Standard and Poor's has raised its foreign currency sovereign credit rating for Ukraine from selective default (SD) to 'B-/B', on Ukraine's completion of a distressed debt exchange operation, the rating agency announced on October 19. The new rating is defined as "highly speculative" and with S&P analysts estimating Ukraine's GDP fall in 2015 at a whopping 15%, Kyiv is not out of the woods yet.

The upgrade is another sign that Ukraine's economic collapse is bottoming out, but that there is a long road to be travelled to restore stability and growth. 

“The raising of the ratings to 'B-' reflects the government's gradual implementation of reforms that support fiscal, financial, and economic stability, alongside improvement in some of Ukraine's external indicators, including its increasing international reserves,” S&P analysts write. “As a result of the debt exchange, Ukraine has restructured about $15 billion of foreign public debt, with a 20% reduction in principal. This reduces Ukraine's gross financing needs by $8.5 billion in the next four years, with equal reductions for the country’s external financing needs.” 

“The stable outlook assumes that over the next 12 months the Ukrainian government will maintain access to its official creditor support by pursuing needed reforms on the fiscal, financial, and economic fronts,” the S&P report concludes.

Russian roulette

The next hurdle for Ukraine to jump is the fate of $3bn in Ukrainian sovereign Eurobonds due on December 20, 2015. The bonds are held by Russia's Sovereign Wealth Fund, and Russia has refused to consent to their restructuring.

According to S&P analysts, one of two scenarios is possible for the Russian-held bonds: Either Kyiv will pay the debt out of its international reserves to put the episode behind it; or Kyiv will not pay the bonds, leaving them in default.

In the second case, S&P analysts believe that the International Monetary Fund (IMF) will implement its "lending into arrears" policy, and continue disbursal of its $17.5bn, four-year Extended Arrangement program ending in 2018. “Most of the program finances the Ukrainian budget, including Naftogaz investment projects, and replenishes the National Bank of Ukraine's international reserves,” S&P analyst write.

GDP collapse

But even if Ukraine successfully navigates the Russian bond, the country will still be reeling from a predicted 15% collapse in GDP in 2015, according to S&P calculations, following on a 6.8% contraction in 2014, leaving “the government's renewed ability to access external markets subject to many domestic and external uncertainties.” The -15% forecast significantly exceeds the -11% forecast of the National Bank of Ukraine and the World Bank/IMF. 

The outlook for 2016 looks better following the bottoming out of Ukraine's GDP fall in the third quarter of 2015, says S&P, meaning 2016 growth could exceed S&P's current 2% forecast.

One 'known unknown' is Ukraine's sovereign private debt. “We do not know the exact amount for Ukraine's untendered debt. For this reason and because Ukraine's second-half 2015 performance could vary widely, our forecast that the ratio of gross general government debt to GDP will be just over 70% at year-end 2015 remains tentative,” the report states.

Shaky private credit

Although the sovereign credit might have stabilised, private credit still looks very shaky, which may feed back into financial stability, S&P analysts warn.

“[P]rivate gross external requirements, including trade credit, deposits, and other short-term debt, over the next several years remain very high - at $47.7bn (65% of GDP) and $44.5bn (52% of GDP) for 2016 and 2017, respectively, by our estimates,” S&P analysts write.

“Some of these obligations may be met by selling hryvnia for foreign currency and some may not be met, in our opinion. Both outcomes will weigh on reserves and confidence,” the S&P report concludes, adding that Ukraine's banking system currently scores the highest possible risk rating of 10. “Conditions in the financial sector appear precarious, with confidence in the system strained,” the report warns.