Moody's downgrades Ukraine's ratings, changes outlook to negative

23 May, 01:26 PM
Moody's believes that Ukraine's GDP could suffer

Moody's believes that Ukraine's GDP could suffer "irreversible" losses (Photo:Photo: L’echiquier financier / flickr)

Moody's Investors Service ("Moody's") on May 20 downgraded the Government of Ukraine's foreign and domestic currency long-term issuer ratings and foreign currency senior unsecured debt ratings to Caa3 from Caa2.

Moody's has also changed the outlook to negative from ratings under review.

"The downgrade of the ratings to Caa3 is driven by the increased risks to Ukraine's government debt sustainability from the invasion by Russia leading to a more protracted military conflict than Moody's initially expected, which increases the likelihood of a debt restructuring and losses being imposed on private-sector creditors," the report says.

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The agency stressed that this concludes the review for downgrade that was initiated on Feb. 25, 2022.

According to analysts, while Ukraine is benefitting from large commitments of international financial support, helping to mitigate immediate liquidity risks, the resulting significant rise in government debt is likely to prove unsustainable over the medium term. Concerns around the sustainability of such a high government debt burden may impede further access to official financing for the purposes of servicing commercial debt.

It is noted that the negative outlook reflects that there is still a high degree of uncertainty around how the invasion will evolve and its credit implications.

"A more protracted military conflict following the invasion by Russia would keep financing needs very high for a prolonged period and result in a further rise in the debt burden. Hence, the recovery by investors in the event of default could be lower than 65-80%, which would be consistent with a rating below Caa3," reads the report.

Moody's expects the military conflict will be more protracted than initially assumed and forecasts real GDP will contract sharply by around 35% in 2022 given the heavy human toll, significant damage to Ukraine's productive capacity and infrastructure as well as the very large displacement of the population.

While Moody's expects the economy to gradually start to recover from 2023, Russia's invasion will likely cause some permanent loss in GDP even if significant external support is provided to help reconstruction.

The more protracted military conflict will act as a drag on the government's financial resources, with Moody's estimating financing needs of around $50 billion (35% of 2022 GDP) for 2022 and forecasting a rise in government debt to around 90% of GDP from around 49% at the end of 2021.

Moody's also believes that Ukraine's fiscal sustainability will also face risks over the medium term from the GDP-linked warrants issued as part of the 2015 debt restructuring.

Subject to a number of conditions, Ukraine is required to pay 15% of the additional economic output it generates if real GDP growth is above 3% and 40% if real GDP growth is above 4%. In particular, strong reconstruction-led growth in 2024 could trigger large payouts on the instruments from 2026, once the 1% of GDP payment cap no longer applies.

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