Ukraine's need for foreign financing is likely to rise even as availability seems to be diminishing in a worsening global market and macroeconomic environment. Fitch projects Ukraine's current account deficit will rise to 7% of GDP in 2008 and 8.5% in 2009 from 4.2% in 2007, driven by a widening trade deficit. Ukraine is heavily exposed to commodity prices, in particular natural gas and steel. The gas import price is set to go up in 2009 as Russia continues to narrow Ukraine's price gap with western Europe. A sharp drop in steel prices from currently elevated levels would intensify the terms-of-trade shock facing Ukraine. Ukraine's external liquidity ratio of 96% for 2008 is well below the 'BB' median of 223%, leaving the country with relatively thin buffers against external-financing shocks.
Capital inflows remain strong so far in 2008, boosting official reserves by 20% to USD38bn over the eight months to end-August. But Ukraine's prospects for attracting needed financing in the rest of 2008 and 2009 are suffering from deterioration in economic policy-making, ongoing political volatility and worsening macroeconomic fundamentals. The fall of the government on 3 September threw Ukraine into its fourth political crisis in as many years and left the country without a credible government able to tackle the risks building up in the economy.
Monetary policy was tightened moderately in April-May 2008, but real interest rates remain strongly negative and Fitch expects inflation of 20% by end-2008, albeit down from 26% in August. Nonetheless, growth is slowing, with construction already in recession. A moderate slowdown could ease risks by cutting imports, but a sharp one could damage investor confidence and the banking system. Debt management has deteriorated as the government's refusal to accept higher yields means it has yet to secure financing for 2008's 2% budget deficit, risking draw-down of fiscal deposits, which would send a poor signal to the markets. However, low government debt of just 10% of GDP (end-2007) and sovereign external amortisation totalling just USD1.3bn in H208 and 2009, relative to foreign reserves of USD38bn and projected 2008 GDP of USD191bn, are rating strengths.
Materialisation of risks in the external finances leading to a sharp drop in the UAH would accelerate already-high inflation, and would affect asset quality in the banking system where 51% of loans are denominated in foreign currency. Further increases in the risk of an external-financing crisis would likely trigger a rating downgrade. Monetary or fiscal policy slippage would also be negative for creditworthiness.
