S&P downgrades Ukraine to 'CC', says default 'virtually inevitable'

By bne IntelliNews April 13, 2015

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Ratings agency Standard & Poor's has downgraded Ukraine's sovereign credit rating from 'CCC-' to 'CC', three levels above default, with a negative outlook. S&P said it views a Ukrainian default as "virtually inevitable", with Ukraine's sovereign debt to reach 93% of GDP in 2015. 

“The negative outlook reflects the deteriorating macroeconomic environment and growing pressure on the financial sector, as well as our view that default on Ukraine’s foreign currency debt is virtually inevitable,” analysts said in a report.

The report also said that it would classify the current efforts to restructure Ukraine's foreign currency debt as "tantamount to default".

"In our view, the biggest risks to regaining sustainable economic growth, and therefore sustainable debt levels, include re-establishing financial-sector and exchange-rate stability," S&P said. Ukraine's situation depends on external factors that Ukraine cannot influence, such as terms of trade and the Russian-backed insurgency in East Ukraine's Donbas region, according to the S&P analysts.

Ukraine's sovereign debt will reach 93% of GDP in 2015, the report finds, after rising in 2014 from 40.2% of GDP to 70.7%. 

GDP will fall by 7.5% in 2015, compared to a 6.8% fall in 2014, with growth of 2% resuming in 2016, according to S&P forecasts. Inflation will surge to 35% in 2015 from 12.2% in 2014, before slowing to 12% in 2016.

Despite a 40% devaluation of the hryvnia currency in 2015, Ukraine will continue to run a current account deficit, reduced to 1.7% of GDP in 2015 from 4.2% in 2014, and reaching 2% of GDP in 2016. 

S&P argues that the hryvnia, although officially floated in February 2015, is currently being artificially supported by a large hike in the refinancing rate and strict currency controls.

Moody’s Investors Service rates Ukraine at Caa3, two levels above default, and Fitch Ratings also puts Ukraine three levels above, at CC. 

Restructuring effort limited

As part of an International Monetary Fund bailout, Ukraine has been required to restructure debt payments to save $15.3bn over the next four years. However, Eurobonds comprise only 20% of Ukraine's sovereign debt, making it unclear how useful restructuring will be.  

The main bondholders include Franklin Templeton with around $7bn, and Russia, which holds $3bn in Eurobonds issued by Ukraine. Russia insists its bonds are “official” debt that Ukraine cannot restructure without jeopardising IMF funding. The IMF says it is undecided on whether Ukraine’s debt to Russia is official or private.

Ukraine's finance minister Natalie Jaresko says she plans to prolong maturities and reduce principal and coupon payments on Ukraine's Eurobonds.

The Russian-held bond “is likely to complicate matters” S&P said. “If Ukraine has to pay the $3bn in debt redemption this year, it will make it very difficult to find the $5 billion in expected debt relief in 2015 that underpins the IMF’s 2015 external-financing assumptions,” S&P said.

The lower rating would have "limited market impact" as it had been expected, Tim Ash of Standard Bank wrote in a note, adding, "Ukraine's financing, macro, political and security situation still looks very, very challenging".

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