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Rating Action:

Moody's affirms Russia's Baa3 ratings, maintains stable outlook

04 Jun 2021

London, 04 June 2021 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Russia's Baa3 long-term issuer and senior unsecured ratings as well as its Prime-3 (P-3) domestic currency other short-term rating. The outlook remains stable.

The factors supporting the decision to affirm Russia's ratings are:

1) The relative resilience demonstrated by the Russian economy to the pandemic and oil-price shock, although potential growth remains low;

2) The government's very low debt and rebuilt fiscal buffers, although the state's dominant role in the economy poses risks to the sovereign's balance sheet; and

3) Russia's susceptibility to political event risks, and in particular the persistent risk of new sanctions

The stable outlook reflects a balance of risks at the current rating level. The government's demonstrated focus on preserving its fiscal and external buffers will continue to add resilience to Russia's credit profile against potential shocks, including from a worsening of the pandemic and further sanctions on sovereign debt. At the same time, Russia's exposure to commodity price volatility alongside the persistent risk of new sanctions results in a stricter than otherwise monetary and fiscal policy setting, weighing on the government's budget flexibility, investments prospects and potential growth.

Russia's local- and foreign-currency country ceilings remain unchanged at Baa1 and Baa2, respectively. The two-notch gap between the local-currency ceiling and the sovereign rating reflects the relatively large footprint of the government in the economy and financial system, relatively strong reliance on a common revenue source from the oil sector and elevated political risk, which is set against moderate policy predictability and limited external imbalances. The one-notch gap between the foreign-currency ceiling and the local-currency ceiling reflects low external debt and a moderately open capital account, which reduce the incentives to impose transfer and convertibility restrictions.

RATINGS RATIONALE

RATIONALE FOR THE AFFIRMATION OF THE Baa3 RATINGS

FIRST FACTOR: THE RELATIVE RESILIENCE DEMONSTRATED BY THE RUSSIAN ECONOMY TO THE PANDEMIC, ALTHOUGH POTENTIAL GROWTH REMAINS LOW

The first factor supporting the rating affirmation is the relative resilience demonstrated by Russia's economy to the impact of the pandemic which reflects a number of factors, including the support provided by the authorities' discretionary fiscal response, monetary easing and macroprudential measures, Russia's strengthened capacity to adjust to shocks and a low reliance on those sectors most impacted by the pandemic. While Russia experienced a marked economic contraction in 2020, with real GDP declining by 3% as the pandemic-related restrictions impacted on private consumption and exports fell in the face of weaker external demand and the cuts to oil production under the arrangement between Organisation of Petroleum Exporting Countries (OPEC) and other major oil-exporting countries (the so-called OPEC+), the fall in growth was relatively mild compared to other G20 economies.

The economy entered the crisis with improved macroeconomic stability as well as larger external and fiscal buffers, while a flexible exchange rate regime and the fiscal rule introduced in 2018 have strengthened Russia's capacity to adjust to shocks relative to 2014-15. Greater exchange rate flexibility has helped conserve foreign exchange reserves, while the conservative fiscal rule has helped to reduce the economic volatility stemming from the government's spending of hydrocarbon revenues. That said, the limited role played by discretionary services and small and medium-sized enterprises (SMEs), as well as the ability for the industrial and construction sectors to continue to operate to a large degree through the pandemic-imposed restrictions, also help to explain the economy's relatively better performance. Moody's expects the moderate economic contraction, limited exposure to sectors most impacted by the pandemic and policy support which has helped prevent a prolonged period of high unemployment will likely limit the extent of longer-term scarring effects on the economy.

Moody's forecasts a modest economic recovery from 2021 as the support from a strengthening oil price is balanced by only a gradual lifting of the constraints on oil production, continuing pandemic uncertainty and tightening monetary policy in response to rising inflationary pressures, while a focus on budget consolidation will limit the extent to which fiscal policy can support growth after this year.

Over the medium term, Moody's sees limited prospects for a material improvement in Russia's potential growth which is expected to remain in the lower half of the 1.5%-2% range. Investment rates will remain low as institutional constraints, including weaknesses in the rule of law and control of corruption, weigh on the business environment and as the unpredictable nature of western sanctions weighs on access to foreign capital, hindering efforts to diversify Russia's exports and government revenues. The pandemic will likely reinforce the degree of state dominance in the economy as the SME sector, which remains a key driver of private sector development, has been disproportionately impacted by the crisis. The country's adverse demographics, given an ongoing contraction in its young working-age population, will continue to pose headwinds to growth.

Furthermore, efforts to sustainably raise medium term growth through the national projects initiative -- which is the cornerstone of Russia's economic policy objectives and envisages higher public spending in areas such as infrastructure, demographics and digitalization -- will, in Moody's view, continue to face implementation challenges, including from deficiencies in the procurement process, mobilising adequate private investment in the face of budget constraints and ensuring regions have sufficient capacity and funding for these projects, and these challenges have been exacerbated by the pandemic.

SECOND FACTOR: VERY LOW GOVERNMENT DEBT AND REBUILT FISCAL BUFFERS, ALTHOUGH STATE'S DOMINANT ROLE IN THE ECONOMY POSES FISCAL RISKS

The second factor supporting the affirmation of Russia's credit rating is the sovereign's very strong fiscal position, supported by low levels of government debt and rebuilt fiscal buffers, which will provide a degree of resilience to its fiscal strength as the budget gradually recovers over the next two years from the impact of the pandemic.

Russia experienced a deterioration in its fiscal balance last year, given the impact of lower oil prices and the broader economic effects of the pandemic on government revenue as well as the government's discretionary fiscal response. Moody's forecasts the general government debt ratio to peak at around 20% of GDP by the end of 2021, which remains modest relative to rating and emerging market peers. Unlike many regional peers, Russia also benefits from a modest share of foreign-currency denominated debt.

Furthermore, the savings accumulated within the National Wealth Fund (NWF) under the fiscal rule -- which totaled 12.1% of projected 2021 GDP as at end April, of which around an estimated 7.6% of projected 2021 GDP is expected to be liquid -- will provide a sizeable backstop in the event of a sustained period of low oil prices. Despite the government's ambitious investment plans, Moody's expects any use of the NWF's excess liquid reserves for domestic investment in the coming years to be limited, in line with the authorities' revealed preference to preserve fiscal buffers.

That said, Moody's expects the codification of existing sanctions and the persistent risk of new measures, including the potential for further restrictions on sovereign debt, will serve to constrain Russia's budgetary options by limiting financing flexibility, weighing on overall fiscal strength.

While government debt remains low, the public sector's dominant and pervasive role in the economy, with the government taking full or part ownership in entities across a range of sectors, will continue to pose contingent liability risks for the sovereign balance sheet. According to the latest estimates by the International Monetary Fund (IMF), the Russian state accounted for 33% of output in 2016[1]. While the Russian banking system remains moderate in size relative to GDP, the government's dominance in the financial sector and its demonstrated willingness to provide support exposes the sovereign's balance sheet to the risk of a systemic financial crisis.

THIRD FACTOR: RUSSIA'S SUSCEPTIBILITY TO POLITICAL EVENT RISKS, AND IN PARTICULAR THE PERSISTENT RISK OF NEW SANCTIONS

The final factor supporting the affirmation of Russia's Baa3 ratings is the sovereign's susceptibility to political event risks, which arise primarily from geopolitical tensions and associated sanctions given Russia's heightened tensions with Ukraine (B3 stable) as well as its alleged interference in foreign elections, use of chemical weapons and role in malign cyber activities. These sanctions have resulted in significant negative economic and financial costs, while ongoing tensions between Russia and the United States (US, Aaa stable) and European Union (Aaa stable) keep open the possibility for new measures to be imposed.

Moody's expects Russia would be able to manage the immediate impact of most new sanctions -- which was a driver of the upgrade in Russia's rating to Baa3 in February 2019 -- given its accumulated financial buffers, low government debt and an enhanced policy toolkit. Furthermore, Moody's considers the authorities ability to plan for, respond to, and operate under sanctions has strengthened. For example, the country's low borrowing needs help to limit the immediate credit impact from the recently announced prohibition on US investors' participation in the primary market for Russian sovereign debt. That said, harder than expected sanctions which materially disrupt the Russian economy or public finances, and therefore impair Russia's ability to refinance its debt, pose a risk to the credit profile.

Importantly, Moody's considers the sanctions environment, including the persistent threat of new measures, will remain a feature of Russia's credit profile and continue to hinder investment prospects, constrain the government's budgetary options and reinforce cautious policy making, weighing on Russia's financing flexibility and the economy's growth potential.

Both domestic and foreign investment are likely to remain meaningfully lower as sanctions weigh on funding options. Furthermore, limitations on access to technological knowhow act as a headwind to efforts to modernise and diversify Russia's economy. While Moody's considers such steps unlikely, the possibility of new restrictions on Russia's access to international payment systems add to the uncertainty surrounding sanctions, impacting economic and policy decisions.

Russia will also continue to face domestic political risks which has resulted in sporadic protests in the capital and other regions in recent years, and in Moody's view reflects public dissatisfaction across a range of economic and social issues. These domestic political dynamics will continue to add to pressures to increase social spending, diverting budgetary funds from public investment. Moody's assessment also incorporates the political uncertainty in relation to the process for presidential succession, and in particular the potential for changes in the government's policy priorities that can accompany leadership changes. The risk of imminent and disorderly regime change remains very low at this stage, but the political system's robustness will be tested as the time for transition in senior leadership approaches, particularly given President Vladimir Putin's dominance of Russian politics for more than two decades. That said, the package of constitutional changes approved by referendum in July 2020 included a reset of the presidential terms, thereby allowing the president to serve another two terms when his current mandate ends in 2024.

RATIONALE FOR THE STABLE OUTLOOK

The decision to maintain the stable outlook reflects a balance of risks at the Baa3 rating level.

The government's demonstrated focus on preserving its fiscal and external buffers will continue to add resilience to Russia's credit profile against potential shocks, including from a worsening of the pandemic and further restrictions on sovereign debt. At the same time, Russia's vulnerability to developments in the oil sector alongside the persistent risk of new sanctions results in a stricter than otherwise monetary and fiscal policy setting, weighing on the government's budget flexibility and potential growth.

The demonstrated ability of the industrial sector to operate through the pandemic will add resilience to the economic recovery underway. However, the slow vaccination progress, with only around 11% of the population having received a first dose of a vaccine, will reduce the country's ability to limit the health and economic impact of a renewed worsening in the pandemic. Furthermore, the recent sharp rise in consumer prices amid elevated household inflation expectations and the potential for a further weakening in the ruble to feed through to inflation, given the heightened sanctions environment, poses a risk to the still fragile economic recovery.

Furthermore, Moody's considers there are limited prospects for reforms which help to materially address Russia's structural credit constraints. For example, Moody's expects initiatives to reduce business regulations as part of the so-called regulatory guillotine will not materially alleviate the challenges in the country's investment environment, while increased financial support to larger sized families is unlikely to address Russia's acute demographic challenges. Efforts to address deficiencies in Russia's infrastructure as part of the national projects initiative will face funding constraints, as the pandemic necessitates a reallocation in spending to other needs, in addition to implementation challenges.

Moody's expects a gradual fiscal consolidation, with a return to the pre-pandemic formulation of the fiscal rule by 2022 alongside limited drawdowns from the NWF over the coming years, will help to preserve buffers. Resilient non-oil revenues may result in a stronger fiscal performance in the near term. However, the government's fiscal consolidation strategy will still face risks from the uncertain economic (and hence oil price) outlook and the potential need to extend discretionary support measures, as well as rising pressures to further improve social welfare given uneven healthcare provisions between regions, low real disposable income growth in recent years and the forthcoming 2021 legislative elections.

Moody's expects the government's accumulated financial buffers and low borrowing needs will help to limit the immediate negative effects in the event of a further tightening in sovereign debt sanctions, which could potentially prohibit US financial institutions from participating in the secondary market for ruble or non-ruble denominated debt. The recent incremental extension of US sanctions on sovereign debt to cover ruble dominated bonds in the primary market included a directive to allow the US government to expand sovereign debt sanctions as appropriate, keeping open the possibility for more punitive measures which extend to the secondary market.

A further extension of sovereign debt sanctions to include the secondary market would likely result in some short-term financial market dislocation, as investors seek to understand the implications of the new restrictions with the possibility of forced sales exerting pressure on government bond prices and the currency. That said, Moody's expects the domestic banking sector would have the capacity to absorb higher levels of sovereign debt in the extreme scenario that all foreign investors exit Russia's domestic bond market, while the Central Bank of Russia has demonstrated its willingness to provide additional liquidity support to the financial sector if needed. The Ministry of Finance would likely draw upon its sizeable cash balances to limit the impact on its funding plan in such a scenario.

However, a marked reduction in foreign investor participation would further restrict the government's financing options and increase its cost of funding, reducing its flexibility to respond to new shocks. The expected tightening in financial market conditions, reduced access to foreign capital and the crowding out of financing available from the banking sector to the domestic economy would also weigh on investment and the country's medium term growth prospects.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS

Russia's ESG Credit Impact Score is moderately negative (CIS-3), reflecting high exposure to environmental risks, moderate exposure to social risks, and a moderately negative governance issuer profile score, in part mitigated by financial resilience.

Moody's assesses Russia's exposure to environmental risks as high (E-4 issuer profile score), reflecting high exposure to carbon transition risk given the important role played by hydrocarbons for exports and government revenue. While global transition towards lower consumption of hydrocarbons will proceed over several decades, Russia is likely to see the impact from a shift in policies in the near term as other countries begin to position their economies to reach their own carbon-neutral targets. Russia also faces moderate risks from the management of waste and pollution which can lead to regional tensions.

Exposure to social risks is moderately negative (S-3 issuer profile score), driven by highly unfavorable demographic trends, which limit growth potential. A rapidly shrinking population of young workers is likely not only to weigh on the country's aggregate labour input but also reduce the economy's dynamism. Russia also faces moderate social risks from relatively low income growth and uneven access to basic services.

The influence of Governance on Russia's credit profile is moderately negative (G-3 issuer profile) and risks are mainly related to weaknesses in the rule of law, property rights and control of corruption, reflected in relatively lower scores on international surveys compared with rating peers. However, the governance profile is supported by credible monetary policy and an effective fiscal rule that limits government spending-induced economic volatility. These aspects of governance, combined with a strong fiscal position underpinned by the government's very low debt burden and very strong debt affordability, support the sovereign's resilience to E and S risks, mitigating the impact of ESG on the rating.

GDP per capita (PPP basis, US$): 27,903 (2020 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -3% (2020 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 4.9% (2020 Actual)

Gen. Gov. Financial Balance/GDP: -4.1% (2020 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 2.3% (2020 Actual) (also known as External Balance)

External debt/GDP: 31.5% (2020 Actual)

Economic resiliency: ba1

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

On 01 June 2021, 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 not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

FACTORS THAT COULD LEAD TO AN UPGRADE

An upgrade of Russia's ratings would likely be conditioned in part on further declines in the country's vulnerability to external shocks. A marked further strengthening in Russia's fiscal buffers, helping to reduce the susceptibility of government finances and the broader economy to sustained periods of low oil prices and providing additional flexibility to manage rising budgetary demands, could provide upward pressure on the rating. A sustained reduction in geopolitical tensions, which reduces the likelihood of new disruptive sanction measures being imposed and creates the conditions for stronger investment prospects, would also be positive for the rating. A further condition is likely to be the enactment of policies which enhance other aspects of Russia's credit profile, for example reforms which help to lessen structural constraints on Russia's medium term growth, including from adverse demographics and weaknesses in the business environment.

FACTORS THAT COULD LEAD TO A DOWNGRADE

The imposition of harder-than-expected sanctions which materially disrupts the Russian economy or public finances, and thereby impairs the government's ability to service and refinance its debt, poses a risk to Russia's credit profile. While unlikely, such credit-negative disruption could arise from sanctions which restrict Russia's access to international payment systems and in turn hinders international trade, or the ability of large state-owned Russian banks to execute cross border payments. A marked deterioration in the country's public finances or external position, for example from a sustained period of low oil prices which depletes fiscal buffers and triggers significant pressure on the exchange rate, resulting in sizeable negative confidence and income effects, would place downward pressure on the rating. Negative rating pressure could also arise if the lending capacity of the banking system were to be impaired such that banks could not provide adequate financing to the government and Russian companies.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating 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 further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1263068.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

REFERENCES/CITATIONS

[1] IMF Working Paper 02-Mar-2019

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.

Evan Wohlmann
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Alejandro Olivo
MD - Sovereign/Sub Sovereign
Sovereign Risk Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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Moody’s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody’s Investors Service, Inc. have, prior to assignment of any credit rating, agreed to pay to Moody’s Investors Service, Inc. for credit ratings opinions and services rendered by it fees ranging from $1,000 to approximately $5,000,000. MCO and Moody’s Investors Service also maintain policies and procedures to address the independence of Moody’s Investors Service credit ratings and credit rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold credit ratings from Moody’s Investors Service and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”

Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors.

Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY550,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

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