Standard and Poor’s rating agency revised its outlook on the Russian Federation sovereign ratings to stable from negative, the agency said on September 16. At the same time, the long- and short-term foreign currency ratings were affirmed at below the investment grade level at 'BB+/B', and the long- and short-term local currency credit ratings at 'BBB-/A-3'. The agency affirmed the long-term national scale rating on Russia at 'ruAAA'.

Although the foreign-currency rating remained in the junk category, the upgrade of the outlook by S&P is likely to trigger a positive revision of evaluation of Russia’s sovereign creditworthiness. Recently, Moody’s was more upbeat on Russia’s banking sector, while Fitch ratings officials noted that Russia’s rating will be revised by early 2017.

S&P attributed the revision to a significant abating of external risks, while Russia’s “economy continues to adjust to the dual shocks of a lower oil price environment and sanctions imposed by the EU and the US”.

The agency expects a return to positive real GDP growth in 2017-2019 averaging to 1.6%, after a contraction of 1% in 2016. Russia is expected to maintain a comparatively low net general government debt burden and strong net external asset position in 2016-2019 despite the fiscal pressures.

The stable outlook thus reflects the expectations that the “Russian economy and policy making will continue to adjust to the relatively low oil price environment while keeping its external and fiscal metrics in check”.

External risks decline

S&P notes the moderation of the capital outflow, expected to decline to about $40bn in 2016 from $140bn in 2014. At the same time, the current account surplus averaging 3.8% of GDP is expected to cover the financial account deficit, which will cause the country’s international reserves increase.

“Russian corporations and banks that have foreign currency debt-service requirements without concomitant foreign currency revenues may continue to be under stress, but, in our view, these risks to the broader economy are less acute than before,” the agency argues, while noting that the Central Bank of Russia (CBR) has been providing substantial foreign liquidity to domestic banks.

Russia’s gross external financing requirement for 2016 is estimated at 60% of current account receipts (CARs) plus usable reserves. At the same time, liquid external assets held by the public and banking sectors are expected to exceed total external debt by about 60% of CARs in 2016-2019.

Sanctions are expected to remain in place over the 2016-2019 forecast horizon, continuing to limit the foreign direct investment (FDI) and medium-term external funding for banks and corporates. However, the agency reminds that Russian sovereign debt is not subject to sanctions, as the country was able to issue a $1.75bn Eurobond in late May 2016.

GDP still a constraint

Despite the expected rise of the GDP per capita to rise from $8,400 in 2016 to $10,300 in 2019, it will remain below the 2015 levels of $15,600, S&P warns. “We project Russia’s real GDP per capita growth will average less than similarly wealthy economies over our 2016-2019 rating horizon, which is a ratings constraint,” the agency notes.

The recovery of the GDP is seen to be driven by a modest rise in oil prices and the expansion of the oil and gas sector in terms of volumes, as well as by non-oil growth, primarily driven by household consumption. S&P assumes an average Brent oil price of $40 per barrel in 2016 rising to $45 in 2017, and $50 in 2018.

“We could raise the ratings if Russia’s financial stability and economic growth prospects improved more significantly than we forecast, possibly due to a loosening of sanctions or a rise in the oil price significantly above our current assumptions,” S&P notes.

Long-term structural obstacles to stronger economic growth (perceived corruption, the state’s pervasive and often inefficient role in the economy, and the challenging business and investment climate) will remain over the 2016-2019 forecast horizon.

Low government debt despite fiscal squeeze

“While fiscal pressures will remain, the general government deficit is forecast to narrow in 2016-2019 and the government should be able to maintain comparatively low general government (net of liquid assets) debt levels, not exceeding 13% of GDP in 2016-2019,” S&P says.

The general government deficit (federal, local governments, and special budgets) is expected to widen to 4.1% of GDP in 2016 from 3.5% in 2015. This includes the federal budget deficit of 3.5% of GDP, including 0.3% of GDP spent on recapitalising the troubled development bank Vneshekonombank.

General government deficit is expected to decline to about 3.3% of GDP on average in 2016-2019, falling steadily as the government implements its fiscal consolidation plan. Russia is therefore expected to maintain its rating strength of modest overall general government net debt position.

Meanwhile, drawing on the government's Reserve Fund and National Wealth Fund (together totalling about 9% of GDP) is expected to have the two funds to be close to being depleted by 2020.

“We project the government's net debt position will rise to 13% of GDP by 2019, still moderate compared with peers at similar rating levels,” S&P forecasts.

Financial sector still under pressure

“We anticipate that the financial performance of the banking sector will remain poor in 2016-2017, given the economic recession in 2015 and 2016, a deterioration in asset quality in the sector, and pressure on funding profiles of banks due to reduced investor confidence and the restricted access of key areas of the economy to international capital markets due to sanctions,” the agency argues.

This will limit the crediting in the economy and the rebound of GDP growth. Russia scores ‘8’ (on a scale of 1 to 10, where 1 is the highest) on S&P’s latest Banking Industry Country Risk Assessment.

Nevertheless, the pressure on Russian banks is stabilising, due to lackluster credit demand and funding costs coming down. S&P also praises the CBR for the banking sector clean-up and for “being broadly effective in managing problem banks”.

S&P’s inflation forecast, however, is above that of the central bank: 7% in 2016 (versus 5%-6%) and 5% in 2017-2019 (versus the 4% target).

“We could lower the ratings if geopolitical events were to result in foreign governments significantly tightening their sanctions on Russia, or if GDP growth or fiscal or external balances were materially weaker than our current projections,” the agency warns.