Fitch Ratings has today downgraded Ukraine`s Long-term foreign and local currency Issuer Default Ratings (IDRs) to `B+`, from `BB-` (BB minus). The Outlooks on both IDR remain Negative. The agency has also downgraded the Country Ceiling to `B+` from `BB-` (BB minus) . The Short-term foreign currency IDR is affirmed at `B`.

"The downgrade reflects Fitch`s concern that the risk of a financial crisis in Ukraine involving a large depreciation of the currency, further stress in the banking system and significant damage to Ukraine`s real economy is significant and rising. Such a scenario would damage the sovereign`s balance sheet. Nevertheless, Fitch believes risks to Ukraine`s ability to meet its sovereign obligations remain low in the near term owing to the sovereign`s modest refinancing needs," said Andrew Colquhoun, Director in Fitch`s Sovereigns Group.

Ukraine has officially requested assistance from the IMF and a Fund team is currently in Kyiv. Fitch would view a sizable and appropriately-designed IMF programme as a positive factor, although the agency awaits precise details before drawing firm conclusions. However, depositor confidence in the banking system may remain shaky and the economy will face a difficult adjustment even if a programme is arranged, extending Ukraine`s exposure to financial instability.

On 13 October, Fitch signalled rising concerns over the health of Ukraine`s banking system amid a sharp tightening in liquidity conditions and some deposit withdrawals from the system following the failure of sixth-largest bank Prominvest. Fitch is unconvinced that the raft of emergency support measures announced by the central bank, including stepped-up liquidity provision and a ban on early redemption of term deposits, will be adequate to shore up depositor confidence and forestall further banking-system stress. New central bank rules restricting loan growth threaten to exacerbate a slowdown in the economy, which could hit banks` asset quality relatively soon.

A relatively high share of FX-denominated lending (51% at end-August) exposes the financial system to risks from enhanced currency volatility. Ukraine`s currency, the hryvnia (UAH), fell to 5.6 against the USD by 8 October, down 10% on the month, before climbing back to around 5.2-5.3 on intervention by the central bank. The UAH is likely to stay under pressure from a widening current account deficit, which Fitch projects at around 7% of GDP in 2008, versus 4.2% in 2007. Falling steel prices will intensify a terms-of-trade shock originating in a likely strong increase in Ukraine`s gas import price next year. Strong borrowing by the private sector took Ukraine`s gross external debt to USD100bn by end-June 2008, including USD28bn of private-sector short-term debt. Hard numbers on private-sector external debt maturities for 2009 are not available, but Fitch estimates these could be around USD19bn for longer-term borrowing. With many private-sector borrowers likely to find it hard to refinance their maturing external borrowing, the sovereign may be forced to provide resources from official reserves, which are also needed to shore up confidence in the exchange rate.

Fitch continues to draw comfort from Ukraine`s moderate sovereign refinancing needs for 2009 of USD2.5bn, of which USD0.9bn are domestic (mostly in UAH) and USD1.6bn are external (including a USD0.5bn eurobond maturity in May), compared with the latest disclosure for official reserves of USD37.5bn on 9 October. The country`s low general government debt/GDP ratio of 10% for end-2007 is well below the `BB` median of 34% (and the `B` median of 33%). However, worsening economic prospects and requirements for official support to the economy could erode Ukraine`s fiscal strength in the medium term.