The triple threat of a high debt burden, low FX reserves and political instability weighs on the sovereign’s risk score.
Ukraine is one of the worst-performing countries in the ECR rankings this year. A 5.5 points score drop in the 12 months before June 2013 left it sitting midway between five countries with the largest year-on-year increases in risk, along with Egypt, Cyprus, Venezuela and Kyrgyz Republic.
Its four-place slip since June means it now, ominously, leads that group, having plunged to a record low of 122nd out of 186 countries. It’s hard to imagine now that the sovereign ranked a giddy 23rd when ECR began its surveys in 1993, one step below Hong Kong and safer than Chile.
ECR experts harbour deep concerns about government stability (down 0.3) as president Viktor Yanukovych risks damaging relations with Russia, the coalition and his own standing by forging a deal with the EU to shun Moscow’s rival trade zone – a decision that could play out badly among voters in his own Moscow-centric backyard.
One of ECR’s experts, Lilit Gevorgyan, senior economist and country risk analyst at HIS Global Insight, says: “November could be a crucial month for Ukraine. It appears that Kiev is intent to pursue EU integration, not least because a number of major Ukrainian businesses will benefit from this decision.
“The EU is likely to be more lenient towards Ukraine and perhaps will try to isolate the Tymoshenko affair from the Association Agreement process.
“The EU’s softer stance could also be a reaction to Russia’s more assertive position on the EU integration issue, as seen in the case of Armenia which made a last minute U-turn on the EU Association Agreement in early September in favour of the Russian-led Customs Union membership.
"Ukraine’s economic priorities dictate seeking good relations with Russia, which can be much stricter with Ukraine and demand prompt payment for gas, including the volumes that Ukraine has failed to import (currently, Ukraine is importing less than it has to under a 2009 take-or-pay gas contract with Russia). Finding a political balancing act between the EU and Russia will be critical for Ukraine’s economic outlook in the coming months."
Meanwhile, five of Ukraine’s six political indicators have fallen since last year – all now chalk up less than half of the 10 points available; corruption being a disheartening 2.4.
Worryingly, the sovereign’s scores for both the economic-GNP outlook and government finances have plummeted by 0.3 points during the past year as trends have worsened.
GDP shrank by 0.5% quarter-on-quarter and 1.7% year-on-year during the second quarter, according to the State Statistics Services, to continue the decline seen during Q1, with industrial production still contracting through to July. The budget deficit is on course to top 5% of GDP this year.
Now on a score of 32.9 out of 100, Ukraine remains mired within the lowest of ECR’s five tiers, commensurate with its junk ratings of B- from Fitch, B3 from Moody’s and B from Standard & Poor’s – all on negative outlook after S&P’s revision in June.
The currency is holding up under pressure, for now. As Vasily Astrov, one of ECR’s Ukraine experts, and a senior economist at the Vienna Institute for International Economic Studies, says: “My baseline scenario is still that there will be no major devaluation until the end of the year. A lot will depend on how fast QE3 will be scaled down.
“If there is a sharp reduction in QE3 – not the main scenario at the moment – this will likely sharply reduce capital inflows into Ukraine, and devaluation will be unavoidable. As we know, the National Bank of Ukraine does not have a lot of buffer in the form of reserves.
“At the same time, I have argued that a moderate devaluation will be good for exporters and in the end for the economy as a whole. By most measures, and first of all the high current-account deficit, the currency is up to 10% overvalued.”
Lilit Gevorgyan adds: "Faced with a deteriorating external position, the Ukrainian central bank could devalue the hryvna-dollar peg to boost its exports, although this may take some time to have a corrective impact on current account.
"The devaluation would also help to increase import prices and help to end persistent deflation. But again, the political considerations may hamper this decision, as the monetary move will hurt the real disposable income of consumers and potentially affect their choice at the ballot boxes."
The authorities are pinning their hopes on a bumper harvest to brighten an otherwise gloomy picture, but a large debt roll-over burden in 2013/14 will still create enormous financing strains without an IMF agreement in place – and the authorities have shown little inclination to date for the conditionality attached.
On the IMF, Astrov says: “I am not at all sure that their insistence on hiking gas tariffs is a wise strategy, given that this is politically totally unrealistic – especially taking into account the potential repercussions on social stability, as demonstrated recently by the events in Bulgaria.
“Besides, I don’t think that [an] IMF programme is absolutely necessary for Ukraine at the moment. If the devaluation revives economic growth and narrows external deficits, Ukraine should be able to borrow privately and on better terms.”
Falling reserves to accommodate debt payments and shore up the currency have nonetheless muddied the waters by weakening import cover. Given the current-account deficit, the international markets might not remain open to Ukraine for long, and the country might soon find itself lagging behind improving Moldova (less than one-point behind at 128th) and Montenegro (ranking 130th), just two of many high-risk alternatives.