12 Nov 2009 18:03

Fitch lowers Ukraine to "B-", outlook negative

LONDON. Nov 12 (Interfax) - Fitch Ratings has lowered the long-term foreign and local currency issuer default ratings (IDR) on Ukraine to "B-" from "B", the agency said in a press release.

The outlook on the ratings is negative.

The country ceiling rating was lowered to "B-" from "B" and the short-term foreign currency IDR was affirmed at "B".

"The recent adoption by parliament of an unaffordable minimum wage and pension law which, according to the IMF, could add 7% of GDP to the budget deficit in 2010, has effectively forced Ukraine's IMF programme off-track and has materially increased risks to fiscal financing, macroeconomic stability and creditworthiness," said David Heslam, Director in Fitch's Sovereigns Group.

Over the past two weeks, Ukraine's parliament has passed a new law increasing the minimum wage and pensions, and President Viktor Yushchenko has declined the IMF's call to veto it, the press release says. Moreover, the government has submitted to parliament a draft 2010 budget with a deficit of 8% of GDP. This compares with a commitment in the IMF programme of 4% (including the operational deficit of state-owned energy company Naftogaz NJSC (rated 'CCC' / Negative Outlook). In addition, the government has effectively abandoned the policy commitment to hike retail gas tariffs made at the time of the second IMF review in July 2009; as a result Fitch projects the 2009 deficit could reach around 8.5% of GDP (11% including Naftogaz), compared with a target of 6% of GDP (8.6% including Naftogaz).

On 7 November, Dominique Strauss-Kahn, the Executive Director of the IMF, said the IMF programme would be suspended, barring a reversal in such policies by the Ukrainian authorities, until after the presidential elections in January. A meeting on Tuesday between senior policy-makers in the government, National Bank of Ukraine (NBU) and presidential administration does not appear to have reached such an agreement. Although a reversal cannot be excluded - Prime Minister Yulia Tymoshenko said yesterday she hoped the courts would challenge the bill - it is not the base case. Furthermore, political dynamics mean the hiatus in IMF lending could be prolonged, particularly if there were a second round of presidential elections in February, possibly followed by parliamentary elections and then a delay in forming a new government.

The marked relaxation in the budget deficit and the loss of the main source of its funding, with the suspension of the USD4bn IMF tranche due for disbursement on 15 November has left Ukraine with a substantial fiscal financing gap. It would appear difficult and costly for Ukraine to cover the deficit through borrowing on the domestic or international market. Therefore Fitch sees an elevated risk that Ukraine could resort more heavily to monetary financing (via NBU providing liquidity to banks), effectively printing money. This would in turn risk undermining fragile confidence in the currency and the banking system, and/or a rapid loss of foreign exchange reserves. At the root of the problem is Ukraine's inconsistent macroeconomic policy framework, as the authorities are aiming to defend the exchange rate while avoiding necessary fiscal tightening in the absence of adequate sources of non-monetary financing.

Political dynamics mean policy may not be restored to a sustainable path before there is a further bout of financial instability. A further sharp depreciation in the hryvnia would intensify pressure on Ukraine's crisis-hit banking system. The non-performing loan ratio hit 30% at end-June 2009 according to the IMF, significantly affected by an 18% contraction in Q209 GDP (year-on-year) and by the hryvnia's near 60% depreciation since September 2008 (impacting the 54% of loans denominated in foreign currency).

Despite this challenging backdrop, Ukraine's creditworthiness is supported by its low sovereign debt repayment profile. It repaid maturing sovereign eurobonds worth USD1.2bn in August and September 2009, demonstrating a willingness to pay. It now has a pause in eurobond maturities until a yen-denominated bond worth about USD0.4bn falls due in December 2010 and a USD0.6bn bond due in March 2011. Gross foreign exchange reserves are USD28bn. The improving global outlook will provide some support to Ukraine's export industries. So far, rollover rates on private-sector external debt have been relatively high at over 80%.