Fitch downgrades Russia to one notch above junk rating

By bne IntelliNews January 12, 2015

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Fitch Ratings has downgraded Russia's long-term foreign and local currency Issuer default rating (IDR) from BBB to BBB-, with a negative outlook. The rating is the agency's lowest degree investment-grade. The short-term foreign currency rating was affirmed at F3.

Fitch believes that the Russian economy, which grew only at 0.6% in 2014, will contract by 4% in 2015 against a previous estimate of a 1.5% recession. The decline in GDP will be due to a steep fall in investment and consumption, only partially offset by an improvement of net exports on the back of a sharp drop in imports.

The outlook is based at an average $70/barrel oil price in 2015, below the $100/barrel expected in July 2014. An oil price below $70/barrel could result in a deeper recession, further straining public finances and limiting the room for authorities to manoeuvre. The agency warns that growth might not return until 2017.

The rating downgrade is attributed to a significant deterioration of the economic outlook since mid-2014, following a sharp decline in the oil price and the ruble, as well as a steep rise in interest rates. Western sanctions continue to weigh on the economy by blocking access to external capital markets, while plunging oil prices have revealed a strong link between the oil prices and growth, in spite of a more flexible exchange rate.

In the meantime, the authorities had to intervene to preserve financial stability after the steep ruble depreciation, sharp market volatility and an interest rate hike from 10% to 17% shocked the banking sector at the end of 2014. After doubling the cap on insured deposits, offering subordinated bonds from the National Welfare Fund and RUB1tn on non-cash subordinated loans, the authorities might have to provide more banking support given the remaining pressure on capital ratios and asset quality. 

At the same time, the faster than expected fall in international reserves, shrinking income, and double-digit inflation are exerting a medium effect on the rating. International reserves at the end of 2014 stood at $390bn, down $120bn year-on-year and lower than Fitch's previous forecast of $450bn by end-2014 and $400bn by end-2015. The reserves/M2 ratio which the agency uses to measure the ability to cope with capital flight is at about 50%, while reserves relative to liquid external liabilities is estimated at a robust 220%.

The current account surplus is seen rebounding from $55bn or a 2.9% of GDP surplus in 2014 to $72bn or a 5.3% surplus due to a drop in imports. However, given the $130bn capital outflow expectation for 2015, and no renewed access to the capital markets, the reserves are expected to decline to $315bn by end-2015.

Inflation, which reached 11.4% in December 2014, is seen as likely to remain double-digit throughout Q1/15, pressuring real incomes and domestic demand. High inflation (remote from the central bank's target of 4.5%), could lead to higher interest rates yet, Fitch warns. At the same time, per capita income in US dollar terms is likely to shrink by up to a third in 2015, reflecting the damage to national income and debt tolerance.

Among the main risk factors that could individually or collectively trigger a negative rating action pushing Russia into the junk category, are: continued exchange rate volatility requiring greater public financing support; sustained low oil prices or continued recession in 2016; faster than expected depletion of international reserves reflecting larger capital flight or accelerated dollarisation domestically; and an intensification of sanctions or a geopolitical risk event.  

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