Fitch Ratings has affirmed Ukraine’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘CC,’ the agency reported on Jan. 20.
“The affirmation of Ukraine's Long-Term Foreign-Currency IDR at 'CC' reflects Fitch's view that a further foreign-currency commercial debt restructuring is probable, given the magnitude of economic damage from the war with Russia and resulting large fiscal needs in the medium term, and that a degree of burden sharing by commercial creditors is a likely condition of the large financial assistance extended by the official sector,” the report says.
Fitch noted that the 24-month deferral in August of Ukraine's Eurobond payments provided $6 billion of external debt servicing relief, but leaves medium-term debt sustainability risks unresolved.
The agency believes that sovereign external debt servicing rises to a relatively high $5.4 billion in 2024 (excluding $3.5 billion in deferred Eurobond interest payments, which could be capitalized) and $7 billion in 2025.
“While the timing of any such restructuring remains uncertain, there will be greater impetus for negotiations if the security outlook improves, and as the expiration of the Eurobond standstill draws closer,” it said.
Fitch also forecasts GDP growth of 2% in 2023, with ongoing conflict preventing a sizeable return of refugees or large-scale investment, while energy outages following Russian strikes provide an additional headwind into 2023.
The agency reiterated that the Ukrainian economy contracted an estimated 31% in 2022, and net outward migration has steadily risen to 8 million (based on UN data, which may be overstated).
According to the forecast, inflation accelerated to 26.6% in December and Fitch forecasts it easing slightly to 21% at end-2023 as loss of productive capacity, electricity shortages, and only gradually improving supply chain disruptions offset weak domestic demand.
Fitch expects the war to continue deep into 2023, within its current broad parameters.
“In the near term, there is an absence of politically credible concessions that could form the basis of a negotiated settlement,” the experts said.
Fitch forecasts the deficit to narrow to 15.2% of GDP in 2023 due to partial enactment of budgeted real-terms social expenditure cuts and somewhat higher grants, but with defense outlays remaining well above the government target.
Fitch also projects general government debt/GDP increases by 37pp in 2022 to 80.2% (excluding government guarantees of 7.5% of GDP), and to84.0% at end-2023, with support from a high GDP deflator averaging 23% in 2022-2023. The foreign-currency share of state debt has risen to 66%, adding to exchange rate risks, although the share of longer-term, concessional debt has also increased, the agency added.
Moreover, according to Fitch, deficit financing in 2023 remains highly dependent on the budgeted $38 billion of bilateral and multilateral aid (up from $32.8 billion disbursed in 2022). The EU and the United States have committed $29 billion, and Fitch anticipates the full 2023 target will be met.
“We expect the domestic rollover rate of local-currency government domestic debt, which fell to 65% in 2022, to partially recover this year, helped by recent reserve requirement measures, a further rise in primary issuance yields, and current record-high bank liquidity (which has been supported by 28% growth in hryvnia deposits since the end of February),” the report says.
“This would allow a reduction in National Bank of Ukraine (NBU) state deficit financing, which accounted for 42% of the total since the end of February, despite falling to within the agreed UAH 30 billion monthly limit since spiking in 2Q22.”
The size of private sector capital outflows remains relatively stable, contained by capital controls, and international reserves ended 2022 at $28.5 billion, from $27.6 billion at the end of February. Fitch projects the current account surplus narrowing to 2.6% of GDP this year on the back of higher import growth, and international reserves at the end of 2023 at 3.8months of current external receipts, down from four months at the end of 2022.
Fitch stressed that the lower default risk of CCC- on domestic-currency debt compared to CC on foreign-currency debt reflects the greater disincentives to include local-currency debt in any further debt restructuring, given that just 5% is held by non-residents, while 55% is held by the NBU and a further 32% by the domestic banking sector (half of which is state owned) for which there could be associated financial stability risks.
“We also do not anticipate strong international pressure to restructure domestic debt, partly due to additional concerns this could undermine efforts to revive demand for new government debt issuance,” the agency said.