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Rating Action:

Moody's changes Ukraine's outlook to positive from stable, affirms Caa1 rating

22 Nov 2019

London, 22 November 2019 -- Moody's Investors Service ("Moody's") has today changed the outlook on the Government of Ukraine's ratings to positive from stable. At the same time, Ukraine's long-term issuer and senior unsecured ratings have been affirmed at Caa1.

The key drivers for the change in the outlook to positive are:

1. The rebuilding of Ukraine's foreign exchange reserves is reducing external vulnerability in the context of large external repayments; and

2. The improvement of Ukraine's macroeconomic stability and the prospect for renewed reform momentum is strengthening the country's economic resilience.

The affirmation of Ukraine's Caa1 ratings reflects its -- while showing signs of improvement -- significant external vulnerability. The sizeable external debt repayments due over the coming years would -- in the absence of a new International Monetary Fund (IMF) programme -- require continued market access. At the same time, the risk of a new flare-up in geopolitical tensions continues to constrain upward movement in the credit rating at this time.

Concurrently, Moody's has affirmed the Ca rating on the $3 billion Eurobond that Ukraine sold in December 2013. The sole subscriber of the notes was the Russian government. The bond is under dispute due to the international armed conflict between the two governments. The Government of Russia (Baa3 stable) has sued Ukraine for repayment of the bond in English courts, under whose jurisdiction the bond was issued, and the case is set for trial.

Finally, Ukraine's long-term foreign currency bond and deposit ceilings remain unchanged at B3 and Caa2 respectively, while the short-term foreign currency ceilings for bonds and deposits remain Not Prime (NP). The country ceilings for local currency bonds and deposits are also unchanged at B3.

RATINGS RATIONALE

RATIONALE FOR THE CHANGE IN OUTLOOK TO POSITIVE

FIRST DRIVER: REBUILDING OF RESERVES IS REDUCING EXTERNAL VULNERABILITY IN THE CONTEXT OF LARGE EXTERNAL REPAYMENTS

The first driver for the change in outlook to positive is the notable strengthening in foreign exchange reserves over the course of 2019, which is helping to improve the country's external position. Moody's expects foreign exchange reserves to remain close to their current levels of around $21.4bn (around 16% of end-2018 GDP), equivalent to more than 3 months of imports, which is significantly in excess of Moody's previous expectation, set at the time of the last rating action in December 2018. As a result, Ukraine's external vulnerability indicator, Moody's measure of reserve adequacy, is expected to fall to 211% in 2020 compared to our previous forecast of 354%.

Reserve accumulation has been supported by stronger demand for local currency bonds from foreign investors amid ongoing fiscal and monetary discipline as well as Ukraine's improved access to international capital markets following recent transactions. Financial markets reacted positively to the orderly political transition following the elections earlier this year. Foreign investment into local currency bonds, and increasingly into longer maturities, has been helped by the linking of Ukraine's domestic debt to Clearstream in May, with the share of total domestic government bonds held by non-resident investors now standing at around 22% when excluding National Bank of Ukraine holdings. The appreciation of the hryvnia over the course of 2019 has also created room for more substantial market interventions by the central bank aimed at strengthening foreign exchange reserves.

A new IMF agreement, which is currently under negotiation, would further support the sovereign's repayment profile in the face of still large external repayments. Furthermore, in addition to providing an anchor for structural reforms (see second driver), a new IMF arrangement would help to unlock associated funding from other international organisations including the European Union (Aaa stable) and World Bank, as well as likely further improve access to international capital markets.

SECOND DRIVER: STRENGTHENING OF UKRAINE'S ECONOMIC RESILIENCE DRIVEN BY IMPROVING MACROECONOMIC STABILITY

The second driver for the recommendation to change the outlook to positive is Ukraine's improving macroeconomic stability which -- together with the prospect for renewed momentum in the reform agenda -- is supporting a more resilient economic growth outlook.

Inflation has fallen closer in line with the central bank's target, which has allowed for a gradual easing in monetary policy, and helps to create the conditions for a stronger and more balanced growth profile. The economy has been growing for 15 consecutive quarters with the prospect for the very sharp pick-up in economic sentiment indicators in recent months to help support higher levels of investment which still remain lackluster relative to the country's needs. At the same time, the fiscal position remains prudent, with the general government debt burden expected to decline to around 54% of GDP by the end of next year, and will be supported by ongoing modest deficits with a target 2.1% of GDP outlined in the 2020 budget.

These improvements to macroeconomic stability are also reinforced by the orderly political transition following the elections earlier this year, which helps to reduce domestic political event risks.

The election of Ukraine's first single-party majority government, resulting in a less politically fragmented administration, raises the possibility for renewed impetus in Ukraine's reform momentum. In conjunction with the negotiations for a new programme with the IMF, the Ukrainian parliament has passed numerous pieces of legislation to progress the government's reform agenda which includes liberalizing the land market, continuing with anti-corruption reforms and increasing privatizations. That said, the government's very ambitious reform targets, including raising annual economic growth to 7% from 2021, will be challenging to achieve. In this respect, Moody's considers the new IMF programme would play an important role in providing not only financial but also technical assistance with implementing the reform agenda, and serve as an anchor against backsliding.

RATIONALE FOR AFFIRMING THE Caa1 RATING

The affirmation of Ukraine's Caa1 ratings reflects the country's significant external vulnerability. While showing signs of improvement, Ukraine's external position remains weak with large principal and interest payments on external government bonds due over the coming years. In the absence of a new IMF programme, these upcoming payments would require continued access to favourable market conditions. Furthermore, Ukraine's institutional capacity remains hampered by very weak governance standards. At the same time, the risk of a flare up in geopolitical tensions continues to constrain upward movement in the credit rating at this time.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Moody's takes account of the impact of environmental (E), social (S), and governance (G) factors when assessing sovereign issuers' economic, institutional and fiscal strength and their susceptibility to event risk. In the case of Ukraine, the materiality of ESG to the credit profile is as follows.

Environmental considerations are material to Ukraine's credit profile through its marked reliance on the agriculture sector, despite ongoing efforts at diversification, such that weather related developments can add to volatility to the country's exports.

Social factors are material to Ukraine's credit profile through its adverse demographic trends. A persistent demographic drag will likely constrain Ukraine's scope for strengthening its economic competitiveness.

Governance considerations are material to Ukraine's credit profile. Ukraine receives relatively unfavorable scores on the Worldwide Governance Indicators in the categories of government effectiveness, rule of law and control of corruption, impeding more robust entrepreneurial activity and investment.

WHAT COULD MOVE THE RATING UP / DOWN

Ukraine's rating would be upgraded if the progress made in reducing its sizeable external vulnerability can be sustained, evidenced by maintaining or further increasing its foreign exchange reserve buffer in relation to its external repayments. While material progress on implementing the ambitious reform agenda is not a requirement for Ukraine to be lifted into the B-rating scale, a further condition is likely to be reaching an agreement with the IMF and remaining in broad compliance with the conditions of a new programme, helping to mitigate the risks posed by Ukraine's large external debt repayments as well as provide an anchor against backsliding on the reform agenda. Continued evidence that the spillovers to Ukraine's economic and fiscal performance from the conflict in eastern Ukraine remains contained, indicating a reduction in the high geopolitical event risk assessment which acts a constraint on the rating, would also be positive. The positive outlook signals that Moody's would expect to draw such a conclusion, or not, over the next 12-18 months, and quite possibly within 12 months.

The positive outlook signals that a downgrade is currently very unlikely. However, the outlook could be returned to stable if Moody's concludes that the improvements to Ukraine's external vulnerability will not be sustained. For example, material delays in accessing new financing which threatens its ability to pay down or refinance its large external payment obligations, possibly resulting from the failure to agree a new IMF programme or an inability to remain in broad compliance with the new agreement, would be negative. At the same time, a notable reduction in the country's foreign exchange buffer, which could be accompanied by an outflow of foreign investors from the domestic market, would support a stabilization in the outlook. Negative ratings pressure would also derive from a further escalation of geopolitical tensions that would have a negative spillover on Ukraine's economic and fiscal profile.

GDP per capita (PPP basis, US$): 9,287 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.3% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 9.8% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -2.1% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -3.3% (2018 Actual) (also known as External Balance)

External debt/GDP: 87.7% (2018 Actual)

Level of economic development: Very Low level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 19 November 2019, a rating committee was called to discuss the rating of the Government of Ukraine. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's institutional strength/framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer has become less susceptible to external vulnerability event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Evan Wohlmann
VP-Sr Credit Officer
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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