Scope downgrades Ukraine's foreign-currency ratings to C with ratings under review
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Scope Ratings GmbH (Scope) has today downgraded Ukraine’s long-term foreign-currency issuer and senior unsecured debt ratings to C, from CCC, and placed the C ratings under review for a developing outcome.* Ukraine’s long-term local-currency issuer and senior unsecured debt ratings have been left unchanged at CCC with Negative Outlook. The Agency has placed the short-term issuer rating of S-4 in foreign currency under review for a developing outcome. The short-term issuer rating in local currency has been left unchanged at S-4 with Stable Outlook.
The downgrade of Ukraine’s foreign-currency ratings to C, reflects pursuant two credit-rating drivers:
Consent solicitation of the Ukrainian government for the restructuring of Eurobond debt and GDP-linked securities; and
- Further weakening of Ukraine’s external-sector resilience.
The downgrade of the foreign-currency credit ratings reflects an analytical adjustment under the methodology’s ‘extraordinary circumstances’ to account for likelihood of foreign debt restructuring.
Severe economic recession, substantive uncertainty around the future evolution of the war, and increase of risk to government long-run debt sustainability raise likelihood that, after potential suspension of select foreign debt service, more significant debt restructuring might be required medium run. An assumed lengthier conflict moving ahead raises military and humanitarian costs for the national government and delays the prospect of fuller economic recovery. In addition, a long-run reconstruction bill diminishes debt sustainability even after recovery gathers further traction. Furthermore, the war is impairing the health of the banking system.
The placement of foreign-currency credit ratings under review for a developing outcome reflects a window for an assessment surrounding negotiations for debt-service suspension. The review represents Scope’s view that the foreign-currency issuer ratings could be revised to a selective default credit rating within the forthcoming period should negotiations conclude successfully in distressed debt restructuring, resulting in changes of repayment from original contractual terms, or under any scenario of no agreement being reached with creditors and Ukraine opting to suspend payments unilaterally.
The foreign-currency ratings could be downgraded if: restructuring negotiations for foreign debt instruments arrive at successful conclusion with creditors, resulting in failure to service coupon or principal on an original due date and/or less-favourable terms of a debt obligation as compared with those of original contractual terms. Conversely, the foreign-currency ratings could be confirmed at C or upgraded upon conclusion of the review period if: Ukraine opted against suspension of payment on foreign debt instruments.
The local-currency ratings and/or Outlooks could be downgraded in case: the likelihood were to increase of debt restructuring that involves holders of domestic-currency debt, such as under a scenario of Ukraine’s debt sustainability outlook further weakening, funding challenges heightening and/or furthering of banking-system fragilities. Alternatively, the local-currency long-term rating Outlooks could be stabilised if the war were to reach a momentary ceasefire, the government’s debt-sustainability outlook were to improve and/or banking-system risks eased.
The downgrade of Ukraine’s foreign-currency long-term ratings to C reflects announcement1 of the Ukrainian Cabinet of Ministers on Wednesday, 21 July for sought postponement of payment on Eurobond debt between 1 August 2022 and 1 August 2024, to enhance resources for covering critical defense, social and humanitarian costs, and begin planning for the post-war reconstruction of the nation. Furthermore, abetting foreign-currency liquidity, the government seeks restructuring of GDP-linked warrants issued during the 2015 debt restructuring, such as postponement of payment on warrants, extension of a limitation on maximum payments from end-2025 to end-2027 and/or reduction of an annual payment ceiling from 1% of GDP to 0.5% of GDP for the period from 2023 moving forward.
The sought two-year postponement affects 13 issues of Ukrainian Eurobonds (reflecting an aggregate Eurobond debt stock of circa USD 20bn), with an aggregate USD 3bn maturing by July 2024: USD 912.35mn on 1 September 2022, USD 1.355bn on 1 September 2023, and USD 750mn on 1 February 2024. Alongside deferred interest payments on the 13 Eurobond issues over the next two years, aggregate savings through July 2024 are envisioned of USD 5bn2 (2.9% of average 2022-24 GDP).
At this stage, it remains unclear the full degree of support from creditors for the restructuring terms – even recognising significant international commitment to assist Ukraine and early indications of explicit backing from a representative group of the largest debt holders. Any modification to a series of notes needs to be approved by holders of two-thirds of the aggregate principal across all debt of the series and at least half of the bonds from each series incorporated. Eurobond and warrants holders have until 9 and 5 August respectively to vote on amendments for delay of associated payments. To achieve comparability of treatment, a group of governments of the G7 has furthermore agreed to suspend a slice of the nation’s bilateral official debt payments from 1 August 2022 until at least end-2023 “with the possibility of an additional year” and urged other creditors to do the same, although savings from the G7 are comparatively moderate.3 The government seeks agreement with bondholders by 15 August 2022 but, under any scenario bondholders do not agree to suggested changes, Ukraine plans to continue the servicing of its foreign debt. Ukraine presents foreign creditors additional interest payments after the period of suspension as one supporting element for creditors during negotiations.
The downgrade of foreign-currency ratings to C furthermore reflects further weakening of Ukraine’s external-sector resilience and capacity to service debt in foreign currency.
The National Bank of Ukraine (NBU)’s foreign-currency reserves eased to USD 19.4bn in June – above highly at-risk levels at this stage but having declined from peaks of USD 29.4bn as of December 2021. The pace of such declines has accelerated as the central bank attempts to defend hryvnia while supporting funding of a USD 5-7bn monthly state financing gap. External-sector cushions are unsustainable on present trajectory given modest reserve coverage of under 40% of short-term external debt liabilities (on remaining maturing basis) as of June 2022, declining from 62% at the end of 2021. This has raised balance-of-payment risks.
The NBU’s significant rate increase has reintroduced a positive real policy rate, even after inflation further rose to 21.5% YoY in June, with the NBU hoping the rate hike eases forex, reserve and dollarisation pressure. A further hike(s) of rates might be necessary to defend value of hryvnia and ease financial-system risk. The official hryvnia exchange has been devalued 25% against the US dollar on 21 July, resulting in significant convergence with the unofficial hryvnia rate. The full-scale invasion has meaningfully compromised Ukraine’s export capacity and brought imposition of goods-import restrictions.
After estimated output growth of 3.4% in 2021, Ukraine’s economy is expected to face a severe 31% economic contraction during 2022, prior to rebound of output in 2023 of circa 12.5%. The conflict’s escalation and decline of output have seen reversal of a strong pre-2022 declining trajectory of government debt and placed substantive strain on an outlook as regards long-run debt sustainability. Under a baseline economic scenario, assumptions are for a headline budget deficit of 19.7% of GDP this year, rising from a pre-crisis 4.0% deficit of 2019, followed by an average general government deficit of 14.9% over 2023-27. The general government debt ratio might reach 89.1% of GDP in 2022, from 48.9% in 2021, prior to concluding a forecast horizon (to 2027) around 90%. Given significant international goodwill for Ukraine, there is likelihood of longer-run debt forgiveness to address possible solvency challenges.
Ukraine’s credit ratings are supported by very significant international financial support. In addition to USD 1.4bn received from the International Monetary Fund via a Rapid Financing Instrument4 during March, the Ukrainian government seeks a new IMF programme and has received international financial assistance on concessional bases from many multilateral and bilateral benefactors. The sought restructuring would ease liquidity pressures over the coming years.
However, financing of Ukraine has relied overly heavily upon monetary financing via the NBU recently – amounting to USD 7.7bn raised from the central bank of an aggregate USD 24.6bn raised by government since escalation of the war through 21 July 2022, followed by USD 4.2bn via local government bond issuance and USD 4.0bn from the United States via grant monies5. An overly significant share of financing has furthermore been in the form of loan financing, raising medium-run sovereign debt challenges.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘b+’ for Ukraine. Ukraine receives no adjustment to this indicative rating via the reserve-currency adjustment under the sovereign methodology. As such, under the methodology, ‘b+’ final indicative ratings can be adjusted by the Qualitative Scorecard (QS) by up to three notches, depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative analysis.
For Ukraine, the following relative credit strength is identified under the QS: ‘monetary policy framework’. Conversely, ‘macro-economic stability and sustainability’, ‘debt sustainability’, ‘debt profile and market access’, ‘resilience to short-term external shocks’, ‘banking sector performance’, ‘social risks’, and ‘institutional and political risks’ are identified as relative credit weaknesses compared with Ukraine’s sovereign peers in the QS.
The combined relative credit strengths and weaknesses under the QS generate a two-notch downside rating adjustment. A further one-notch adjustment to CCC was made at rating-committee level to account for unique geopolitical risk relevant to the sovereign linked to ongoing war with the Russian Federation, representing an adverse contingency for the long-term outlook of the ratings. Aggregate adjustments signal a local-currency long-term credit rating of CCC for Ukraine. A further two-notch downside adjustment at rating-committee level is made to foreign-currency long-term ratings, reflecting solicitation for the restructuring of Eurobond debt. Aggregate adjustments signal a foreign-currency long-term credit rating of C for Ukraine.
A rating committee has discussed and confirmed these results.
Factoring of Environment, Social and Governance (ESG)
Scope explicitly factors in ESG sustainability issues during its ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) as well as in the qualitative overlay (QS). Under governance-related factors under the CVS, Ukraine presents weak performance across an aggregate of the World Bank’s six Worldwide Governance Indicators (WGI). However, since year 2015, in view of a significant institutional reform programme, percentile ranks improved across WGI. Ahead of parliamentary elections not later than October 2023, President Volodymyr Zelenskyy’s political group has seen support increase appreciably due to the President’s leadership since Russian military operations began on 24 February. In an assessment of Ukraine’s ‘institutional and political risks’ in the complementary QS, Scope evaluates this qualitative analytical category as ‘weak’ against Ukraine’s ‘b+’ indicative sovereign peer group – representing a credit-rating constraint.
Socially-related credit factors are similarly captured under Scope’s CVS quantitative model as well as QS qualitative overlay. In the CVS model, Ukraine receives strong scoring on income inequality (as captured through the ratio of the income share of the 20% of persons with the highest household incomes to the 20% of persons with the lowest household incomes), moderate marks on labour force participation rate, and below-average scoring with respect to an old-age dependency ratio. In addition, Ukraine’s comparatively modest GDP per capita (estimated of USD 4,828 in 2021) as a lower-middle-income economy and a medium (under a global comparison) level of unemployment (10.9% as of Q4 2021 for those of working age) are evaluated under the CVS. Declines of the working-age population weigh upon economic growth potential (estimated of 2.5%). In the QS assessment of Ukraine’s ‘social risks’, Scope evaluates this qualitative analytical category as ‘weak’ against the government’s ‘b+’ indicative sovereign peer group.
Finally, with respect to environmental risk – Ukraine scores poorly on the CVS on carbon emissions per unit of GDP (a proxy variable of “transition costs” in achieving a greener economic model in the long run) but Ukraine scores strongly on lesser degree of exposure and vulnerability to natural-disaster risk – the latter as measured by the World Risk Index. Ukraine’s marks are, moreover, strong under the CVS on ecological footprint of consumption compared with the country’s available biocapacity. Outside of the CVS, Ukraine ranked an improved 52nd on a 2021 Environmental Performance Index of 180 countries6. Ukraine plans to reduce emissions while growing the economy, reducing poverty and simultaneously combating aggression from neighbouring Russia – aiming to curtail greenhouse gas emissions from 62% under 1990 levels as of 2019 to 65% below 1990 levels by 2030, and thereafter achieve full climate neutrality not later than 2060. However, the conflict is triggering sizeable, long-lasting environmental and climate damage as far as waterways, air and soil pollution, forest destruction, and increase of carbon footprint via the use of weapons, which contributes to raising greenhouse gas emissions. In summer 2021, Ukraine constructively took first steps towards inauguration of a green bond market. Ukraine’s environmental objectives and challenges are also considered within Scope’s QS via an assessment of ‘neutral’ on ‘environmental risks’ as compared with indicative sovereign peers.
*On 25 July 2022, an addition was made to insert the former foreign-currency long-term rating level of Ukraine in the rating action paragraph. In the original publication, the first sentence of this rating action did not include the former rating level.
The main points discussed by the rating committee were: i) announcement of foreign debt restructuring; ii) scenarios for debt-service suspension moving forward; iii) Naftogaz restructuring; iv) external-sector dynamics; and v) peers considerations.
Rating driver references
1. Cabinet of Ministers of Ukraine, Decree dated July 19, 2022 No. 805, On the execution of transactions with the state debt in 2022
2. Ministry of Finance of Ukraine, Sergii Marchenko: Ukraine will Save USD 5 Billion during Two Years As a Result of Suspension of Debt Service Payments
3. French Ministry of the Economy and Finance, Group of creditors of Ukraine: statement
4. IMF, Ukraine: Request for Purchase under the Rapid Financing Instrument and Cancellation of Stand-by Arrangement
5. Ministry of Finance of Ukraine, Ukraine’s State Budget Financing Since the Beginning of the Full-scale War
6. Yale Center for Environmental Law & Policy, Environmental Performance Index
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sovereign Ratings, 8 October 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation YES
With Access to Internal Documents NO
With Access to Management YES
The following substantially material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst Dennis Shen, Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 January 2022. The Credit Ratings/Outlooks were last updated on 17 June 2022.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings of Ukraine are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Publication Calendar: Sovereign, Sub-Sovereign and Supranational Ratings" published on 7 June 2022 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for deviation. In this case, the deviation was due to announcement of the Ukrainian government to seek restructuring of its Eurobond debt – a potential event that Scope has highlighted in the past as core risk posing default rating implications. This event has prompted publication of this credit rating action on a date deviating from previously scheduled release dates per Scope’s sovereign release calendar.
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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