The fighting in eastern Ukraine has intensified since the beginning of this year. As a result, January has been the worst month in terms of fighting and casualties since the Minsk ceasefire agreement signed in September 2014. The rebels took control of the Donetsk airport after heavy fighting. Mariupol, a strategic port in the Donbas under government control, was hit by shelling. Intense clashes were reported around the town of Debaltseve which is still controlled by the government but surrounded by the rebels. The city is a key transport hub between the two main rebel strongholds (Luhansk and Donetsk). It seems that the rebels try to enlarge the region under their control in order to create a viable zone and protect themselves against the government. On 31 January, peace negotiations in Minsk between the government and the rebels collapsed. Amid allegation – denied by Moscow - of Russia’s support to the rebels’ advance with heavy weapons, tanks and staff, the EU and the US have threatened to intensify sanctions against Russia. However, with Siriza coming into power in Greece, the EU foreign ministers failed to agree on new economic sanctions. Instead, they agreed to prolong the sanctions that expired in March and clarified the designation criteria for the freezing of funds targeting persons identified as responsible for the misappropriation of Ukrainian State funds. Hence additional persons are likely to be targeted by sanctions next week.
Impact on country risk
The intensification of the conflict is an additional challenge for the government that has to cope with an extremely difficult economic situation. The economy is likely to contract further this year. The foreign exchange reserves plunged by more than 60% in 2014 to USD 6.6 billion and covered less than one month of imports, rising prospects of strengthened foreign exchange controls. The hyvrnia fell sharply from UAH 8 per USD in January 2014 to UAH 15.769 per USD end of December 2014. The banking sector, which was already weak before the political crisis erupted, was further hit by the hyvrnia’s depreciation and the deterioration of asset quality. As a result, several banks already failed and the banking sector needs to be recapitalised. The government is likely to launch discussions with investors in order to restructure (in a friendly way) its public debt. On the positive side, the EU pledged to provide EUR 1.8 billion (USD 2.1 billion) of financial support, and the US pledged to grant a USD 1 billion loans guarantee. The IMF is ready to discuss a multi-year arrangement (Extended Fund Facility) to replace the existing Stand-By arrangement. It would provide breathing space for the government but may be insufficient to cover Ukraine’s high external financial needs. In this context, prospects to reopen cover for Ukraine remain meagre.
Analyst: Pascaline della Faille, email@example.com