Rating action

Scope Ratings GmbH (Scope) has today downgraded Ukraine’s long-term issuer rating in foreign currency to C, from CC, and maintained a Negative Outlook.

The long-term senior unsecured debt rating in foreign currency and Eurobond securities ratings are left unchanged (CC and Negative Outlook) – reflecting uncertainty currently concerning: i) the specific instruments to experience non-payment or approve restructuring; and ii) the precise changes of terms and/or losses to be accepted by creditors*.

Ukraine’s long-term issuer and senior unsecured debt-category rating in local currency and domestic-law debt instrument ratings are unchanged (CCC and Stable Outlook). In addition, the Agency has left unchanged short-term issuer ratings in local- and foreign-currency (S-4 and Stable Outlook).

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Key rating drivers

The start of formal negotiations for near-term external commercial debt restructuring for conclusion within the coming month(s). The driver of the downgrade of the long-term issuer rating in foreign currency reflects expectation of finalisation within the coming month(s) of an external commercial debt restructuring – the proximity currently to such a distressed debt exchange being consistent with a C rating. This announcement is in line with the Agency’s base-case expectation since 2022 of a second external debt restructuring by this year and is in accordance with the Agency’s rating announcement dated 12 May 2023 signalling a cut of the foreign-currency issuer rating to C at this stage of formal start of commercial debt renegotiation. The Ministry of Finance announced during March of 2023 an intent for negotiations around commercial debt treatment¹ and currently targets an agreement by June (2024).

The foreign-currency issuer rating is expected to be revised to a selective-default credit grade within the forthcoming period should negotiations conclude successfully in a distressed debt restructuring, resulting in changes of repayment from current contractual terms, or, alternatively, under the non-baseline scenario of no agreement being reached with creditors before a current debt-servicing freeze concludes by August of this year and Ukraine having to suspend payments unilaterally as negotiations resume.

The authorities plan a full-fledged commercial debt restructuring for this year on around USD 23.6bn in Eurobonds and past due interest. If agreement around such a proposition with external commercial creditors cannot be reached under the available time before August, an interim more-moderate restructuring of the debt – such as the further deferral of Eurobond debt service for several years (per one example to 2027) – reflects an alternate scenario. Any modification of a series of notes must 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.

The International Monetary Fund has outlined goals for the restructuring of external debt²: i) public debt should reach 65% of GDP by 2033; ii) gross government financing needs should average 8% of GDP during the “post-programme” phase (2028–33); and iii) as complementary objectives, public debt should be brought (down) to 82% of GDP by 2028 and achieve debt-service flow relief on external debt obligations of 1–1.8% of GDP a year. Achieving such targets implies significant haircuts for the Eurobond securities whether promptly this year or by 2027. The restructuring is being advanced consistent with IMF programme parameters of delivering debt sustainability under IMF baseline and the downside economic scenarios. The objective of the Ukrainian government is to access international debt markets for fresh financing after restructuring of the debt. Ukraine targets borrowing fresh debt by selling collateralised and guaranteed bonds (backed by either multilateral institutions or western sovereign governments).

In addition, as a precondition for the historic USD 15.6bn IMF Extended Fund Facility approved for Ukraine in March of 2023³, the Group of Creditors – comprising select G-7 countries: Canada, France, Germany, Japan, the United Kingdom and the United States – agreed earlier on 21 December 2023⁴ for the extension of their existing debt-service suspension until March 2027 (the month of conclusion of the present IMF programme) on the segment of loans issued to Ukraine before the 2022 Russian full-scale invasion (legacy debt), extending on an earlier termination date of earliest end-2023. The Group has urged all other official bilateral creditors to reach an agreement with Ukraine on a further debt treatment on terms at least as favourable. The Group furthermore plans to agree on and execute a comprehensive debt restructuring on this segment of legacy debt due to the Group once the conflict is stabilised or at the latest by the present conclusion of the IMF facility (2027).

Excluding the debt-curtailing effects of future cuts of principal on the external commercial and bilateral-official debt, the debt-to-GDP ratio of Ukraine is projected by Scope to reach 106% by end-2027. This debt-ratio projection reflects a rise from an estimated public-debt ratio of 84.4% of GDP at end-2023 and 48.9% as of end-2021 before escalation of the war. This expectation reflects the continued expectation of the Agency of a protracted conflict. Agency projections reflect a comparatively more-pessimistic assumption than an IMF base case for the war to wind down by end-2024.

Under the IMF base case – similarly excluding the effects at this stage of debt restructuring, the IMF projects general government debt peaking at 96.7% of GDP by 2025 – before easing to 93.8% by end-2027. The IMF March-2024 “Pre-Restructuring Downside Scenario” envisions debt peaking at 135.7% by 2026 under such an adverse scenario.

General-government fiscal deficits are seen remaining significant around 19% of GDP this year before 11% by next year based on rating-agency forecasting, as war-time conditions inhibit fiscal flexibility.

Rating strengths: significant international financing support and an observable resilience of the domestic financial system. Near-term stresses for Ukraine’s capacity for self-defence have temporarily eased after approval of USD 61bn of American military assistance, including USD 1bn to be immediately delivered⁵. This follows up to EUR 50bn to be paid out in grants and highly-concessional loans between 2024-27 under an EU financial facility approved February for Ukraine⁶. Any further suspension of debt service as part of the forthcoming restructuring of Eurobonds combined with the already-approved suspension of payment on the legacy segment of bilateral-official loans might deliver an aggregate USD 4.6bn (2.5% of GDP) of savings for Ukraine this year before a cumulative added USD 7.2bn from 2025 to the end of the IMF programme by March 2027². Official reserves stand presently at record highs of USD 43.8bn.

Complementing actions of the international sector, Ukraine has prudently augmented domestic-bank financing of the sovereign for sustaining an elimination of monetary financing since January 2023. Here, the resilience of the domestic financial system since escalation of Russia’s war on Ukraine supports creditworthiness of the domestic debt. Domestic banks have adapted and continued operating effectually although operational risks have risen from the need to adapt bank branches to power outages. Dollarisation has declined moderately, with foreign-currency deposits and loans representing around 32% and 26% of aggregate deposits and loans as of March. Because of banking-sector reforms of the previous years, as well as rapid administrative and capital controls adopted by the National Bank of Ukraine following the invasion, there have been no systemic bank runs despite the exceptionally-challenging economic conditions. However, tier 1 capital ratios moderated to 12.0% of risk-weighted assets by February 2024, from 14.9% at October-2023 highs and recapitalisations are required especially for privately-held small and medium-sized banks. Non-performing loans remain elevated (37.4% as of end-2023).

*NB. Scope debt-instrument ratings are evaluated on loss given default, and issuer ratings are judged on probability-of-default bases.

Outlook and rating sensitivities

The Negative Outlook on the foreign-currency long-term issuer rating reflects an expectation that risks to the rating remain skewed to the downside.

The upside scenario for the foreign-currency long-term issuer rating and/or Outlook is:

1. If the renegotiation of debt obligations due to external commercial creditors does not reach an agreement and the borrower opts to resume servicing of the external commercial debt following conclusion of the prevailing debt-servicing suspension.

Downside scenario for the foreign-currency long-term issuer rating is:

1. An agreement is reached on the restructuring of the external private debt instruments within the coming month(s) or, alternatively, Ukraine suspends payment on Eurobonds unilaterally after an existing debt-servicing suspension concludes by August. Either scenario is consistent with the foreign-currency long-term issuer rating being revised to a selective-default grade.

The Stable Outlook on the domestic-currency debt ratings reflects an opinion of risks to the domestic-debt ratings being balanced.

Upside scenarios for the domestic-currency debt ratings and/or Outlooks are if (individually or collectively):

1. Security risks were to be significantly reduced.
    
2. The government’s debt-sustainability outlook were to improve.
    
3. Banking-system risks ease.

The downside scenario for the domestic-currency debt ratings and/or Outlooks is if:

1. The likelihood were to rise of restructuring of the domestic debt, such as under a scenario of the war worsening for Ukraine and the debt-sustainability outlook remaining impaired even following comprehensive external liability restructuring.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses core sovereign credit fundamentals, signals a first indicative credit rating of ‘b+’ on Ukraine. Under Scope’s sovereign-rating methodology, this first indicative rating receives 1) no further positive adjustment from the methodological reserve-currency adjustment; and 2) a three-notch downside adjustment from the methodological political-risk quantitative adjustment, reflecting the presence of war on sovereign territory. On this basis, the final SQM quantitative rating of ‘ccc’ is assigned and next judged by the analyst Qualitative Scorecard (QS). Under the QS, this final indicative rating from the model can be changed by up to three notches up or down depending on the size of the Ukraine’s qualitative credit strengths or weaknesses compared against a model-assigned peer group of sovereign states.

Scope identified the following QS relative credit strengths for the Ukraine: i) monetary policy framework; ii) debt profile and market access; iii) current account resilience; iv) financial sector oversight and governance; and v) financial imbalances. Conversely, the following relative credit weaknesses have been identified under the QS: 1) macro-economic stability and sustainability; 2) long-term debt trajectory; 3) environmental factors; 4) social factors; and 5) governance factors. On aggregate, the QS generates no net adjustment for Ukraine’s indicative credit rating. As such, aggregate adjustments signal a long-term issuer credit rating in local currency of CCC for Ukraine. A final two-notch downside adjustment under the additional considerations is made to the foreign-currency long-term issuer rating, reflecting formal negotiations around external commercial debt restructuring – signalling a foreign-currency long-term issuer rating of C.

 A rating committee has discussed and confirmed these results.

Environment, social and governance (ESG) factors

Scope explicitly factors in ESG issues in its ratings process vis-à-vis the sovereign-rating methodology’s stand-alone ESG sovereign-risk pillar, which holds a significant 25% weighting under the quantitative model (SQM) and 20% weight under the methodology’s qualitative overlay (QS).

With respect to environmental risk – Ukraine scores poorly on the SQM on carbon emissions per unit of GDP (a proxy variable for “transition costs” for achieving a greener economic model long run) although Ukraine scores comparatively well on greenhouse gas emissions per capita. Ukraine scores strongly on the economy’s degree of exposure and vulnerability to natural-disaster risk – as measured by the ND-GAIN Index. Ukraine’s marks are, however, below-average under the SQM regarding the ecological footprint of consumption compared against available biocapacity. This results in an aggregate SQM model score for environment near a global median. Ukraine’s environmental objectives and challenges are furthermore considered by the analyst under the QS through an assessment of ‘weak’ for Ukraine for the ‘environmental factors’ QS category compared against Ukraine’s ‘ccc’ sovereign peer group assigned by the SQM. Ukraine plans to reduce emissions while growing its economy, reducing poverty and simultaneously combatting 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 for waterways, air and soil pollution, forest destruction, and an increase in the carbon footprint because of the use of weapons – contributing to greenhouse gas emissions.

Socially-related credit factors are captured under the SQM as well as the QS qualitative overlay. Under the SQM, Ukraine receives a middle-of-the-road score on income inequality (as captured by the ratio of the income share held by the bottom 50% of the population), average marks on labour-force participation, and relatively-weak scoring with respect to the old-age dependency ratio. This results in a slightly under-global average SQM score for social factors. In addition, Ukraine’s comparatively modest GDP per capita (estimated around USD 15,464 in 2024 on purchase-power-parity basis) as a lower-middle-income economy is captured by the SQM. A long-run decline of the working-age population undermines economic growth potential (estimated at 2.5% a year). In the QS ‘social factors’ assessment of Ukraine, Scope evaluates this qualitative analytical category as ‘weak’ compared against the credit’s sovereign peers.

Finally, under governance-related factors, Ukraine scores under the World Bank’s Worldwide Governance Indicators (WGIs) represent a credit-rating constraint. Nevertheless, between 2015 and 2021, given meaningful institutional reforms, percentile ranks had improved across WGI categories – although scores except on control of corruption have declined since 2022 compared against 2021 due to Russia’s full-scale invasion. This WGI evaluation includes the three-notch downside adjustment for the SQM indicative rating based on the political-stability WGI category. In an assessment of Ukraine’s ‘governance factors’ under the QS analyst judgments, Scope evaluates this qualitative analytical category as ‘weak’ against Ukraine’s ‘ccc’ indicative sovereign peers.

Rating Committee
The main points discussed by the rating committee were: i) external private-debt restructuring and associated negotiations; ii) debt sustainability; iii) rating definitions in default; and iv) sovereign peers considerations.

Rating driver references
1. Ministry of Finance of Ukraine – Ukrainian Authorities anticipate a Commercial Debt Treatment in 2024 
2. International Monetary Fund – Ukraine: Third Review of the Extended Arrangement under the Extended Fund Facility, requests for a waiver of nonobservance of a performance criterion, and modifications of performance criteria-Press Release; Staff Report; and Statement by the Executive Director for Ukraine 
3. 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 
4. Federal Ministry of Finance of Germany – Debt service suspension for Ukraine extended until 2027 
5. AP News – Biden says the US is rushing weaponry to Ukraine as he signs a $95 billion war aid measure into law 
6. European Commission – EU Leaders agree on €50 billion of reliable financial support for Ukraine until 2027

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Sovereign Quantitative Model Version 3.0), 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 and/or Outlooks 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: Dr. Giacomo Barisone, Group Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 28 January 2022. The Credit Ratings/Outlooks were last updated on 12 May 2023.
As a "sovereign rating" (as defined in EU Credit Rating Agency (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 2024: Sovereign, Sub-Sovereign and Supranational Ratings" published on 30 April 2024 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 beginning of formal negotiations between the Ukrainian government and debtholders around restructuring of the external commercial debt – an event that Scope has highlighted previously would see a rating change. 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/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
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