Wall Street: Ukraine Debt Default Is Imminent

Who will get left holding the bag on all those tens of billions of dollars worth of debrs?

Fitch Downgrades Ukraine to 'C'

Wed 24 Jul, 2024 - 17:01 ET

Related Content:
Ukraine - Rating Action Report

Fitch Ratings - 24 Jul 2024: Fitch Ratings has downgraded Ukraine's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to 'C' from 'CC'. Fitch typically does not assign Outlooks to sovereigns with a rating of 'CCC+' or below.

A full list of rating actions is at the end of this rating action commentary.

Under applicable credit rating agency (CRA) regulations, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this schedule in order to comply with the CRAs' obligation to issue credit ratings based on all available and relevant information and disclose credit ratings in a timely manner. Fitch interprets these provisions as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch's rating on Ukraine is 6 December 2024, but Fitch believes that developments in the country warrant such a deviation from the calendar and our rationale for this is set out in the first part (High weight factors) of the Key Rating Drivers section below.

KEY RATING DRIVERS

The downgrade reflects the following key rating drivers and their relative weights:

HIGH

Start of Default-Like Process: The downgrade of Ukraine's LTFC IDR reflects Fitch's view that the agreement in principle reached on 22 July between the government and some Eurobond holders on restructuring terms, after parliament approved legislation last week allowing the government to suspend commercial external debt payments for three months, marks the start of a default-like process. In Fitch's view, the reported agreement with external commercial creditors constitutes a distressed debt exchange (DDE) under its sovereign rating criteria, as it involves a material reduction in terms, including reductions in principal amount and interest, and extension of maturities.

On 18 July, the Ukrainian parliament approved legislation that allows the government to temporarily suspend payments on state and state-guaranteed external commercial debt. Fitch expects that the sovereign will not service its external commercial debt, including the 2026 Eurobond coupon due on August 1st, until a restructuring agreement with bondholders is completed.

Restructuring Required by IMF Programme: The deal with bond holders and the law on debt suspension are consistent with the government's efforts to comply with its four-year USD15.6 billion Extended Fund Facility IMF programme, which foresees a debt restructuring with substantial debt reduction to create fiscal space and restore debt sustainability. In late June, Ukraine completed the fourth review under this programme.

Ukraine's ratings also reflect the following rating drivers:

'CCC-' LTLC IDR Affirmed: The higher rating for local-currency (LC) debt reflects our expectation that Ukraine will continue to service its LC debt and that LC debt will be excluded from a restructuring agreement with external commercial creditors, partly because only 2.2% of it is held by non-residents, compared with 41.4% held by National Bank of Ukraine (NBU) and 42% by domestic banks (mostly state-owned banks).

This ownership structure would limit the benefits to Ukraine from any LC debt restructuring by creating potential fiscal costs (including bank re-capitalisation). In addition, such a restructuring could create risks for financial sector stability and impair the development of the domestic debt market.

High Deficits, Rising Debt: Maintaining IMF and official creditor support is critical to meet high financing requirements derived from the war. In our June review, we forecast that the general government deficit will remain high at 17.1% of GDP in 2024, and considered that significant fiscal consolidation will be constrained by the continuation of the war (defence spending was 31.3% of GDP in 2023), maintaining elevated reliance on foreign financing. We also projected then that debt will increase to 92.5% of GDP in 2024, well above the projected 70.3% median for 'B'/'C'/'D' rated sovereigns, without including the impact of external commercial debt restructuring.

Manageable Macro-Financial Risks: International reserves stood at USD37.8 billion in June, but have declined over the past three months due to increased FX sales. Greater exchange rate flexibility, a credible policy mix and continued official support in line with the IMF programme reduce risks to macroeconomic and financial stability in the near term.

Near-Term Financing Availability: In June, we projected external budget financing requirements at USD39 billion in 2024, of which USD23.1 billion was disbursed in 1H24. In mid-June, the G7 agreed to provide a USD50 billion loan to Ukraine to be repaid with the interest proceeds from frozen Russian assets, which could reduce uncertainty regarding external financing sources in 2025. Nevertheless, the risk of reduced US support after the November elections, potentially weaker political support in Europe, and limitations in local bank's capacity to absorb rising government debt issuance means financing will remain challenging, in our view.

Protracted War: Fitch anticipates the war will continue throughout 2024 and into 2025 within its current broad parameters. While it is not clear either side could win a decisive advantage, there is also no sign of a willingness to make concessions, so the war could prove very protracted. Over a longer horizon, we anticipate some form of settlement, but view a 'frozen conflict' as more likely than a sustainable peace deal, at least for a significant period.

Ukraine has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Ukraine has a low WBGI ranking at the 29th percentile, reflecting the Russian-Ukrainian conflict, weak institutional capacity, uneven application of the rule of law and a high level of corruption.

Ukraine has an ESG Relevance Score of '5' for creditor rights given Ukraine's 2022 deferral of external debt payments and our expectation of a new restructuring.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

-The LTFC IDR would be downgraded to 'RD' and the affected securities to 'D' if there is failure to make a payment on a Eurobond in line with the original terms and within the applicable grace period, or if a debt restructuring agreement is achieved with bondholders involving a material reduction in the terms, and following confirmation that the exchange will be executed.

-The LTLC IDR would be downgraded to 'CC' on increased signs of a probable default event on local currency debt, for example, from severe liquidity stress and reduced capacity of the government to access financing.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

- Payment on external commercial debt in line with its original terms indicating that the government is no longer pursuing a commercial debt restructuring.

-The LTLC IDR would be upgraded on reduced risk of liquidity stress, potentially due to more predictable sources of official financing, greater confidence in the ability of the domestic market to roll over government debt, and/or lower expenditure needs.

read more at:

https://www.fitchratings.com/research/sovereigns/fitch-downgrades-ukraine-to-c-24-07-2024#:~:text=Fitch%20Ratings%20%2D%20London%20%2D%2024%20Jul,of%20'CCC%2B'%20or%20below.