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Rating action

Scope Ratings GmbH (Scope) has today upgraded Ukraine’s long-term foreign-currency issuer and senior unsecured debt ratings to CC from selective default (SD) and assigned a Negative Outlook. The Agency has left Ukraine’s long-term local-currency issuer and senior unsecured debt ratings unchanged at CCC with Negative Outlook. The short-term issuer rating in foreign currency has been left unchanged at S-4 with Negative Outlook. The short-term issuer rating in local currency has been left unchanged at S-4 with Stable Outlook.

Summary and Outlook

The upgrade of Ukraine’s foreign-currency ratings to CC reflects conclusion of foreign debt restructuring following execution of Ukraine’s liability management exercise for restructuring of Eurobond debt and GDP-linked securities launched 20 July 2022. The restructuring prudently supported deferral of nearly USD 6bn of debt service over the next two years and received consent of bondholders of around 75% of an aggregate principal amount, more than the two-third minimum required for the restructuring’s success. In line with Scope’s sovereign criteria and rating definitions, upgrade to CC foreign-currency ratings reflects forward-looking assessment of Ukraine’s creditworthiness of newly-restructured debt.

Concurrently, Scope has upgraded the local-law foreign-currency bonds that were not included in the restructuring to CCC from C, with Negative Outlook.

The upgrade of the foreign-currency ratings reflects an analytical adjustment under the methodology’s ‘extraordinary circumstances’ to account for conclusion of foreign debt restructuring.

Scope has left the local-currency ratings unchanged, as the default risk on Ukraine’s local-currency debt has not changed materially since Scope affirmed the ratings on 16 August 2022.

The Negative Outlook for foreign- and local-currency long-term debt represents the view that risk to the sovereign ratings is skewed to the downside over the forthcoming 12-18 months. This reflects risk to still-weak long-run government debt sustainability resulting from severe economic recession, fiscal and external-sector stress, and substantive uncertainty around the future evolution of the war. Despite deferral of foreign debt service payments for two years, a broader restructuring of debt, such as involving principal write-down and/or further postponement of debt service, involving the private sector is probable over the future.

The foreign- and local-currency ratings and/or Outlooks could be downgraded in case: the likelihood were to increase of further debt restructuring plans or non-payment of obligations, resulting in the 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 Outlooks could be stabilised or revised to Positive if, individually or collectively: i) the conflict were to reach a ceasefire – significantly reducing underlying challenging factors that impair the credit outlook; ii) the government’s debt-sustainability outlook meaningfully improved, such as commitment of significant further international assistance for Ukraine; iii) external-sector dynamics are re-anchored, such as stabilisation of foreign-currency reserves, shoring up of hryvnia and/or reestablishment of international market access; and/or iv) banking-system risks eased.

Rating rationale

Ukraine’s CC foreign-currency ratings are supported by significant international financial support. In addition to USD 1.4bn¹ received from the International Monetary Fund via a Rapid Financing Instrument 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 implemented restructuring of sovereign liabilities moderates still-significant liquidity pressures over the coming years, nevertheless enhancing resources for covering critical defense, social and humanitarian costs, and the beginning of planning for the post-war reconstruction of the nation.

However, funding² of Ukraine has relied overly heavily upon monetary financing via the National Bank of Ukraine (NBU) recently – amounting to USD 8.5bn raised from the central bank of an aggregate USD 27.3bn raised by government since escalation of the war through 16 August 2022, followed by USD 4.7bn via local government bond issuance and USD 4.0bn from the United States via grant monies. An overly significant share of financing has furthermore been in the form of loan financing, raising medium-run sovereign debt challenges.

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 continuing 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 potential solvency challenges.

The NBU’s foreign-currency reserves eased to USD 19.1bn in July 2022 – 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 accelerated earlier as the central bank attempted 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 June rate increase has reintroduced a positive real policy rate, even after inflation further rose to 22.2% YoY in July, 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 July³, resulting in significant convergence with the unofficial hryvnia rate. The full-scale invasion of the nation has meaningfully compromised Ukraine’s export capacity and brought imposition of goods-import restrictions.

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, except for extraordinary circumstances under the methodology.

For Ukraine, the following 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 was made at rating-committee level to account for unique geopolitical risk relevant to the sovereign linked to the 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 one-notch downside adjustment at rating-committee level is made to foreign-currency long-term ratings, reflecting higher long-run credit risk for foreign-currency than for local-currency debt. Aggregate adjustments signal a foreign-currency long-term credit rating of CC 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) – representing a credit-rating constraint. 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.

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 52^nd on a 2021 Environmental Performance Index of 180 countries⁴. 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’ for Ukraine on ‘environmental risks’ as compared with indicative sovereign peers.

Rating Committee
The main points discussed by the rating committee were: i) the completion of foreign debt restructuring; ii) credit strengths and weaknesses; iii) rating drivers; and iv) peer considerations.

Rating driver references
1. IMF 
2. Ministry of Finance of Ukraine 
3. National Bank of Ukraine 
4. Yale Center for Environmental Law & Policy, Environmental Performance Index 

Methodology
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.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties.
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.

Regulatory disclosures
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: Levon Kameryan, Associate Director
Person responsible for approval of the Credit Rating: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 January 2022. The Credit Ratings/Outlooks were last updated on 16 August 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 conclusion of foreign debt restructuring following execution of Ukraine’s liability management exercise on Eurobond debt and GDP-linked securities launched 20 July 2022. 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.

Potential conflicts
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
© 2022 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, Scope Innovation Lab GmbH and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.