​Everything seems to be good in Ukraine in the short term. In contrast to the more cautious forecasts at the beginning of the year, Ukraine's economy is growing much faster than expected and should record GDP growth of at least 3.5% in 2018.

With its International Monetary Fund (IMF) extended fund facility effectively frozen, thanks to the government’s foot-dragging on reforms, the country has been desperately short of cash and that has undermined the strength of the hryvnia. But as the year comes to a close it looks like a sharp currency devaluation has been avoided in 2018 - a very difficult year for some other emerging markets - although Ukraine is one of the most fragile emerging markets in the world according to some key credit risk metrics.

And the National Bank of Ukraine (NBU) has established itself as one of the most credible economic policy players in the post-Maidan government, having stuck to its guns with a restrictive monetary policy geared to guarding against surging inflation and managing risk.

So far, so good. Now, after extremely tough negotiations, a new 14-month agreement with the IMF is within reach. This will allow Ukraine to enter the 2019 election year without facing the threat of a payment bottleneck or a potential financial and economic crisis.

But this is also where the problems lies. With a new IMF deal almost in the bag (the IMF board needs to approve the deal and wont until after the government passes the 2019 budget law, expected to happen in December) Ukraine has already tapped the international capital market with a $2bn Eurobond issues and has the possibility of hitting the market again without any material restrictions.

The government, it seems, has been waiting for this. Almost as soon as the IMF signalled that deal is back on the state tapped the international market. Now other Ukrainian issuers, such as state-owned gas monopolist Naftogaz, have expressed an interest in following the ministry of finance into the debt capital markets.

At first glance, this indicates a certain degree of international investor confidence. However, the international investor community should not be unworried. On the one hand, Ukraine sovereign risk - after a considerable recovery rally in 2017 into the spring of 2018 - is currently still priced at the lower end of reasonable market ranges; on the other hand, a considerable shift in risk is currently underway.  

At the current market valuations Ukraine is trading close to its historical lows in relation to other emerging market benchmarks – e.g. other global Emerging Markets with B ratings or countries such as Pakistan, Egypt and Nigeria. In this respect, markets are gifting Ukraine with a considerable advance of confidence that the country will make more progress.

International capital market investors are currently taking on more and more risk when compared to the international banks. International banking statistics currently show there is around $10bn-$11bn in consolidated cross-border claims against Ukraine. At its peak some ten years ago, there used to be more than $50bn in consolidated cross-border claims. In other words: international bank exposures currently amount to only about 15-18% of their peak value. 

In terms of internationally issued bonds, the picture is slightly different. If you include the latest or upcoming international bond issues, external debtors from Ukraine are currently in the game and holding $10bn-$11bn of debt. This reading reflects a certain leveraging up as the pre-crisis high in international bonds outstanding stands at some $27bn. Therefore, current value of internationally traded debt corresponds at least to 35-40% of pre-crisis highs. In terms of GDP, calculated in dollar terms, the international capital market issuance coming out of Ukraine is currently around 4-5% of GDP and is thus already running above the long-term average of about 2-3%.

In principle, there is nothing wrong with the fact that Ukrainian risks are currently being spread more widely in the financial ecosystem. As a rule, capital market financing should lead to better risk diversification than bank financing. It is to be expected, however, that investors are currently investing in Ukraine with a healthy dose of risk awareness.

As things stand it is still unclear whether Ukraine is already back to a situation where it has too much debt or whether it is possible to pursue a longer-term and stability-oriented economic policy in Ukraine. 

Moreover, it is important to stress this point: Ukraine faces an economically and politically difficult election year in 2019. An election campaign marked by populism is looming, while the IMF agreement currently being sought does not provide for a very ambitious surveillance of economic policy. The chances of more reform slippage remain considerable.

In view of the rather short-term IMF programme – the IMF has downgrade Ukraine’s deal status from the multi-year extended fund facility to a simpler 14-month stand by agreement – Ukraine could be faced with the question of whether a new IMF agreement is needed as early as 2019 and on what terms.

It is also unclear how great are the risks of an escalation of the “frozen” conflict with Russian-backed separatists in Eastern Ukraine in 2019. Russia has already been accused of meddling in many country’s internal politics and the same can also be expected in Ukraine.

It remains to be seen what will happen if attempts to influence upcoming elections in Ukraine are made and then do not produce the desired results. Furthermore, one should not underestimate the newly won independence of the Ukrainian orthodoxy church, which is certainly a core element of the state and ideology of Ukraine. Clearly the “schism” and break with the Russian Orthodox Church has not gone down well in Moscow and this can also be expected to have consequences. 

Taken together all these factors create a recipe for instability. The crucial question becomes whether international investors are prepared for what could turn out to be a very challenging 2019 for Ukraine.