Fitch Affirms Russia at ‘BBB-‘; Outlook Negative

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The FINANCIAL — Fitch Ratings-New York/London-16 October 2015: Fitch Ratings has affirmed Russia’s Long-term foreign and local currency IDRs at ‘BBB-‘ with a Negative Outlook. The issue ratings on Russia’s senior unsecured foreign- and local-currency bonds are also affirmed at ‘BBB-‘. The Country Ceiling is affirmed at ‘BBB-‘ and the Short-term foreign-currency IDR at ‘F3’.

KEY RATING DRIVERS 

External conditions have deteriorated since July, translating into a weaker oil price outlook, higher rouble volatility and higher inflation. However, the depreciation of the rouble has continued to benefit the balance of payments, with imports falling 39% year on year by value in 9M15 and substantial declines in services imports and outward profit remittances. The current account is on course to run a surplus of 5%-6% of GDP in 2015, up from 3% in 2014.

The current account surplus has been and will be balanced by net private capital outflows, which have fallen since 2014. Rollover rates of private sector debt have exceeded expectations and other net outward flows have moderated. Capital markets are re-opening to non-sanctioned borrowers. As a result of these factors, and the current account surplus, demand for foreign exchange to meet debt service is not expected to generate undue pressure on reserves. 

The sovereign balance sheet remains a key support to creditworthiness. Government debt is on course to end 2015 at 13% of GDP and sovereign net foreign assets are estimated at 26% of 2015 GDP. Reserves of the Central Bank of Russia (CBR) have been steady since 1Q, ending September at USD371bn, or over 10 months of prospective current account payments (CXP), and Fitch now expects they will be little changed in dollar terms in 2016-2017. The CBR suspended regular purchases of foreign exchange in July, but these could resume in support of their goal of rebuilding reserves. Lower oil prices and/or stronger demand for foreign currency present the main downside risks to the reserves outlook.

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Monetary policy is working to contain risks from dollarisation and the CBR is targeting inflation of 4% by end-2017. Deposit dollarisation is well above pre-2014 levels, at 41%, but pressures are being held in check. The CBR kept its policy rate on hold at 11% at its September meeting. A renewed upsurge in demand for foreign currency, as seen in December 2014, perhaps triggered by a policy or geopolitical shock, remains a risk to the forecast. Provided rouble volatility is contained, average inflation could fall to 9% in 2016, from 15.5% in 2015.

Fitch expects the federal fiscal deficit will widen to 2.8% of GDP in 2015, within the target of 3.7% of GDP set out in the revised 2015 budget. The authorities are aiming for a similar deficit in 2016, a slower pace of consolidation than Fitch had expected in July. Spending growth will be contained at 4%, well below expected inflation of 9% (annual average) for 2016. The authorities have held down wage increases, and will also reduce the public sector workforce. 

On the revenue side, the only significant measure is to increase the tax take from oil companies. They will also create a contingency reserve within the budget. Fitch expects a federal deficit of 2% of GDP, based on a more optimistic oil price assumption of UD60/b in 2016, compared with the official USD50/b.

As in 2014, the government will finance the deficit by drawing on the reserve fund, eroding fiscal buffers and reducing financing flexibility. Following the suspension the fiscal rule and three-year budgeting, the Ministry of Finance still sees preserving a buffer in the reserve fund as a key objective of fiscal policy. However, it expects to deplete the reserve fund to RUB1.8trn by end-2016, less than half of its current level in rouble terms. 

The economy is in recession and only a tentative recovery is forecast in the latter half of 2016. The economy contracted 3.5% in 1H15, and is on course for a 4% full-year contraction in 2015, led by a fall in consumption and investment. Net trade has made the only positive contribution, with commodity exporters able to increase exports as a result of the competitiveness boost delivered by a weaker rouble. Consumption and investment are unlikely to recover in 2016. Under Fitch’s revised forecasts, we now expect the economy to stabilise, growing by up to 0.5% in 2016, and rising to 1.5% in 2017. The downgrade to our growth forecast since July reflects lower oil price expectations, a weaker rouble, and tight monetary and fiscal policy. 

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Fitch believes that the risk of more severe sanctions being imposed on Russia – particularly measures that would affect the payments system or trade – has diminished. The rate of casualties and military activity in eastern Ukraine has both subsided. 

RATING SENSITIVITIES

Future developments that could individually, or collectively, result in the Outlook being revised to Stable include:

-An easing of macroeconomic and financial sector stress and progress in reducing inflation 

-Avoiding further significant depletion in international reserves

-Progress in consolidating the budget

-Further evidence that economic growth prospects and external finances are resilient to long-lasting constraints on access to foreign financing, or the unwinding of sanctions

Future developments that could individually, or collectively, result in a downgrade include:

-Weakening in the sovereign balance sheet

-Failure to recover from recession, coupled with significant deviation from stated macroeconomic and fiscal policy aims

-Rise in geopolitical tensions and/or sanctions risks

KEY ASSUMPTIONS

Fitch assumes that EU and US sanctions remain in place for the medium term.

Fitch assumes that oil prices average USD55/b in 2015, USD60/b in 2016 and USD70/b in 2017.

Fitch assumes that Russian military action in Syria does not escalate in a way that leads to a significant fiscal or economic impact. 

 

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