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Moody’s places Russia’s Ba1 rating on review for downgrade

March 05, 2016, 2:37 UTC+3

Moody's on February 20, 2015 downgraded Russia's sovereign debt rating from Baa3 to Ba1 with a negative outlook

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NEW YORK, March 5. /TASS/. The Moody’s ratings agency on Friday placed Russia’s Ba1 government bond and issuer ratings on review for downgrade.

"During the review, Moody's will assess the extent of the impact of the further sharp fall in oil prices, which Moody's expects to remain low for several years, on Russia's economic performance and government balance sheet, including the government's deficit financing options, in the coming years," Moody’s Investors Service said in a statement.

Moody's said it expects to complete the review within two months.

Rationale for initiating review for downgrade

"Russia is highly dependent on hydrocarbons to drive economic growth and to finance government expenditure. Oil and gas account for close to 60% of goods exports and roughly 17% of GDP. Hydrocarbons still provided around 43% of federal government revenues in 2015," the agency said.

"Between September 2014 and September 2015, global oil prices roughly halved. Since then, oil prices have fallen a further 40% to around US$30/barrel. Moody's recently revised its oil price assumptions for Brent crude to average US$33 per barrel in 2016 and US$38 per barrel in 2017, rising only slowly thereafter to US$48 by 2019," it said.

"The structural shock to the oil market is weakening Russia's economy and its government balance sheet and therefore also its credit profile. Assuming no policy response and other factors being equal, Moody's estimates that depressed oil prices for the coming years would imply a further gradual decline of three 3 percentage points to 15.5% in the federal government revenue to GDP ratio, federal government deficits of 3% of GDP or more and around a 12-percentage-point rise in Russia's debt burden over a four-year period," the statement said.

"That would shift down our assessment of the government's balance sheet strength from 'Very High' to 'Very High (-)'," it said.

"The roughly 27% depreciation in the exchange rate against the US dollar since the start of 2015 has contained the impact of the terms of trade shock on the Russian government's revenues somewhat," Moody’s said.

"The country's current account balance relative to GDP has stayed in surplus, largely due to a compression of imports of nearly 35%. However, this was at the cost of higher inflation, which rose from 11.4% in 2014 to a high of nearly 17% in March 2015, before subsiding to 8.1% in February 2016 as the base effect from the initial spike in inflation in December 2014/January 2015 passed," it said.

"Meanwhile, Moody's expects real growth over the next four years to be just 0.4%, unchanged from the last four years. Although the Russian government envisages improved competitiveness afforded by the weaker exchange rate to stimulate investment in non-oil sectors of the economy, Moody's expects that the potential growth rate will not rise meaningfully given the structural problems facing the economy, in particular chronic underinvestment, which persists despite depreciation-inflated profits at Russian companies given their fears of pending corporate tax hikes," the statement said.

"Meanwhile, exports are subject to capacity constraints across sectors, including oil. In addition, the significant loss of income for workers due to double-digit real wage cuts is likely to continue to depress consumption and as mentioned previously, the government's budget constraints are now binding," Moody’s said.

"The move to a floating exchange rate has helped to conserve foreign exchange reserves. At US$310 billion (or 28% of forecast 2016 GDP) as at the end of January 2016, the country's foreign currency reserve assets remain large, representing 13 months of imports of goods and services, which is an increase from nine months at the end of 2014, due to the 35% fall in imports last year," it said.

"However, calls on these funds would grow if substantial capital outflows were to resume for example due to financial or political volatility or in the event that the central bank were called upon to support the banking industry," the statement said.

"Fiscal reserves have declined markedly. The US$38 billion drawdown from the government's Reserve Fund in 2015 contained the rise in debt, but at the cost of reducing the government's fiscal buffer from US$88 billion at the end of 2014 to US$50 billion at the end of January 2016," Moody’s said.

"Given pressures on the government's finances, Moody's sees risks that the government would become overly reliant on a weak currency to offset the lower oil prices or else resort to central bank financing, both of which would keep inflation at relatively high levels and threaten the recovery of the domestic banking system," the agency said.

"During the review, Moody's will assess the government's ability to mitigate the impact of the recent fall in oil prices on Russia's credit standing. It will assess the clarity, scope and ambition of the government's plans relative to the scale of the task, the time required for them to bear fruit, and the reliance that can therefore be placed on them to sustain Russia's credit strength," it said.

"The government has announced its intention to undertake a range of measures to mitigate the impact of the renewed fall in oil prices on its fiscal deficit and credit standing. The plans include immediate cuts to expenditure, hikes in excise taxes, the further tightening of tax enforcement and administration and higher dividend payments from state-owned enterprises (SOEs)," Moody’s said.

"In Moody's opinion, the government will need to rely heavily on domestic sources of financing as long as international sanctions remain in place, constricting access to foreign finance for the government, state-owned enterprises and banks (even though the government itself is not sanctioned)," the agency said.

"The liquidity of the domestic banking system has improved because of banks' deleveraging over the past two years and the strong growth of the deposit base, despite low profitability. Assessing the extent to which domestic credit will be sufficient to fill the funding gap will be an important element in Moody's rating review," it said.

What could lead to downgrade

"Moody's would downgrade Russia's Ba1 rating if its rating review were to conclude that the government's plans are probably inadequate to sustain Russia's economic or government balance sheet strength at its current level. Signs of an emerging fiscal or balance-of-payments crisis would also exert downward pressure on the rating," the agency said.

"Those signs might include a further sustained fall in the price of oil, significant capital outflows and pressure on the exchange rate and foreign-currency assets, a marked worsening in the fiscal balance for which there was no clear reversal, or further stress in/support for the banking system. Deterioration in the domestic or regional political environment, resulting in disruptions to oil production and/or foreign investments in the economy, would also be highly credit negative," it said.

"Given the extent of the negative impact and the current strength of the government balance sheet, however, a rating downgrade would most likely be limited to one notch," Moody's said.

What could stabilize rating

"Although currently less likely, Moody's would maintain and confirm Russia's current Ba1 rating if its rating review were to conclude that there is evidence of institutional strength, as reflected in the enunciation of a clear, credible fiscal and economic policy response, such that the government could contain its fiscal deficits to a size that can be readily financed from its own savings or other domestic or external resources without relying upon central bank monetization," the agency said.

Earlier downgrades

Moody's on February 20, 2015 downgraded Russia's sovereign debt rating from Baa3 to Ba1 with a negative outlook. Earlier, on January 26, 2015, another ratings agency, S&P, downgraded Russia's sovereign credit rating to BB+ from the investment grade BBB-.

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