Fitch: IMF loan supports Ukraine, but risks remain

/Fitch Ratings, London, November 06, 08/ - Fitch Ratings says the IMF Executive Board's approval of a two-year stand-by arrangement (SBA) for Ukraine of USD16.4bn, with immediate disbursement of USD4.5bn, provides both vital financial support and an anchor of a well designed economic policy programme for the country. However, downside risks to creditworthiness persist. Ukraine is rated Long-term foreign and local currency Issuer Default B+ with Negative Outlook. "The substantial foreign currency finance and the attached policy conditions bolster Ukraine's financial position and prospects for putting its economy and financial system back on a sustainable footing," said Andrew Colquhoun, Director in Fitch's Sovereigns Group. "However, even with the IMF's SBA, the risks to Ukraine's macroeconomic and financial stability remain elevated as the economy faces a painful adjustment, which will test the authorities' commitment to sustain implementation of the IMF programme." The SBA is intended to support a strategy to restore macroeconomic and financial stability in Ukraine. Key elements of the strategy include a transition to a more flexible exchange rate policy, with base money the near-term policy anchor ahead of the introduction of inflation targeting; a tightening in fiscal policy to near-balance in 2009; and support to banking system stability including improving the mechanism for resolving bank failures, recapitalisation of viable banks, and enhanced deposit insurance. The programme envisages a recession in Ukraine, with real GDP falling 3% in 2009, and a rapid fall in the current account deficit to 2% in 2009, from 6% in 2008. Inflation is expected to fall to 17% in 2009, from 26% in 2008. Ukraine has a minority caretaker government and the country's long-running political volatility raises doubts about the ability of the politicians to stay the course. Approval of key reforms needed to secure IMF support was delayed by disagreements over the timing of fresh parliamentary elections which are still unresolved. In addition, presidential elections in late 2009 may extend the pressure on politicians to retreat on policy commitments. Fitch downgraded Ukraine on 17 October 2008 on concern over significant risk of a financial crisis amid signs of a deposit run in the first three weeks of October, accompanied by severe downward pressure on the hryvnia as foreign capital inflows dwindled. Ukraine's currency fell 40% against the strong USD from the start of the month to a trough on 29 October of around 7 hryvnia to the dollar. The dollarisation of Ukraine's banking system, with 51% of lending FX-denominated, exposes the country's domestic macroeconomic and financial stability to exchange-rate risk. Significant intervention by the National Bank of Ukraine (NBU) has bolstered the currency to around 5.8 hryvnia (to the dollar), but this has helped reduce official reserves to USD32bn, compared with USD38bn at end-September. The sizable IMF package must be assessed against Ukraine's large external financing need in 2009. Under IMF projections, Ukraine's current account deficit should narrow to about 2% of GDP in 2009 (about USD4bn) as import compression outweighs a terms-of-trade shock from rising prices for imported gas and falling prices for steel, a major export. Ukraine's private-sector short-term debt totalled USD28bn at end-June 2008, and Fitch estimates Ukrainian borrowers may have to refinance USD19bn of longer-term debt falling due in 2009. Deposit switching into FX and/or capital flight could put further pressure on Ukraine's external finances. Fitch notes the immediate IMF disbursement of USD4.5bn will not restore all the reserves lost in October's currency turbulence. Ukraine's ratings are supported by low public debt and moderate sovereign refinancing needs for 2009 of USD2.5bn, of which USD0.9bn is domestic (mostly in UAH) and USD1.6bn is external (including a USD0.5bn eurobond maturity in May). However, worsening economic prospects and requirements for further official support to the economy could erode Ukraine's fiscal strength in the medium term. Contact: Andrew Colquhoun, London, Tel.: +44 207 417 4316 Ed Parker, London, Tel.: +44 207 417 6340 Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364 Email: peter.fitzpatrick@fitchratings.com [2008-11-07]