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Rating Action:

Moody's Downgrades Russia's Ratings to Baa2; Outlook Negative

Global Credit Research - 17 Oct 2014

New York, October 17, 2014 -- Moody's Investors Service has today downgraded the government of Russia's debt rating by one notch to Baa2 from Baa1. The short-term rating is affirmed at Prime-2 (P-2). The outlook on the rating remains negative.

The key drivers for the downgrade and for maintaining the negative outlook are the following:

1) Russia's increasingly subdued medium-term growth prospects, exacerbated by the prolongation of the Ukraine crisis, including through the impact of expanded international sanctions.

2) The gradual, but ongoing erosion of the country's foreign-exchange buffers due to capital flight, Russian borrowers' restricted international market access and low oil prices.

In a related decision, Moody's has lowered Russia's long-term country ceilings for local and foreign-currency debt and for local currency deposits by one notch to A3 from A2 and its short-term country ceilings for foreign-currency debt to P-2 from P-1. The long-term country ceiling for foreign-currency bank deposits was lowered to Baa2 from Baa1 while the short-term country ceiling for foreign currency bank deposits was unchanged at P-2.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO Baa2

The first driver for the downgrade of the Russian government's debt ratings to Baa2 relates to the longer term damage the already weak Russian economy is likely to incur as a result of the ongoing crisis in Ukraine and, relatedly, the additional sanctions imposed against Russia since Moody's confirmation of the government's Baa1 rating in June 2014. That confirmation reflected Moody's view at the time that harsher and prolonged sanctions were unlikely. However, the assignment of a negative outlook reflected the rising risk of further conflict and the possibility of economic sanctions. Since then, sanctions have been extended and now include Russian majority state-owned banks and key companies in the defense and energy sector. Additional restrictions include limits or bans on the provision of goods, services and technologies to these and other companies as well as asset freezes and visa bans on individuals.

The military confrontation in Ukraine and escalating sanctions against Russia are likely to have an increasingly negative macroeconomic impact on Russia's investment climate and consequently on its medium-term growth prospects. Even prior to the crisis in Ukraine, the potential growth rate of the Russian economy was falling, constrained, according to the IMF, by economic rigidities such as infrastructure bottlenecks and shortfalls in labor skills and education. Additional constraints are posed by the high degree of dependence on the hydrocarbon sector, which has not materially decreased despite the government's diversification strategies, and demographic shifts. Much needed domestic and external investment was already being undermined by the challenges posed by the Russian business climate and by Russia's weak institutions.

The tightening of sanctions against Russia has already begun to aggravate the slowdown in economic growth and to undermine consumer and investor confidence in the country. Domestic demand slumped in the second quarter, including a notable decline in inventories and investment. Consumer confidence has been undermined, aggravated by the acceleration of inflation and higher interest rates resulting from, among other things, the depreciating exchange rate.

Moody's expects this trend to continue the longer that the conflict in Ukraine and sanctions against Russia persist. While Moody's does not currently expect the Russian economy to contract this year, the rating agency expects real growth to start to decline by around the end of the year and continue to do so at least until mid-2015. The longer the conflict in Ukraine and sanctions against Russia last, the more significant will be the damage to investors' confidence in Russia as a source of profitable investment opportunities, leading to the loss of economic output over the medium term. Even at today's levels, sanctions are likely to undermine medium-term growth somewhat, for example by impeding exploration activities in the hydrocarbon sector. Any widening in the scope of the sanctions, as would be increasingly likely the longer the crisis persists, would magnify the medium-term effect.

The second factor behind the downgrade in Russia's rating to Baa2 is the negative impact on the government's balance sheet of the gradual erosion of the country's foreign-exchange (FX) buffers, resulting from capital flight, Russian borrowers' restricted international market access and low oil prices. Even if trade and current account balances are temporarily strengthening, due in part to the 20% fall in the exchange rate this year, the current account surplus has financed only around 60% of the $85.2 billion of capital outflows in the first nine months of this year. The Russian government and Russian-domiciled entities have been largely shut out of the international capital markets since the second quarter. This has increased their demand for onshore FX liquidity and contributed to a $60 billion decline in the Central Bank of Russia's (CBR's) FX reserves to $396 billion since the end of last year, despite a current account surplus that the CBR estimates came to $52.3 billion in January-September.

The CBR has been proactive in its response to the situation, raising interest rates by 250 bps to try to stem the outflow of capital. It has also established an overnight swap facility to relieve onshore FX liquidity shortages and is standing ready to provide the FX needed by important public and private sector companies to pay their foreign-currency obligations. The CBR also has used the exchange rate as a flexible tool, adjusting the trading bands as needed to deal with sustained downward pressure on the ruble.

The government's FX reserves remain substantial, but the need to provide both the public and private sector with liquidity will place them under significant strain. Until now, the very high strength of the government's balance sheet -- including its large FX reserves -- has sustained Russia's credit profile notwithstanding its weak institutions, exposure to geopolitical event risk and worsening medium-term economic prospects. However, while government finances remain extremely strong, the recent and prospective erosion of FX buffers accentuates those other weaknesses in the government's credit profile.

RATIONALE FOR NEGATIVE OUTOOK

The tensions between Russia and Ukraine have not been alleviated by the announcement of a cease-fire in September, with military activity in eastern Ukraine continuing. While the situation remains fluid and unpredictable, it is increasingly difficult to see what might bring the conflict in Ukraine, and the international sanctions against Russia, to an end in the foreseeable future. The negative outlook reflects the downside risk to Russia's economic and fiscal strength from a sustained crisis involving broader sanctions and wider economic dislocation. It also reflects uncertainty regarding potential Russian reactions to additional sanctions that could be imposed, leading to decisions that further undermine Russia's economic strength and its ability to service its debt.

WHAT COULD CHANGE THE RATING -- UP

Given the negative outlook on the rating, Moody's sees limited upward pressure in the next 12-18 months. A stabilization of the rating outlook could be triggered by a resolution of the crisis in Ukraine, or if Moody's were to observe institutional or structural changes that it believed could herald a reversal of the downward trend in Russia's medium-term growth potential.

WHAT COULD CHANGE THE RATING -- DOWN

Russia's rating would come under downward pressure if the crisis in Ukraine were to escalate further, particularly if this resulted in harsher sanctions, as well as accelerated capital flight and the likelihood of more prolonged lack of market access for Russian corporates and banks. Russia's rating would also come under downward pressure from a prolonged period of low commodity prices, given the lack of progress on economic diversification.

Moody's would also consider downgrading Russia's sovereign rating if the domestic growth outlook were to deteriorate further, and in particular if lower growth and/or sanctions were to further undermine Russia's fiscal and external accounts. A material deterioration of the government's net worth (higher debt, lower assets) would erode its stronger position relative to similarly-rated governments that have more robust institutional strength.

Finally, we would consider downgrading the rating if we believe that the institutional framework becomes less predictable, potentially damaging creditors' interests.

GDP per capita (PPP basis, US$): 24,298 (2013 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 1.3% (2013 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 6.5% (2013 Actual)

Gen. Gov. Financial Balance/GDP: -1.3% (2013 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 1.6% (2013 Actual) (also known as External Balance)

External debt/GDP: 34.8% (2013 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 15 October 2014, a rating committee was called to discuss the rating of the Russia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has decreased. The issuer has become increasingly susceptible to event risks.

The principal methodology used in this rating was Sovereign Bond Ratings published in September 2013. Please see the Credit Policy 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 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 rating action on the support provider and in relation to each particular 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 rating action, and whose ratings may change as a result of this 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

Alastair Wilson
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 Downgrades Russia's Ratings to Baa2; Outlook Negative
No Related Data.
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