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S&P: Ukraine Government's Assumption Of Lost Savings Obligations Will Accelerate Overheating Risks

January 15, 2008 | Cbonds

LONDON (Standard & Poor's) Jan. 15, 2008--Standard & Poor's Ratings Services
said today that the decision by the new Ukrainian government to incorporate
payouts of "lost savings" liabilities into the 2008 budget, at a cost of just
under 3% of GDP, will further stoke demand pressures in an economy that is
already overheated. In total, the government could assume as much as 19.8% of
GDP in liabilities via the assumption and revaluation of these Soviet-era
retail deposits, the value of which was rendered almost worthless in the early
1990s by hyperinflation. Over the medium term, however, there is a strong
possibility that the value of the deposits is once again reduced by higher
than budgeted inflation.

While at present the Ukraine's (foreign currency BB-/Negative/B, local
currency BB/Negative/B) current account deficit (estimated at 3.4% of GDP for
2007) is relatively modest and over-financed by robust FDI, it is set to
nearly double in 2008 on the back of the higher cost of gas imports from
Turkmenistan and Russia and surging demand. Were global metals prices to
decline, the deterioration of Ukraine's external accounts could worsen more
rapidly. Over the medium term the possibility of a negative adjustment in the
terms of trade accompanied by high inflation could lead to downward pressure
on the hryvnia and an end to the de facto pegged exchange rate regime.

The Ukraine's 2008 budget not only reflects the government's revaluation
of its liability to private sector depositors, but also includes an explicit
guarantee of a portion of Naftogaz's debt, roughly equivalent to 2.0% of GDP.
This measure constitutes a quick fix, rather than a permanent repair for the
state-related entity, which is heavily indebted to Russia's Gazprom as well as
other non-resident lenders. As long as Naftogaz is forced to extend subsidies
on gas imports to Ukraine's municipalities, it will continue to run large
losses.

In summary, the new government's populist approach to fiscal and
quasi-fiscal policy runs the risk of exacerbating the loss in purchasing power
it purports to address, while undermining the Ukraine's recent impressive
economic performance, with negative implications for sovereign
creditworthiness.

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