Below is an excerpt from our weekly report from last Wednesday.  On Friday, Moody’s downgraded Ukraine to Caa1 (from B3), citing plummeting FX reserves, downside risk from future negotiations with the IMF, and Ukraine’s worsening relations with Russia.

Less reported than the travails of other EMs, the situation in Ukraine is nearing a tipping point.  Ukraine is one of the most vulnerable EMs from the perspective of FX reserves (second chart).  FX reserves are falling at an alarming 28% YoY rate (first chart).  Meanwhile the repayments schedule to Ukraine’s international creditors looks daunting.  Total external debt due for repayment over the next 12 months stands at around $62 billion, or 35% of GDP.  Moreover, the likelihood is that much of the 2013 debt refinancing will be short term, leaving next year’s debt burden little better than this year’s.

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In addition, Ukraine continues to run a greater than 7% current account deficit which it needs to finance, and the fiscal deficit is sliding dangerously out of control (bottom chart).  To complicate matters, the current standoff with Russia, over Ukraine’s overtures to the EU, has caused exports to Russia (which are 25% of total exports) to come to almost a total standstill.  Indeed, the spat with Russia could turn out to the straw that broke the camel’s back.

We wrote in a report from August 2012 that to avoid a hard default, Ukraine needs to drop its currency peg (or widen the trading band) to the USD and devalue its currency.  With the hryvnia still seriously overvalued and the external situation deteriorating rapidly, what we said back then is doubly true today.