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Rating Action:

Moody's places Russia's Ba1 rating on review for downgrade

04 Mar 2016

New York, March 04, 2016 -- Moody's Investors Service has today placed Russia's Ba1 government bond and issuer ratings on review for downgrade.

During the review, Moody's will assess the extent of the impact of the further sharp fall in oil prices, which Moody's expects to remain low for several years, on Russia's economic performance and government balance sheet, including the government's deficit financing options, in the coming years.

Moody's expects to complete the review within two months.

RATINGS RATIONALE

RATIONALE FOR INITIATING A REVIEW FOR DOWNGRADE OF RUSSIA'S Ba1 RATING

Russia is highly dependent on hydrocarbons to drive economic growth and to finance government expenditure. Oil and gas account for close to 60% of goods exports and roughly 17% of GDP. Hydrocarbons still provided around 43% of federal government revenues in 2015.

Between September 2014 and September 2015, global oil prices roughly halved. Since then, oil prices have fallen a further 40% to around US$30/barrel. Moody's recently revised its oil price assumptions for Brent crude to average US$33 per barrel in 2016 and US$38 per barrel in 2017, rising only slowly thereafter to US$48 by 2019.

The structural shock to the oil market is weakening Russia's economy and its government balance sheet and therefore also its credit profile. Assuming no policy response and other factors being equal, Moody's estimates that depressed oil prices for the coming years would imply a further gradual decline of three 3 percentage points to 15.5% in the federal government revenue to GDP ratio, federal government deficits of 3% of GDP or more and around a 12-percentage-point rise in Russia's debt burden over a four-year period. That would shift down our assessment of the government's balance sheet strength from 'Very High' to 'Very High (-)'.

The roughly 27% depreciation in the exchange rate against the US dollar since the start of 2015 has contained the impact of the terms of trade shock on the Russian government's revenues somewhat. The country's current account balance relative to GDP has stayed in surplus, largely due to a compression of imports of nearly 35%. However, this was at the cost of higher inflation, which rose from 11.4% in 2014 to a high of nearly 17% in March 2015, before subsiding to 8.1% in February 2016 as the base effect from the initial spike in inflation in December 2014/January 2015 passed.

Meanwhile, Moody's expects real growth over the next four years to be just 0.4%, unchanged from the last four years. Although the Russian government envisages improved competitiveness afforded by the weaker exchange rate to stimulate investment in non-oil sectors of the economy, Moody's expects that the potential growth rate will not rise meaningfully given the structural problems facing the economy, in particular chronic underinvestment, which persists despite depreciation-inflated profits at Russian companies given their fears of pending corporate tax hikes. Meanwhile, exports are subject to capacity constraints across sectors, including oil. In addition, the significant loss of income for workers due to double-digit real wage cuts is likely to continue to depress consumption and as mentioned previously, the government's budget constraints are now binding.

The move to a floating exchange rate has helped to conserve foreign exchange reserves. At US$310 billion (or 28% of forecast 2016 GDP) as at the end of January 2016, the country's foreign currency reserve assets remain large, representing 13 months of imports of goods and services, which is an increase from nine months at the end of 2014, due to the 35% fall in imports last year. However, calls on these funds would grow if substantial capital outflows were to resume for example due to financial or political volatility or in the event that the central bank were called upon to support the banking industry.

Fiscal reserves have declined markedly. The US$38 billion drawdown from the government's Reserve Fund in 2015 contained the rise in debt, but at the cost of reducing the government's fiscal buffer from US$88 billion at the end of 2014 to US$50 billion at the end of January 2016.

Given pressures on the government's finances, Moody's sees risks that the government would become overly reliant on a weak currency to offset the lower oil prices or else resort to central bank financing, both of which would keep inflation at relatively high levels and threaten the recovery of the domestic banking system.

During the review, Moody's will assess the government's ability to mitigate the impact of the recent fall in oil prices on Russia's credit standing. It will assess the clarity, scope and ambition of the government's plans relative to the scale of the task, the time required for them to bear fruit, and the reliance that can therefore be placed on them to sustain Russia's credit strength.

The government has announced its intention to undertake a range of measures to mitigate the impact of the renewed fall in oil prices on its fiscal deficit and credit standing. The plans include immediate cuts to expenditure, hikes in excise taxes, the further tightening of tax enforcement and administration and higher dividend payments from state-owned enterprises (SOEs).

However, the plans announced to date are unlikely to be sufficient to contain entirely the impact of the shock on the government's balance sheet. One major driver of the government's shortfall in revenues is the pensions deficit, and over the longer term, Russia's policymakers have acknowledged the need to undertake pension reforms that would involve both raising and unifying the retirement age of men and women. For now, however, the political sensitivity of any such reform is likely to postpone its enactment until after the upcoming parliamentary election in September and possibly even until after the presidential election in early 2018.

Russia's policymakers have also indicated their intention to partially privatize a handful of SOEs for later this year, selling minority stakes, in the expectation of raising R800 billion or more. These plans look optimistic. Amongst other things, any such acquisitions would probably require buyers to repatriate capital from overseas in order to avoid putting pressure on banking system liquidity. Furthermore, Russia has historically been reluctant to pursue privatization, so Moody's remains somewhat skeptical about whether this program will proceed as envisaged at the present time.

Moreover, the government is using an average oil price of US$40/barrel this year and US$45/barrel next year to prepare its revised budget plans -- significantly above Moody's own forecasts of US$33/bbl and US$38/bbl, respectively. As a consequence, the deficits actually registered are likely to be much larger than the official 3% of GDP target. Questions regarding whether the financing is available to cover the larger deficits will be a key focus of Moody's review.

In Moody's opinion, the government will need to rely heavily on domestic sources of financing as long as international sanctions remain in place, constricting access to foreign finance for the government, state-owned enterprises and banks (even though the government itself is not sanctioned). The liquidity of the domestic banking system has improved because of banks' deleveraging over the past two years and the strong growth of the deposit base, despite low profitability. Assessing the extent to which domestic credit will be sufficient to fill the funding gap will be an important element in Moody's rating review.

Moody's will also assess how much positive weight should be placed on the country's remaining fiscal buffers (including the government's savings funds), given the likelihood that the Reserve Fund will be mostly depleted within the next year. While there is still roughly US$48 billion (4.3% of forecast 2016 GDP) in liquid funds in the National Wealth Fund to support the local economy, these funds will be stretched since Moody's expects that a number of enterprises will come under financial pressure and will seek support from government coffers to endure the protracted recession.

Moody's expects to conclude its review for downgrade of Russia's rating within two months. Where appropriate as part of the review, Russia's country ceilings -- the Ba1 foreign-currency bond ceiling, the Ba2 foreign-currency deposit ceiling and the Baa3 domestic-currency bond and deposit ceilings -- may also be reassessed.

WHAT COULD RESULT IN A DOWNGRADE

Moody's would downgrade Russia's Ba1 rating if its rating review were to conclude that the government's plans are probably inadequate to sustain Russia's economic or government balance sheet strength at its current level. Signs of an emerging fiscal or balance-of-payments crisis would also exert downward pressure on the rating. Those signs might include a further sustained fall in the price of oil, significant capital outflows and pressure on the exchange rate and foreign-currency assets, a marked worsening in the fiscal balance for which there was no clear reversal, or further stress in/support for the banking system. Deterioration in the domestic or regional political environment, resulting in disruptions to oil production and/or foreign investments in the economy, would also be highly credit negative. Given the extent of the negative impact and the current strength of the government balance sheet, however, a rating downgrade would most likely be limited to one notch.

WHAT COULD STABILIZE THE RATING AT THE CURRENT LEVEL

Although currently less likely, Moody's would maintain and confirm Russia's current Ba1 rating if its rating review were to conclude that there is evidence of institutional strength, as reflected in the enunciation of a clear, credible fiscal and economic policy response, such that the government could contain its fiscal deficits to a size that can be readily financed from its own savings or other domestic or external resources without relying upon central bank monetization.

GDP per capita (PPP basis, US$): 24,449 (2014 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -3.7% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 13.5% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -3.5% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 5% (2015 Actual) (also known as External Balance)

External debt/GDP: 39% (2015 Actual)

Level of economic development: Moderate level of economic resilience

Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.

On 29 February 2016, a rating committee was called to discuss the rating of the Government of Russia. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Kristin Lindow
Senior Vice President
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's places Russia's Ba1 rating on review for downgrade
No Related Data.
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