On Friday, S&P cut its foreign currency rating on Russia to BBB- from BBB due to rising risks to the country’s growth prospects on large capital outflows in 1Q14 and the narrower possibility for external financing.
It kept the rating outlook as negative, citing risks to Russia's creditworthiness from potentially much weaker medium-term economic growth, reduced monetary policy flexibility and sanctions-related weakening of Russia's net external position.
We do not share the ratings agency’s concern that large 1Q14 capital outflows might jeopardise Russia’s creditworthiness. As we wrote in our BoP in 1Q14 – Internal adjustment vs. dollarisation, of 9 April, the bulk of these outflows was related to intense savings dollarisation and so did not actually leave the country, while structural capital outflows have shown tentative signs of moderation/stabilisation. Besides, risks related to external funding also seem exaggerated: we estimate about USD 45bn of Eurobonds and syndicated loans coming due this year, rather than the USD 94bn on the CBR’s numbers (inflated with intra-group lending). Moreover, on aggregate the private sector seems to have abundant FX liquidity to cover ST refinancing needs: as of end 1Q14, banks had USD 80bn on CA and ST deposits with foreign banks and the CBR.
Nor do we think that the CBR decision to lift interventions in early March heralds a major deviation from the path to inflation-targeting and flexible FX regime. We see this as an emergency step to break the devaluation expectation spiral.
Overall, we think the rating downgrade was driven more by geopolitical uncertainty and sanctions-related risks than deteriorating fiscal fundamentals. Also, the downgrade came amid news that MinFin at least as of now has managed to resist rising claims to relax the budget rule.
The outlook language leaves room to downgrade ratings further in our view. The risk of other agencies following suit also remains elevated, especially in Moody’s case (now Baa1/neg).