Fitch Ratings has upgraded Ukraine's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to 'CC' from 'RD' (restricted default).

"The upgrade of Ukraine's LTFC IDR to 'CC' follows the execution of consent solicitation on 11 August to restructure external debt, which we deem constitutes completion of a distressed debt exchange (DDE), curing the 'restricted default," Fitch said in a report.

Fitch said that near $6 billion of principal and interest on Ukraine's Eurobonds has been deferred by 24 months, alleviating external debt servicing pressure, in the context of weakening international reserves and acute war-related spending needs.

At the same time, as Fitch said, the 'CC' rating reflects unresolved debt sustainability risks resulting from Russia's attack and Ukraine's highly stressed public and external finances and macro-financial position.

Fitch expects the war to extend well into 2023, driving public debt above 100% of GDP, adding to the already huge costs to infrastructure and economic output, and fuelling inflationary and external pressures, while deficit financing sources remain uncertain.

"A broader restructuring of the government's commercial debt is therefore probable in our view, although the timing is uncertain," Fitch said, adding that it could potentially be in 2024.

Fitch also said that the prospects of a negotiated political settlement over the war with Russia are weak. The Ukrainian government appears unlikely to cede any substantial territory lost to Russia, and we anticipate President Putin will continue to pursue an objective of undermining the sovereign independence of Ukraine. "It is unclear either side will have sufficient military superiority to deliver on objectives, which could result in a long-drawn-out conflict," Fitch said.

Fitch forecasts the economy contracts 33% this year, with a shallow recovery of 4% in 2023. Fitch projects inflation to accelerate from 22.2% in July to 30.0% at end-2022 due to monetary financing, ongoing supply chain disruptions, weak monetary policy transmission and the hryvnia depreciation, and to remain high in 2023, averaging 20.0%.

International reserves fell $5.7 billion to $22.4 billion in the four months to end-July driven by financial account outflows. Fitch projects the current account will return to a deficit of 1.7% of GDP in 2023, putting further pressure on international reserves.

Fitch forecasts the general government deficit rises to 28.6% of GDP in 2022 and remains large in 2023, at 21.9%, due to the ongoing war effort and need to replace critical infrastructure.

According to the report, Fitch does not consider there has been a material change in the default risk on Ukraine's local-currency debt since the agency downgraded the Long-Term Local-Currency (LTLC) IDR to 'CCC-' on 22 July.

"The lower default risk than on foreign-currency debt partly reflects the greater disincentive for the government to restructure local-currency debt, given 47% is held by NBU, a further 40% by banks, and just 6% by non-residents, and the absence of strong international pressure to bring domestic debt into a restructuring process," Fitch said.