S&P threatens Russia with junk rating if it raids National Welfare Fund

By bne IntelliNews November 27, 2014

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Russia's sovereign credit rating risks being downgraded to "junk" by Standard & Poor's if the government carries through a proposal to raid its so-called rainy day wealth fund, the ratings agency said on November 26.

The cash-strapped Russian government is hunting for ways to finance budget spending and money to prop up indebted state-owned companies without raising taxes. It has proposed to release money from the National Welfare Fund, a reserve of money siphoned off in previous years from oil taxes and intended to support future pension payments.

S&P warned that the government has only "limited room" for using money from the fund to cover budget spending without getting a ratings downgrade.

Russia's rating was marked up to "investment" grade by the agency in 2003, but with public finances deteriorating through a combination of poor economic growth and sanctions,  its financial standing has weakened.

“If money is spent to support the economy, to support specific companies -- that would lead to a decline of those fiscal buffers beyond what we currently expect,” S&P analyst Christian Esters said in an interview in Moscow, reported Bloomberg. The rainy-day funds “are strong mitigating factors for the stresses Russia has been experiencing".

Currently the fund, one of several, contains $82bn but has already fallen 13% from its peak in 2011. The state has proposed releasing RUB100bn ($16bn) from the fund to support state-owned companies that have a heavy external debt repayment schedule to the end of the year, but have been cut off from international capital markets by the west's sanctions regime.

S&P said that if the government sticks to this amount then that “alone would probably not breach a threshold for us", but that a downgrade is possible if such a decrease were compounded by additional sanctions and a prolonged decline in oil prices.

Some analysts were surprised by the S&P's tough talk, which appeared to contrast with its own note that said Russia is not in immediate danger of a downgrade. "Surprisingly harsh statement I thought from S&P - I have argued that Russia is a long way from seeing its IG status removed, but maybe the rating agencies have a lower threshold than I imagined," said Tim Ash, head of emerging markets research at Standard Bank, in a note to clients.

Several state-owned companies such as Rosneft and VTB bank have already been to the government with their hands out for money, but so far the finance ministry has rebuffed their pleas for bailouts.

S&P last month kept Russia’s sovereign rating at BBB-, an investment grade that is only one notch above "junk" status. Junk status precludes some investors, such as international pension funds, from taking buying  Russian assets. A downgrade would add to Russia's funding woes and reduce the size of the already limited pool of international money it can tap. S&P's next review is slated for April.

However, sentiment is definitely flowing against Russia. Both its debt and equities are trading well below  "fair value" estimates based purely on macroeconomics and companies' earnings performance.

"Some would argue that the market is already trading Russian sovereign as "junk" with Russia 5Y CDS at 300bps, that is 130bps wide of Turkey now which S&P only rates BB+, with a negative outlook, and also 30bps wide of Croatia which S&P also rates as junk these days, at BB. Meanwhile - and some would say quite remarkably, Russia trades wide even of Egypt, by 15bps, which is rated B- by S&P," says Ash.

Apart from the lack of cash, Russia's economic fundamentals are strong otherwise. It is currently running a triple surplus – the federal budget, current account and trade balance are all positive – which remains unusual on the planet. Also the government's net external debt is very low by international standards at about 35% of GDP.

However, a sliding ruble and tumbling oil prices have put the state's finances under a great deal of pressure. The official forecast for GDP growth this year is 0.8% but economists say it could be lower and the outlook for next year is flat growth or recession according to most experts. Russia's gross international reserves have been under pressure after the state spent some $100bn in managing the currency lower and other growth-boosting schemes. The ruble has been one of the worst performing currencies in the world this year.

Russia’s “usable” currency reserves will shrink to about four months of imports by 2017, down from eight months this year, as a result of “liquidity support” provided by the central bank to the economy, according to S&P, reports Bloomberg. On a gross basis Russia has 1.7 years of import cover, where three months is the recommended minimum by economists. Usable reserves are defined as total holdings adjusted for investments made by the central bank on behalf of the government.

As Russian borrowers struggle to access foreign capital markets amid US and European sanctions over Ukraine, the government approved channeling more than RUB400bn ($8.6bn) from the Welfare Fund to Russian Railways and other companies including fixed-line operator OAO Rostelecom and Avtodor and the state road-building agency. The Economy Ministry has also given its preliminary approval for allocating another RUB300bn from the fund.

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