Moody’s cuts Ukraine’s credit rating to the third-lowest level as war raises debt

Moody’s Investors Service cut Ukraine’s credit rating to the third-lowest level, as the three-month war with Russia rumbles on and raises the risk the country will not be able to repay its debt.

The downgrade of Ukraine's government ratings to Caa3 was driven by the increased risks to Kyiv's debt sustainability from Russia's military action, leading to a more protracted conflict than Moody's expected, the New York-based agency said on Friday.

This “increases the likelihood of a debt restructuring and losses being imposed on private sector creditors … a more protracted military conflict following the invasion by Russia would keep financing needs very high for a prolonged period and result in a further rise in the debt burden,” Moody's said.

Moody's gave a negative outlook, reflecting a “still a high degree of uncertainty around how the invasion will evolve and its credit implications. Hence, the recovery by investors in the event of default could be lower than 65 per cent to 80 per cent, which would be consistent with a rating below Caa3.”

Russia and Ukraine have been at odds since 2014, and the war that began in February has taken a heavy toll on the latter. The conflict is expected to shrink the economy by more than 35 per cent in 2022, with the fiscal gap projected to reach between $3 billion and $10bn a month, the Institute of International Finance said last month.

The IIF also said that the war would have a spill-over effect to the global economy, which it described as “teetering on the brink of recession” on Friday.

The coronavirus lockdowns in China and a hawkish US Federal Reserve are also weighing on activity worldwide.

The World Bank last month said it expects the Ukraine economy to contract by about 45 per cent in 2022 because of the conflict.

A more prolonged conflict will also weigh on Kyiv's financial resources, with Moody's estimating financing needs of around $50bn in 2022 — which is 35 per cent gross domestic product this year — and forecasting a rise in government debt to around 90 per cent of GDP from about 49 per cent at the end of 2021.

“The severity of the economic damage from the protracted military conflict will have long-lasting negative implications for the government's finances, increasing risks to debt sustainability,” it said.

Financial support from the international community will help mitigate external and liquidity risks, Moody's said. The agency estimates that global financial institutions and other donors have committed about $38bn, of which $5bn so far has been disbursed, since the start of the conflict.

That should cover a large portion of Ukraine's estimated financing needs for 2022, and would come as a big relief for Kyiv. Last month, the IIF said that commitments would “certainly fall short” at a time when they were at $6bn.

This week, Group of Seven financial leaders pledged $18.4bn to Ukraine to help it pay its bills in the coming months, with the group saying it will offer more support if needed, and the US Congress gave final approval for a $40bn aid package for the country.

The recent opening of an account at the International Monetary Fund to channel donor resources for balance of payments and budgetary needs, including the possibility for countries to transfer Special Drawing Rights, will further increase funding, Moody's said.

“The challenge for the banking system to absorb significant new sovereign debt and the potential inability to access international markets will likely keep Ukraine dependent on official funding,” it added.

The negative outlook on Ukraine suggests an upgrade is unlikely in the near term — but it could be changed to stable if the war were to end relatively soon, Moody's said.

This would contribute to “helping to contain Ukraine's financing needs and reducing risks to the sustainability of Ukraine's government debt burden. Furthermore, indications that the recovery for bondholders in the event of default was expected to remain in line with a Caa3 rating could also lead to a stabilisation of the outlook.”