Moody’s Investors Service (“Moody’s”) on June 12 upgraded the Government of Ukraine’s long-term issuer and senior unsecured ratings to B3 from Caa1.
The agency’s outlook on the ratings is “stable.” The upgrade comes on the back of the International Monetary Fund (IMF) approving an 18-month Stand-by Arrangement (SBA), worth roughly $5 billion, but Ukraine is still expected to have a funding shortfall this year, and will likely need to issue public debt.
Investor appetite for emerging market countries is returning after record outflows at the onset of the COVID-19 pandemic, however, market appetite for Below Investment Grade countries is not assured.
Moody’s’ upgrade of Ukraine came after the SBA was approved and evaluated; the IMF program was sufficiently easing Ukraine’s near-term funding challenges as well as the safeguarding of recent improvements.
“At present, the humanitarian and economic crisis stemming from the COVID-19 pandemic has refocused policy priorities away from deep structural reforms,” IMF managing director Kristalina Georgieva, said.
The SBA conditionality will attempt to refocus Ukrainian authorities on what the IMF has outlined as priorities: (i) mitigating the economic impact of the crisis, including by supporting households and businesses; (ii) ensuring continued central bank independence and a flexible exchange rate; (iii) safeguarding financial stability while recovering the costs from bank resolutions; and (iv) moving forward with key governance and anti-corruption measures to preserve and deepen recent gains.
The IMF specifically pushed Ukraine to pass legislation safeguarding the banking sector clean-up. The bank reform legislation blocks previous owners of nearly 100 banks, which were liquidated or nationalized under the banking sector clean-up, from reclaiming ownership or obtaining compensation through Ukrainian courts. This legislation, passed on May 13, came after special measures were implemented to thwart legislators from derailing the passage.
There was a higher level of uncertainty around Ukraine’s ability to pass this legislation. It was assumed that former owners of nationalized banks, such as President Volodymyr Zelensky’s key political supporter, oligarch, and former owner of PrivatBank, Igor Kolomoisky, would pressure lawmakers away from the legislation.
“At present, the humanitarian and economic crisis stemming from the COVID-19 pandemic has refocused policy priorities away from deep structural reforms”
PrivatBank was taken over by the central bank for a $5.5 bln hole in its balance sheet due to fraudulent lending.
In 2016, Ukraine spent nearly 6 percent of GDP to recapitalize the nationalized bank. The now adopted legislation will prevent Kolomisky from claiming any compensation.
Land reform was also on the IMF’s demand list, but proved less contentious– Ukrainian legislators passed on March 31, reform allowing Ukrainians but not foreigners or foreign-owned corporations to buy and sell farmland. It will only take effect in July 2021, with various other stipulations on prices and sizes of purchases.
The IMF program is likely to give other multilateral institutions such as the World Bank, the European Bank for Reconciliation and Development, and the European Union confidence to release aid to the country. Estimates suggest Ukraine could count on approximately $6bn worth of support from these multilateral institutions leaving it with an estimated $3bn shortfall in funding for the country in 2020 according to JP Morgan Emerging Markets Research.
A Subtle Rebound
JP Morgan Emerging Market flow data also shows that EM bonds posted its 3rd week of positive inflows marking a distinct reversal from the record outflows seen during the earlier part of the Covid-19 pandemic.
Emerging market retail bonds added $2.6 bln in the week ending June 11, but the asset class is still $30 bln smaller year-to-date. Emerging market countries are today giving investors plenty of opportunities to buy new debt. Although markets were shut in March, EM countries have notched $76.8bn in new debt issuance, eclipsing $17.5bn issued over April/May 2019. There has been a bias towards investment-grade sovereigns (US$66.2bn of the total) versus Below Investment Grade countries. Ukraine may be testing the markets if it issues to fund its $3 bln funding shortfall.
Both Standard and Poor’s and Fitch Ratings currently rate Ukraine “B” with a stable outlook, one notch higher than Moody’s.