Analysts unfazed by S&P's Russia downgrade
MOSCOW. Dec 8 (Interfax) - Standard & Poor's downgraded Russia on December 8 for the first time since 1998. Further downgrades are possible as the agency's outlook on Russia is negative. But the action is expected to have limited impact on the markets for now. It came as no surprise and in any event the long-term debt market, for which the ratings bear significance, is out for the long term, and it is unclear when it will pick up in earnest.
Russia's sovereign ratings hit their low in September 1998, when S&P assigned a 'CCC' rating which reflected the fact the country was on the verge of bankruptcy right after the default in August that year. The sovereign rating had only climbed since, and Russia received investment grade ('BBB' on the S&P scale) as early as 2005, thanks to good trends in the commodity markets, the rapid clearance of foreign debt and the accumulation of huge reserves. The rating was raised again in December 2006.
The alarm bells started to ring on October 23 this year, when S&P changed its Russia outlook to negative as the country's reserves declined, export commodity prices fell and the government started to spend heavily on support for the economy.
So the ten-year ascent to the coveted 'AAA' rating never quite came off with Monday's downgrade.
S&P said it had lowered its foreign currency sovereign credit ratings on Russia to 'BBB/A-3' from 'BBB+/A-2'.
S&P also lowered its long-term local currency rating on Russia to 'BBB+' from 'A-', while the short-term local currency rating was affirmed at 'A-2.' In addition, Russia's Transfer and Convertibility (T&C) assessment was lowered to 'BBB' from 'BBB+'.
The outlook is negative.
"The lowering of the ratings on Russia reflects risks associated with the sharp reversal in external portfolio and other investment flows, which has increased the cost and difficulty of meeting the country's external financing needs," Standard & Poor's credit analyst Frank Gill said.
Since August 2008, Russia's international reserves have fallen from $583 billion to $455 billion (74% of its 2009 gross external financing needs), S&P said.
Pressures on the financial account stem from corporations prepaying or hedging foreign exchange borrowing, from banks refinancing their foreign currency obligations domestically with public sector banks, and from resident capital flight, while the central bank tries to offset intensifying pressures on the nominal exchange rate, S&P said.
The balance of payments is also pressured by the current account: S&P projects that Russia's current account will swing into a 2.6% of GDP deficit in 2009 from a 5.0% of GDP surplus in 2008 due to the sharp deterioration in the country's terms of trade.
Although a decade of husbanding its export earnings has given Russia much room to maneuver in the current market turbulence, the rapid depletion of reserves in order to resist a more substantive adjustment of the nominal exchange rate increases the chances of discontinuous exchange rate movements later, at a lower level of international reserves, with even more severe consequences for the private sector, S&P said.
S&P expects GDP growth to decelerate sharply during 2009, with Russian economic output in nominal U.S. dollar terms likely to decline.
In 2009, the general government budget is likely to shift into deficit as the presidential administration implements various tax cuts and lower commodity prices and a weaker economy hurt tax revenues, the agency said.
Over the ratings horizon, fiscal deficits should narrow after peaking at 4% of GDP in 2010. S&P estimates that, in the absence of a rebound in global oil prices, the amount of financing required for Russia's 2009 and 2010 fiscal deficits plus the recapitalization needs of its domestic banks will equal the 14% of GDP in fiscal reserves now held in Russia's Reserve and National Welfare Funds.
The negative outlook reflects the likelihood of a downgrade if the banking crisis and external pressures continue to impair the government's balance sheet and its still substantial arsenal of liquid assets, amid a weakening of underlying economic fundamentals. The economy's ability to attract capital inflows continues to be impaired by the unpredictability of the business environment, S&P said.
"On the other hand, passage of measures to improve the legal and institutional framework for foreign direct investment and enhance competitiveness of the broader economy, as well as implementation of monetary policies to preserve the government's still substantial liquid assets, could lay the foundations for greater resistance of the balance of payments to external shocks, and lead to a stabilization of the sovereign rating," S&P's Frank Gill was quoted as saying.
"This was not unexpected. S&P warned in October when it changed the outlook that that it would lower the rating if the reserves continued to decline, and so it has," Trust (RTS: HBTT) Bank analyst Pavel Pukulev said.
"But in today's conditions ratings are the last things on investors' minds. Assets have fallen so low in price that the rating downgrade will not affect them very much," Pikulev said.
Russia is still investment-grade, and there is a risk the rating will fall below that, but not even this will have much effect on the market. "There's a risk, but it's not the biggest one," the analyst said.
Alfa-Bank's (RTS: ALFB) Natalya Orlova said she, too, was not surprised by the rating downgrade. There was reason enough for it - Russia's international reserves have shrunk more than $140 billion in four months, she said.
The debt markets are closed anyway, so the downgrade won't have much impact, Orlova said.
What matters more to investors is whether Moody's will follow suit and downgrade Russia. Its assessments are not as conservative as S&P's, she said.
"The downgrade could have been expected in view of the drop in the reserves and probability of a double deficit - budget and external - next year," said Deutsche Bank's chief economist, Yaroslav Lisovolik.
But the market had already worked the downgrade into its prices, Lisovolik said.
"At the same time I don't think this will automatically trigger a whole wave of rating downgrades because the situation could change," he said. Take the exchange rate policy, which has been adjusted somewhat in recent weeks, and enable the Central Bank to accumulate some reserves.
Lisovolik said the rating could even be reinstated next year, but a lot would depend on the quality of macroeconomic policy and oil prices.
UniCredit's head of strategic planning and development, Vladimir Osakovsky, said the rating downgrade would have limited impact due to the state of the capital markets, but this was still bad news.
"The debt markets are off-limits right now, so the rating won't have a direct impact, at least not now. But a rating downgrade is not good. It raises the cost of borrowing for all, and this limits the potential for the Russian market's recovery," Osakovsky said.
Russia faces a period of adaptation, including adjustment to its exchange rate policy and perhaps even budget policy. This will take at least a year. Only then could the rating be reinstated, he said.
"Further rating downgrades could be expected - the outlook is negative. S&P has after all always said that reserves are Russia's key rating driver. If the reserves continue to fall, the potential for a further S&P downgrade is significant," Osakovsky said.