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Fitch: Gas Dispute Not an Immediate Threat to Ukraine's Ratings

January 05, 2006 | Cbonds

Fitch Ratings says today that the escalation of tensions in the ongoing gas price dispute between Russia and Ukraine is a serious concern, although the situation remains fluid. Both sides are under considerable pressure from the European Union to resolve the dispute and, while Fitch will continue to monitor developments closely, it would be premature to take any sovereign rating action at the present time. Ukraine's foreign and local Issuer Default Ratings (IDR) are both 'BB-' (BB minus) with Positive Outlooks.
Fitch notes that a four-fold increase in the price that Ukraine pays for its gas imports from Russia would represent a serious external shock for the Ukrainian economy. However, while it would boost the import bill significantly, the final net effect on the current account could be contained by a concurrent increase in transit fees for the transport of Russian gas to the EU. More significantly, the higher energy prices would increase near-term inflationary pressures while having a negative impact on domestic industrial production.

Ukraine's economy is already in a weak position with GDP growth having slowed sharply over the last year. After showing some initial signs of recovery during the autumn, real GDP contracted by 2.7% in November compared to a year earlier, resulting in growth for the first 11 months of 2005 of just 2.2%, and more than a third of Ukrainian firms continue to run at a loss. Against this background, it seems likely that sharply higher domestic energy prices would force a large part of the industrial base into a period of rapid and painful restructuring. Nonetheless, a lasting and severe physical shortage of energy is unlikely since, with 80% of Russian exports to Western Europe passing through Ukraine, Russia would be unable to cut off supplies to Ukraine without simultaneously affecting its major European trading partners.

Despite the challenging economic outlook, Ukraine's IDRs remain supported by low general government and net external debt ratios, which are far below those of its rated peers. In addition, near-term support to the external position is provided by official foreign exchange reserves of over USD19 billion. Fitch's willingness to convert the Positive Outlook on the IDR into an upgrade of Ukraine's sovereign ratings will be determined by political developments, how well macroeconomic management responds to this, or other shocks and concrete progress with structural reforms.

The possibility of a united and strong government emerging after the March 2006 Rada election that is capable of delivering in these key policy areas now hinges on how the main political players react to the domestic political arguments of the past year and the external foreign policy pressures created by the current dispute with Russia. Even with a strong government, institutional weaknesses and opposition from powerful vested interests will be working against rapid progress.


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