For the updated Rating Report accompanying this review, click here.

Rating action

Scope Ratings GmbH (Scope) has today affirmed Ukraine’s long-term foreign-currency issuer and foreign senior unsecured debt ratings at CC, and maintained the Negative Outlook. Ukraine’s long-term local-currency issuer ratings and domestic senior unsecured debt ratings in local and foreign currency are affirmed at CCC and the Outlook changed from Negative to Stable. The Agency has affirmed the short-term issuer rating of Ukraine in foreign currency at S-4, and changed the Outlook from Negative to Stable. The short-term issuer rating in local currency is affirmed at S-4, and Outlook maintained at Stable.

Summary and Outlook

1. The affirmation of Ukraine’s foreign-currency long-term issuer and foreign-law securities ratings at CC and maintenance of a Negative Outlook reflect the agency’s baseline since 2022’s external debt restructuring for further debt renegotiation by mid-2024 – on conclusion of an original two-year debt-service suspension agreed August of the year. In line with this assumption, the Ministry of Finance of Ukraine announced¹ on 24 March 2023 an intent of beginning discussion by early 2024 with external commercial creditors around further debt treatment next year.
   
   Furthermore, the agency has assumed since last June a more significant debt restructuring – presenting debt forgiveness – being part of the long-run solution for Ukraine. In March 2023, the Group of Creditors committed to executing such a comprehensive debt restructuring once the conflict situation is stabilised or at the latest by the end of the IMF programme (by 2027). Such a (third) external debt treatment – for the restoration of debt sustainability – would presumably require more substantive losses from the private sector.
    
2. The affirmation of Ukraine’s long-term local-currency issuer ratings and domestic securities ratings in local and foreign currency at CCC and revision of the Outlook from Negative to Stable reflects a stronger prioritisation over the forthcoming years on domestic commercial-bank financing of the sovereign state and associated curtailment in likelihood of restructuring of domestic debt of Ukraine over the coming period. After agreement around an historic IMF programme, the securing of material external financing projected to fulfil Ukraine’s external financing gap, embedding savings from programmed external debt-service suspension, also reduces near- to medium-term risks for the domestic debt. The resilience of the domestic financial system since the full-scale war anchors ratings of the domestic debt.
   
   This revision of the Outlook for long-term local-currency issuer ratings to Stable, from Negative, reflects updated analytical assessments of Ukraine under the sovereign rating methodology’s ‘public finance risk’ and ‘financial stability risk’ analytical pillars.
    
3. The affirmation of foreign-currency short-term issuer ratings at S-4 and revision of the Outlook to Stable, from Negative, considers Ukraine’s outstanding short-term foreign-currency debt being exclusively domestic-law short-term debt securities denominated in hard currency. Due to an absence of international-law short-term debt, this revision to a Stable Outlook aligns the rating of short-term foreign-currency domestic treasury bills to the Outlook of other domestic debt not anticipated for debt treatment by 2024.

The foreign-currency long-term issuer ratings are expected to be downgraded during the coming period should: negotiations prudently advance for the further restructuring of foreign debt instruments by 2024. Conversely, the Outlook for the foreign-currency long-term issuer ratings could be revised to Stable should: a significant change in geopolitical, economic and/or funding outlooks compel any annulment of present plans for renegotiation of obligations due to external commercial creditors.

In addition, the ratings and/or Outlooks on the domestic debt could be downgraded if: the likelihood were to rise of restructuring of the domestic debt, such as under a scenario of the war intensifying and Ukraine’s debt sustainability outlook substantively further weakening, funding challenges heightening and/or banking-system fragilities escalating. Alternatively, the domestic-debt ratings and/or Outlooks could be upgraded if: i) security risk to be significantly reduced; ii) the government’s debt-sustainability outlook were to improve; and/or iii) banking-system risks ease.

Rating rationale

1. The affirmation of Ukraine’s CC foreign-currency long-term issuer and Eurobond securities ratings and maintenance of a Negative Outlook reflect the agency’s expectation since a 2022 external debt restructuring of further debt renegotiation by mid-2024.

As preconditions for the historic USD 15.6bn IMF Extended Fund Facility approved for Ukraine this March², the Group of Creditors – comprising select G7 countries: Canada, France, Germany, Japan, the United Kingdom and the United States – agreed on 24 March 2023³ for extending their existing debt-service suspension until 2027 (the conclusion year of the IMF programme), from a present termination date of the debt suspension by end-2023. The Group of Creditors encouraged other official bilateral creditors to reach an agreement with Ukraine on terms at least as favourable. Furthermore, to restore debt sustainability, curtail an outstanding financing gap over the years of the IMF programme and ensure comparable commercial-sector engagement during debt treatment, the Ministry of Finance announced¹ its intent of starting discussion by early 2024 with commercial creditors around a further debt treatment. The goal being to complete such a commercial debt operation as quickly as possible, and no later than the middle of 2024.

Scope expects an agreement with the external private sector to be concluded next year for further restructuring of Eurobonds* and other international securities. If so, under Scope’s sovereign methodology, such a (second) external debt restructuring following the 2022 debt postponement would be likewise assessed through a temporary ‘selective default’ foreign-currency issuer rating by 2024. As G7 creditors frequently present the most significant disposition as concerns debt relief, their commitment at this stage to only extend the debt-servicing freeze suggests the external private sector may, however, be unlikely to go much further than that in negotiations next year. Nevertheless, although Ukraine is only scheduled to pay USD 200m (0.1% of GDP) of debt service to the Paris Club next year, extending such a debt-service suspension for international bondholders would deliver a more significant USD 4.4bn (2.9% of GDP) of savings for Ukraine in 2024 alone.

Furthermore, the Group of Creditors committed earlier this year to executing a more comprehensive debt restructuring for restoring Ukraine’s debt sustainability once the conflict situation is stabilised or at the latest by the termination of the IMF programme – e.g., latest 2027⁴. In following the external debt-servicing suspension since 1 August 2022 being a stopgap measure for provision of liquidity during the war, a more comprehensive debt restructuring medium run is anticipated by Scope to consider principal and interest cuts as possible recourse for assurance of a sustainable reconstruction and recovery. The Group of Creditors’ commitment of delivery of such a comprehensive debt restructuring came on condition of private external creditors presenting a debt treatment at least as favourable by that stage.

Scope projects a rise of Ukraine’s general government debt to roughly 100% of GDP by 2024 from the 78% at end-2022 and double the 49% ratio of 2021 before Russia’s full-scale invasion. By comparison, the IMF’s baseline economic scenario sees sovereign debt peaking at 105% by the end of 2024 before declining to 78% by 2033. The IMF envisages gross financing requirements normalising from wartime peaks of above 27% of GDP between 2023-2024 to around 10% a year by 2027.

Such projections have not in the past automatically resulted in a conclusion from the IMF of debt being unsustainable. But conventional debt-sustainability assessments are interpreted differently under the exceptional circumstances faced today by Ukraine. Furthermore, the decision with respect to more comprehensive debt restructuring will rest partially on the IMF’s debt sustainability assessment under its “downside scenario”, under which public debt rises to a more stressed level of nearly 150%. On such bases, the commitment for more comprehensive external debt restructuring appears sound.

2. The affirmation of Ukraine’s long-term local-currency issuer ratings at CCC and revision of Outlooks to Stable, from Negative, considers a stronger prioritisation over the forthcoming years on domestic commercial-bank financing of the sovereign state and associated reduction in likelihood of restructuring of domestic instruments over the coming period. The securing of sizeable external funding projected to meet Ukraine’s financing gap, embedding savings from programmed external debt-service suspension, further curtails near- to medium-term risks for repayment of the domestic debt. In addition, the resilience of the domestic financial system anchors ratings of domestic government securities.

The IMF’s 48-month Extended Fund Facility⁵ opened a suggested USD 115bn (53% of average 2023-27 GDP) of aggregate external funding support over the coming four years – reflecting sizeable official financing via grants and concessional loans, as well as debt relief. This compares against a total external funding gap estimate of USD 114bn for the years to 2027. The external funding is projected to meet a significant external financing gap for the forthcoming years driven by general-government deficits of around 20% of GDP for this year, 17.5% in 2024 before averaging 8.1% over 2025-28 based on Scope forecasts.

Complementing actions of the international sector, Ukraine plans to augment the domestic-bank financing of the sovereign for sustenance of an elimination of monetary financing since January of this year. The Ministry of Finance recently hiked rates on domestic debt to make it more marketable for commercial creditors. The National Bank of Ukraine (NBU) allowed banks to meet half of reserve requirements using specific government securities. A transition of the domestic banking sector to net positive financing of the state starting this year after the net redemptions of 2022 cuts macroeconomic risk from central-bank financing and reduces a likelihood of domestic debt restructuring over coming years as the anchoring of financial stability and stability of domestic debt capital markets appears strategically core regarding the sought transition. The domestic banks are forecast to deliver UAH 314bn of net bond financing for the sovereign between 2023 and 2027 (after the negative UAH 77bn in net financing last year), substituting for the NBU’s negative UAH 76bn of aggregate net sovereign financing for 2023-27 following supply of an extraordinary UAH 383bn during 2022.

The resilience of the domestic financial system since escalation of the war furthermore abets creditworthiness of the domestic debt. Domestic banks have adapted and continued operating effectually although operational risks have risen from need to adapt bank branches to power outages. Dollarisation trends have modestly reversed: system-wide deposits and loans in foreign currency represent around 37% and 27% of totals respectively as of March. Because of banking-sector reforms from prior years, as well as rapid administrative and capital controls adopted by the NBU following the invasion, there have been no systemic bank runs despite exceptionally challenging economic conditions. Tier 1 capital stood at 13.4% of risk-weighted assets as of February of this year, stronger than the 11.7% pre-invasion. This is although areas such as banking supervision face significant challenges, non-performing loans have risen (towards 40%) and recapitalisations are needed especially for privately-held, small and medium-sized banks.

*NB. 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.

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 further adjustment to this indicative rating vis-à-vis the reserve-currency adjustment of the sovereign rating 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 against sovereign peers based on analysts’ qualitative analysis.

For Ukraine, the following relative credit strengths were identified via the QS analysis compared with the credit’s ‘b-’ indicative sovereign peers: ‘monetary policy framework’ and ‘debt profile and market access’. Conversely, the ‘macro-economic stability and sustainability’, ‘debt sustainability’, ‘environmental factors’, ‘social factors’, and ‘institutional and political factors’ analytical categories were identified in the QS as relative credit weaknesses compared against sovereign peers.

The combined relative credit strengths and weaknesses from the QS generate a one-notch downside rating adjustment. Aggregate adjustments signal a long-term issuer credit rating in local currency of CCC for Ukraine. A further single-notch downside adjustment at rating-committee level is made to foreign-currency long-term issuer ratings, reflecting an expectation of further restructuring of the Eurobonds. Aggregate adjustments signal a foreign-currency long-term issuer 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 25% weighting under the quantitative model (CVS).

With respect to environmental risk – Ukraine scores poorly on the CVS on its carbon emissions per unit of GDP (a proxy variable for “transition costs” in achieving a greener economic model in the long run) although Ukraine scores in the middle of the pack on greenhouse gas emissions per capita. Ukraine scores strongly on the country’s lesser degree of exposure and vulnerability to natural-disaster risk – as measured by the World Risk Index. Ukraine’s marks are, moreover, very strong on the CVS regarding ecological footprint of its consumption compared with the country’s available biocapacity. Ukraine’s environmental objectives and challenges are furthermore considered in Scope’s QS via an assessment of ‘weak’ for Ukraine on ‘environmental factors’ as compared with its indicative sovereign peer group. Ukraine ranked an improved 52^nd on the 2022 Environmental Performance Index of 180 countries⁶. Ukraine plans to cut emissions while growing its 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, thereafter achieving full climate neutrality not later than 2060. However, the war is triggering sizeable, long-lasting environmental and climate damage as far as waterways, air and soil pollution, forest destruction, and an increase in the carbon footprint via the use of weapons, which contributes to raising greenhouse gas emissions.

Socially-related credit factors are likewise 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 via 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, and slightly-below-average scoring with respect to the old-age dependency ratio. In addition, Ukraine’s comparatively modest GDP per capita (estimated around USD 5,000 in 2023) as a lower-middle-income economy is captured by the CVS. A long-run decline of the working-age population undermines economic growth potential (the latter estimated at 2.5%). In the QS assessment of Ukraine’s ‘social factors’, Scope evaluates this qualitative analytical category as ‘weak’ compared against the credit’s indicative sovereign peers.

Finally, under governance-related factors in the CVS, Ukraine displays weak historical performance across an aggregate of the World Bank’s six Worldwide Governance Indicators (WGIs) – representing a credit-rating constraint. However, since 2015, in view of a meaningful institutional reform programme, percentile ranks have improved across the WGIs. An assumed protracted conflict raises military and humanitarian costs for the government and delays the prospect of fuller economic recovery. In an assessment of Ukraine’s ‘institutional and political risks’ in the QS analyst overlay, Scope evaluates this qualitative analytical category as ‘weak’ against Ukraine’s subset of sovereign peers.

Rating Committee
The main points discussed by the rating committee were: i) external debt-service suspension; ii) medium-run comprehensive debt relief; iii) IMF programme; iv) monetary financing and domestic markets; v) banking-sector stability; vi) financing outlook; vii) fiscal balance and debt sustainability; viii) structure of the public debt; and ix) peers considerations.

Rating driver references
1. Ministry of Finance of Ukraine – Ukrainian Authorities anticipate a Commercial Debt Treatment in 2024             
2. IMF Executive Board Approves US$15.6 Billion under a New Extended Fund Facility (EFF) Arrangement for Ukraine as part of a US$115 Billion Overall Support Package           
3. Federal Ministry of Finance of Germany – Debt service suspension for Ukraine extended until 2027              
4. Government of Canada – Group of Creditors of Ukraine Provides Financing Assurances to Support the IMF’s Approval of an Upper Credit Tranche Programme            
5. IMF, Ukraine: Request for an Extended Arrangement Under the Extended Fund Facility and Review of Program Monitoring with Board Involvement-Press Release; Staff Report; and Statement by the Executive Director for Ukraine                 
6. Yale Center for Environmental Law & Policy, Environmental Performance Index               

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for this Credit Rating and Outlook is the Core Variable Scorecard (version 2.1), available in Scope Ratings’ list of models, published under 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.

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: Dennis Shen, Senior Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director, Sovereign and Public Sector
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 January 2022. The Credit Ratings/Outlooks were last updated on 22 August 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2023 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Fund Analysis GmbH, Scope Investor Services 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.