Ukraine: conditional love

• Anti-government protests have continued for a month in Kiev.

• Ukraine and Russia have agreed on a financial aid but the conditions are unknown.

• Devaluation and credit default risks have decreased significantly but only until 2015.

Assessment and outlook

For almost a month, the central streets of Ukraine’s capital Kiev and western towns have been flooded with protesters following President Viktor Yanukovich’s refusal to sign a free trade agreement with the EU. Beginning as protests against the President’s so-called ‘anti-European’ move, protesters demands now go further: they also require the resignation of the Government and the President.

On 17 December, President Yanukovich and Russia’s President Vladimir Putin signed a deal in Moscow under which Russia will buy Ukraine’s sovereign debt (first, USD3bn of two-year eurobonds) and lower its gas price to USD268.5 per thousand cubic metres from around USD400. According to Ukraine’s Energy Minister Eduard Stavitsky, the country will save USD4-7bn per year after the gas price discount. Altogether Russia has promised USD15bn of inflows. However, the conditions under which the deal has been made remain unclear. This has raised questions from protestors and the Ukrainian opposition. This does not help in solving the political crisis despite the relief for debt markets and the economy. On financial aid, President Yanukovich comfortably receives extra time to take him safely through the presidential elections in March 2015. Yet, the amount of outstanding debt is set to increase in H2 15, pushing the country closer to default if it does not negotiate new conditional financing.

Ukraine’s official reserve assets have been decreasing from one month to another reaching USD18.8bn in November, a 51% fall from April 2011. Since then, the UAH has lost 4.3% against the USD moving to 8.28 in December 2013. Before the Russian deal, we expected a worst-case scenario of 30% UAH devaluation in 2014 as the current account deficit hit the unbearable level of approximately 7% of GDP. However, the gas price discount would improve the deficit to around 6% in 2014, which takes significant pressure away from the UAH and lowers the probability of a large-scale devaluation. If we see positive development in the political situation backed by economic aid, we expect USDUAH not to cross the 9.00 level in 2014, which is 8% higher than the current rate. Despite this and the peg regime of UAH, we believe high volatility is here to stay. Some 1.5% movement within a week is very possible.

Ukraine’s short-term debt gets a boost from the deal, as default fears, which increased on deteriorating macroeconomic and political stability, are vanishing. The curve has been extremely inverted, as markets were unsure about Ukraine’s ability to serve the debt expiring in 2014-15. We estimate a significantly lower credit default risk from now until H2 15 and see great uncertainty arising after March 2015.