Fitch Downgrades Russia’s Outlook to Negative

Fitch Ratings has revised the outlook on Russia’s long-term foreign and local currency issuer default ratings (IDR) to negative from stable and affirmed the IDRs at BBB.

The credit ratings agency added that issue ratings on Russia’s senior unsecured foreign and local currency bonds have also been affirmed at BBB. The short-term rating has been affirmed at F3 and the country ceiling at BBB+.

Fitch’s next scheduled review date for Russia’s sovereign rating was 25 July 2014, but the CRA believes that recent developments warrant a deviation from the calendar for a number of reasons.

The revision of the outlook to negative reflects the potential impact of sanctions on Russia’s economy and business environment. Growth slowed to 1.3% in 2013 and investment is contracting. Since US and European Union (EU) banks and investors may well be reluctant to lend to Russia under the current circumstances, the economy may slow further and the private sector may require official support.

Following the referendum in Crimea on 16 March, the US and EU applied sanctions (visa restrictions and the freezing of property and financial assets) to a list of Crimean, Russian and Ukrainian individuals that they determined were contributing to the ongoing situation in Ukraine.

The direct impact of sanctions announced so far is minor, but the incorporation of Crimea into the Russian Federation will likely lead the EU and US to extend sanctions further in response. Furthermore, foreign investors may anticipate further official action and restrict Russian entities’access to external financing. Risk premiums have already risen and syndicated loans to a number of large corporates are reported to be on hold. In a worst-case scenario, the US may prevent foreign financial institutions from doing business with Russian banks and corporates.

A hiatus in access to the external markets is manageable, provided it is not prolonged. The corporate sector must repay US$67bn in March-December 2014 and the banking sector US$36bn, according to Central Bank of Russia (CBR) data. If corporate financing needs cannot be met in the markets, the authorities could draw on ample foreign exchange (FX) reserves to provide FX liquidity, through the state-owned banks or from the reserve fund.

Medium Rating Drivers

Fitch notes that the current climate is negative for economic growth. Russia was already experiencing a slowdown, with growth falling to 1.3% in 2013 and investment declining. Fitch has revised down its growth forecast to less than 1% in 2014 and 2% in 2015. These projections still rely on a mild upturn in investment, which is now less likely. Indeed, recession is possible, given the impact of higher interest rates, a weaker rouble (RUB) and geopolitical uncertainty.

Economic spillovers from recent events include higher capital outflows and pressure on the rouble. The CBR raised its policy rate by 150bps to 7% on Monday 3 March, when it spent US$11bn to defend the currency and pledged to stabilise it in a more tightly controlled range. Since then, the RUB has steadied without the need for massive CBR intervention.

A period of slower growth increases the risks of a departure from the fiscal policy framework in order to stimulate the economy, carrying medium-term risks that buffers are eroded or government debt rises from low levels. However, RUB depreciation is helping government finances by boosting the RUB value of oil revenues.

Russia’s ratings also reflect the following key rating drivers:

Russia has a strong balance sheet at both the sovereign and country level. Gross external assets exceed debt by 15% of gross domestic product (GDP). Central Bank international reserves are US$494bn, while corporate and banking sector external debt (excluding liabilities to foreign direct investors) is US$483bn, of which corporate FX-denominated debt is US$208bn (September 2013).

Low government debt (11% of GDP) and sovereign net foreign assets of 23% of GDP support the rating, although the sovereign balance sheet has largely stopped strengthening. Russia ran a small federal budget deficit in 2013, and aims to keep it below 1% of GDP through 2016.

Commodity dependence is high. Oil and gas account for 67% of goods exports and half of federal government revenue, exposing the balance of payments and public finances to external shocks. Governance is a relative weakness, manifested in the World Bank governance indicators.

Rating Sensitivities

Fitch said that future developments that could individually or collectively, result in negative rating action include:

• An intensification of sanctions, resulting in further restrictions in access to financing for the private and/or public sectors or reduced export market access, large-scale capital flight and further impact on the real economy.
• A weakening in the balance of payments leading to a substantial fall in reserves.
• A further deterioration in growth prospects, with an impact on the financial system.
• A steep and prolonged oil price fall that had a material impact on the economy and public finances.

As the outlook is negative, Fitch does not currently anticipate developments with a high likelihood of leading to a positive rating change.

However, future developments that could individually or collectively, result in a stabilisation of the outlook include a reduction in tensions with the international community over Crimea, resulting in a reduced risk of wide-ranging sanctions being imposed.

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