S&P expects Ukraine's GDP to fall by 7.5% in 2015, grow by 2% in 2016

Standard&Poor's Ratings Services forecasts that the gross domestic product (GDP) of Ukraine in 2015 will fall to 7.5% compared to a 6.8% fall in 2014, but will grow 2% in 2016, 3.5% in 2017 and 4% in 2018.

The agency said this in a report on lowering its long-term foreign currency sovereign credit rating on Ukraine to 'CC' from 'CCC-'.

S&P expects the average acceleration of inflation from 12.2% last year to 35% this year, which will be followed by its sharp slowdown to 12% and 8% in 2016 and 2017, respectively.

According to the agency, the state debt, after rising last year from 40.2% of the GDP to 70.7% of the GDP, at the end of this year will reach 93% of the GDP, while by the end of 2018 will fall to 82.6% of the GDP.

"Ukraine's macroeconomic situation remains challenging. In our view, the biggest risks to regaining sustainable economic growth, and therefore sustainable debt levels, include re-establishing financial-sector and exchange-rate stability," S&P said.

These in turn depend primarily upon external factors that Ukraine does not directly control, including the country's terms of trade, and the current military conflict in the east of the country, which is undermining trade and confidence, the agency said.

The agency expects support for Naftogaz Ukrainy and banking-sector recapitalization costs to affect fiscal balances, though a large part of the fiscal impact will likely be monetized by the National Bank of Ukraine (NBU). "Despite a significant narrowing of the current account deficit, dollarization and capital outflows--including cut-backs in trade credit and reduced demand for foreign currency deposits and private debt outflows--will continue to lead to outflows on the financial account this year," S&P said.

According to its estimate, the current account balance will shrink from 4.2% of the GDP last year, to 1.7% of the GDP this year, and 2% of the GDP next year.

The envisaged fiscal consolidation in terms of a reduction in public-sector employment, freezing of pensions and wages in nominal terms, and tariff hikes will weigh on growth, as will the 40% year-to-date depreciation of the hryvnia and rising inflation, S&P added.

The eurobonds included in the restructuring talks, which should help Ukraine save $15.3 billion on debt payments in the next four years, even when including the $3 billion Russian eurobond, which Russia is reluctant to reorganize, comprise only around 20% of Ukraine's total government and guaranteed debt stock, calling into question the extent of the relief on the debt burden that can be expected from the talks, the agency said.

Meanwhile, domestic market liabilities make up around 40% of total debt stock, of which close to 70% is held by the NBU. The IMF program does not support reprofiling of debt held by the NBU, the agency said.

According to S&P, the situation in the financial sector is precarious, with confidence in the system severely strained. Although hryvnia deposits are now relatively stabilized, outflows in foreign currency continue despite currency controls.

S&P added that the hryvnia was officially floated in February 2015, although now it is being artificially propped up by a steep refinancing rate hike and strict currency controls.

"The negative outlook reflects the deteriorating macroeconomic environment and growing pressure on the financial sector, and our view that default on Ukraine's foreign currency debt is virtually inevitable," the agency explained the updated forecast for the countries sovereign ratings.

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