Political turbulence and fragile external finances are weighing on Ukraine's (Caa3 negative) economic prospects and will hinder its ability to cover its upcoming debt maturities in the coming years, Moody's Investors Service said in its annual Ukraine Credit Analysis, noting that there is a high likelihood of a Ukrainian bond restructuring next year.
The rating agency expects the economy to contract by 7.5% in 2014 and by a further 6% in 2015, although the latter is subject to a high level of uncertainty depending on if and how the crisis is resolved. The 2014 result is in part due to a drop in domestic demand following the steep hryvnia depreciation of more than 50%, which caused inflation to rise to over 20% as of early December. Moody's expects the central government deficit to be around 5% of GDP in 2014.
The conflict in the eastern regions and the economic downturn have also caused public finances to deteriorate. Foreign exchange reserves fell to $8 bln in November, which is about one month's worth of import cover using reduced 2014 estimates of import levels.
The risk of default is rising as the government faces roughly $28 bln in external debt maturities next year, with new credit from the IMF, EU and other official lenders likely to be insufficient to cover these payments, says Moody's. External financing needs of banks and companies — state-owned oil and gas company Naftogaz especially — also remain substantial.
To meet these needs, the rating agency expects that the government will seek other sources of funding, including privatisation of state assets, in the near future. These will likely include companies in the energy sector, which remains a drag on the economy.
Moody's notes that Ukraine's external financing is already under pressure. While the government has received $3 bln in IMF support which has helped temporarily improve cash balances from very low levels at end 2013, the rest of the tranches that were scheduled for 2014 will only be received in the first quarter of 2015.
Moreover, Ukraine's debt burden continues to rise. Moody's estimates that a 50% currency depreciation would increase the country's debt stock to 76% in 2014 and 79% in 2015 given that around half of government debt is denominated in foreign currency.
Depending on the cost and volumes of gas imports and the flexibility of Gazprom, with regard to payment arrears for previously supplied gas, and assuming little or no capital flight — which is unlikely — Ukraine will need to borrow at least $15-20 bln beyond what is provided by existing programs over the next 12 months. In the estimate, Moody's assumes that the Russian government will not call for the early repayment of its $3 bln Eurobond due in December 2015.
The central bank remains dependent on new borrowing in the local market — which has become very expensive — and loans from the IMF, MDBs and bilateral creditors in order to plug the deficit and refinance debt falling due. Even with this new borrowing, however, the central bank is resorting to printing money to cover shortfalls.
In addition, high interest rates and recurring political instability are deterring both domestic and foreign investment, while the very weak state of the banking system is also restraining economic activity.
