since 2016, estimated per capita GDP ($2,800 in 2018) is still 70% of its 2013-level and the second lowest, after Tajikistan, in Europe and the Commonwealth of Independent States. Low income levels explain high net emigration. Over one million Ukrainians worked in Poland last year, with several hundreds of thousands in other neighboring countries. This has reportedly caused shortages of qualified labor in western Ukraine, for instance, where a successful automotive industry cluster has been establishing itself over the past few years. We project GDP growth will average 2.8% over our forecast horizon through 2021 supported by domestic demand. Absent accelerated reform momentum, however, such a growth rate is unlikely to help Ukraine's income levels converge, even with the less advanced members of the EU. The authorities have achieved some important reforms: the NBU's independence has been preserved; previously implemented gas tariff hikes have eliminated losses at state-owned oil and gas company, Naftogaz, and markedly reduced public deficits; pension reforms have been implemented; and financial stability has been strengthened after the country's largest bank, PrivatBank, was nationalized in 2016," S&P stated.

"And yet the pace of reforms under the IMF's EFF (signed in 2015) has slowed and reviews have stalled since March 2017. The establishment of an anti-corruption court and the adjustment of domestic gas tariffs have proved stumbling blocks. Over the summer, the authorities adopted legislation on the ACC and made further changes to bring the law in line with the Venice Commission's recommendations. The anti-corruption court will process cases brought forward by the National Anti-Corruption Bureau of Ukraine. The importance of and need for an independent anti-corruption court has been highlighted by the IMF and is underpinned by Transparency International's Corruption Perception Index, where Ukraine ranks at 130 of 180 countries," the agency added.

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