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Analysis & Opinion
11.12.08 Russia’s Rating Scare
By Sergei Balashov

Standard & Poor’s has revisited Russia’s sovereign rating ten times over the past eight years, and every time this rating was changed for the better. Now, this streak is over. Russia’s economic downfall hit a new low on Monday, when Standard & Poor’s lowered its sovereign rating for the country for the first time since 1999. The credit ratings in domestic and foreign currency were downgraded by one point to BBB+ from A-, and to BBB from BBB+ respectively. This change is largely ascribed to an overwhelming capital outflow and a rapidly shrinking reserve fund.

The dwindling of the reserves, the main pillar that bolstered Russia’s credit rating, was induced by the government’s relentless efforts to support the banks and prop up the ruble, which has lost 20 percent of its value vis-?-vis the dollar since August. The government has also been spending heavily to support the freefalling stock market. But these moves have hardly improved the situation. Experts argue that in order to help the market, attention should be focused on improving the economy rather than on shopping for stocks. As for the ruble, its current rate is more of a turnoff for potential outside investors than any rating, and thus it would make more sense to actually devalue it rather than try to keep it where it is.

Enough pressure has been put on Russia’s international reserves to cause them to shrink to $437 billion from the $583 billion the country had back in August. The current reserves cover 71 percent of Russia’s projected demand for external financing for 2009. While Russian public debt is rather low at $40 billion, the heaviest borrowers are state-owned companies like Gazprom and Rosneft, meaning that the government will be liable for paying off their debts. “The reserves have declined sharply and now everyone is waiting to see how they’ll fall in the wake of the external debt payoffs in the next few years,” said the Chief Economist at the Troika-Dialog Investment Bank Evgeny Gavrilenkov.

How ratings work

In its research report published following S&P’s announcement, Alfa Bank stated that Russia’s relegation to BBB had to do with the international reserves going below the $450 billion threshold, which amounts to 85 percent of Russia’s external debt. The report also noted that S&P’s ratings were “conservative when it comes to Russia.”
Other rating agencies, such as Fitch and Moody’s, appear to be in no hurry to revise their ratings. Fitch is still giving Russia a BBB+ rating, while Moody’s has it at Baa1. According to Pavel Pikulev, an analyst at the Trust investment bank, no changes are likely to be made anytime soon. In his report, he noted that these two agencies are trying to make it look like they have considered the possible risks when giving out their initial ratings. Pikulev pointed out that S&P, which rated sub-prime mortgages at AAA, is being very procyclical. “This is what’s really surprising,” said Pikulev. “Their credibility took a blow after they meted out high ratings for mortgages,” said Andrei Kochetkov, an analyst at RosFinCom.

Although the weight carried by S&P’s ratings is disputed, they are still bound to have an impact. Experts from Alfa Bank noted that Russia’s forecast was still negative, and should the reserves shrink any further, more downgrades would come. The latest change in the rating, they said, could damage the ratings of Russian banks and bring the quality of the bank loans into question, producing a negative impact on the stock market.

And this happened almost immediately, as S&P moved to cut the short-term and long-term ratings of six Russian banks including VTB, Raiffeisenbank and UniCredit Bank, while some corporate ratings were adjusted prior to the change in Russia’s sovereign rating. The state-owned diamond company Alrosa was downgraded from BB to BB- in November. MDM got a negative forecast in the wake of the merger with URSA Bank and saw its BB rating placed in CreditWatch, signaling a possible change. Following Russia’s fall to BBB+, Russian Railways’ long-term standing was relegated to BBB from BBB+, with a negative forecast. The outlook for LUKoil was downgraded from positive to stable. “This does matter to international investment funds, which will start dumping the shares of Russian corporate entities with bad ratings as well as Russian state bonds,” said Kochetkov.

At the same time, the change in the rating is unlikely to have any effect on external investors, as most of them have long since been gone, and are not planning to come back anytime soon. “Everyone’s gone now, so that was a smart move--to decrease the ratings now, and not half a year ago. Banks have already closed all limits for Russia,” said the General Director of the National Rating Agency Viktor Chetverikov, adding that international shareholders will quit strategic partnerships they’ve had with Russian banks.

It will also get more expensive for both the government and the companies that had their ratings decreased to issue bonds, drawing less funding but having to pay off the interest rate for the face value of the bond. So far, however, there has only been a slight correction of the stock market in response to the news, while Russian bonds grew to 81 percent from their nominal value of 80 percent on Tuesday. “Other agencies haven’t updated their ratings yet, and it’s unclear when they will, but when they do, it will most likely fall into the pattern established by S&P. Then the impact might be felt,” said Kochetkov. However, he downplayed the potential long-term effect of the government’s policy of heavy spending, which could result in further negative developments.

The government is now faced with a difficult choice between stabilizing the ruble and the stock market and accumulating enough reserves to handle the external debts, once they are called due. For now, Russia seems to be spending heavily to pull through the hard times, hoping that the oil prices will bounce back and the debt problem will take care of itself. “This is true to an extent. If international reserves that are dealing with limited inflows in the wake of the declining commodity prices will be accumulated to pay off the debts, the next year may not be as painful,” said Chetverikov.
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