OREANDA-NEWS. Fitch Ratings has downgraded Ukraine's Long-term foreign currency Issuer Default Rating (IDR) to 'CC' from 'CCC' and affirmed its local currency IDR at 'CCC'. The issue ratings on Ukraine's senior unsecured foreign currency bonds have been downgraded to 'CC' from 'CCC', while the senior unsecured local currency bonds have been affirmed at 'CCC'. The Country Ceiling has been affirmed at 'CCC' and the Short-term foreign currency IDR at 'C'.

KEY RATING DRIVERS
The downgrade of Ukraine's Long-term foreign currency IDR to 'CC', which indicates that a default of some kind appears probable, reflects the following factors and their relative weights:

HIGH
The new IMF programme announced on 12 February 2015 will help to close Ukraine's financing gap, but an associated restructuring of privately-held external debt appears increasingly probable. Sovereign creditworthiness has deteriorated. The consolidated fiscal deficit, including losses of state energy company Naftogaz, reached 13% of GDP in 2014. We estimate that direct and guaranteed debt rose to 72% of GDP in 2014. Conflict and economic weakness have led to large additional financing needs beyond those envisaged in Ukraine's IMF programme agreed in April 2014.

The escalation of the conflict with rebels in the eastern regions of Donetsk and Lugansk has severely affected the economy. We estimate that real GDP fell 7.5% in 20152014, and forecast a further contraction of 5% in 2015, considerably worse than expected at the time of Fitch's last review in August 2014.

The reserves position is precarious, with foreign exchange reserves declining to just 1.3 months of imports in January 2015. The hryvnia fell almost 50% against the dollar in 2014, and a further substantial depreciation has occurred in February 2015. This is leading to a sharp external adjustment, mostly driven by a steep contraction of imports. The current account deficit narrowed from 9.1% of GDP in 2013 to an estimated 4.1% of GDP in 2014, and will fall further in 2015.

MEDIUM
Banks have been heavily affected by economic turmoil and currency depreciation, and also continue to suffer from the overhang of the 2008-09 crisis. The government has budgeted around 2% of GDP for bank recapitalisation in 2015, but in Fitch's view, the costs will be materially higher, putting further upward pressure on public debt.

Political transition continues following the ousting of former president Viktor Yanukovych in February 2014. The new government formed in December, following parliamentary elections in October, has expressed a strong commitment to undertake structural reforms. However, political risks to the implementation of reforms are high.

RATING SENSITIVITIES
The main factors that could, collectively or individually, result in a downgrade are:
- Announcement of a restructuring operation with private external creditors.
- Failure to make progress on structural reforms leading to a suspension of the IMF programme.
- Further escalation of the conflict in eastern Ukraine and intensification of economic stress, such that financing needs increase beyond what external partners are willing to provide and default becomes inevitable.

We currently do not envisage a situation in the short term in which the rating would be upgraded.

KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to a number of assumptions:

Ukraine receives timely disbursements from the IMF and retains support from other multilateral organisations and western partners including the EU and the US.

Talks with private creditors on restructuring public external foreign currency debt begin.

Ukraine does not succumb to a material escalation of incursions into its sovereign territory.