Fitch Ratings has affirmed Russia's Long-term foreign and local currency Issuer Default Ratings (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
The 'BBB-' ratings balance Russia's strong external and sovereign balance sheets and low sovereign financing needs against structural weaknesses, such as commodity dependence and governance risks, low growth potential and geopolitical tensions, Fitch said..
"External risks have abated over the last 12 months. Fears about a sharp draw down in reserves to cover capital outflows and sizeable debt maturities have eased. A sharp external rebalancing, (imports fell 35% in 2015), helped by a steep depreciation of the real exchange rate, saw the current account surplus (5% of GDP or USD70bn) cover a capital account deficit".
"For 2016, Fitch forecasts that the current account surplus will remain sufficient to cover expected capital outflows of USD40bn, helping to preserve foreign exchange reserves above 12 months of current external payments, which is above the 'BBB' median of 5.6 months. Lower oil prices or a pick-up in demand for foreign currency represent the main risks to the reserves outlook".
"Risks to public finances have increased, reflecting a renewed decline in oil revenue, delays in announcing a revised 2016 budget, the lack of a medium-term fiscal framework, as well as likely challenges in executing fiscal reforms given the electoral calendar. Uncertainty about deficit financing, once the Reserve Fund has been depleted in 2017, also presents risks. Discussions on a new budget rule are only expected after the September parliamentary elections".
Fitch expects that the federal fiscal deficit will widen to 3.9% of GDP in 2016 (2.4% in 2015), above the government's 3% target based on a lower oil price assumption (USD35/b versus USD40/b) as well as risk that the approaching elections may lead to higher-than-planned indexation of pensions or public sector wages. Without a medium-term fiscal framework and greater clarity on fiscal reforms, particularly revenue measures and social reforms, it is unclear how the authorities will meet their target of balancing the budget by 2020.
As in 2014 and 2015, the government will continue to finance the deficit by drawing on the Reserve Fund (USD50bn or 3.7% of GDP), eroding fiscal buffers and reducing financing flexibility. Fitch expects the Reserve Fund to cover 60% (roughly USD33bn) of the deficit, dropping to 1% of GDP by end-2016. The shortfall will be funded through domestic debt issuance. There are risks that the proposed USD3bn Eurobond as well as planned privatisation (RUB600bn in 2016) will not be realised. Once the Reserve Fund is depleted, the authorities will draw down on the National Wealth Fund, with liquid assets worth USD49bn. The sovereign balance sheet remains a key support to the investment-grade rating. Government debt ended 2015 at 11.3% of GDP and sovereign net foreign assets are estimated at 26% of 2015 GDP.
"The speed of external rebalancing helped prevent a more sizeable economic contraction. Output fell 3.7% in 2015, against 7.8% in 2009 - the last time oil prices collapsed. The bulk of adjustment fell on consumers, who saw real wages plummet, while net trade made a large positive contribution to growth of nearly 6pp. Fitch expects the economy to contract a further 1.5% in 2016, as investment declines further. Medium-term growth potential is constrained at below 2%, weaker than the 'BBB' median of 3.3%. The authorities' aim to rebalance the economy from the non-tradeable to the tradeable sector faces obstacles outside a few sectors, unless they are able to implement meaningful structural reform and attract significant investment. Fitch views both as unlikely".
Fitch expects inflation to remain above the Central Bank of Russia's (CBR) target of 4% by end-2017 and the 'BBB' median of 3.3% over the medium term, as structural rigidities and likely above-target wage indexation contain downward pressure on prices. Moderating inflation, which eased to 7.3% in March, from 16.9% in April 2015, is unlikely to persuade the CBR to ease monetary policy in 2016. Rather, the CBR aims to ensure a stable interest rate path by seeking to moderate stubbornly high inflation expectations and ensuring increased liquidity from the drawdown of the Reserve Fund does not translate into inflation.
Parliamentary elections in September will likely prove uneventful, with the ruling party expected to retain a majority in the Duma, agency commented. Fitch expects that the authorities will focus on preventing a repeat of the demonstrations following the 2011 elections.
"Structural factors are weak relative to peers. Commodity dependence is high: energy products account for almost 60% of merchandise exports and 40% of federal government revenue, exposing the public finances and the balance of payments to external shocks. Governance is a relative weakness. Russia scores below rated peers on World Bank and Transparency International indicators, for example. Russia's score in the World Bank's Doing Business survey has improved, but the business environment has long hampered diversification outside the energy sector and encouraged capital flight".