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Rating Action:

Moody's changes outlook on Russia's Ba1 government bond rating to stable from negative; affirms rating

Global Credit Research - 17 Feb 2017

New York, February 17, 2017 -- Moody's Investors Service ("Moody's") has today changed the outlook on Russia's Ba1 government bond rating to stable from negative. Moody's also affirmed Russia's government bond rating and issuer rating at Ba1 and the short term rating at Not Prime (NP).

RATINGS RATIONALE

The main driver for changing the outlook on Russia's Ba1 government bond rating to stable from negative is the government's enactment of a medium-term fiscal consolidation strategy that is expected both to lower the government's dependence on oil and gas revenues and to permit the gradual replenishment of its savings buffers. In addition, the Russian economy is now recovering after a nearly two-year-long recession. Moody's believes that, when combined, those two factors have eased the downside risks the rating agency had identified last year when it assigned the negative outlook.

The rationale for affirming Russia's government rating at Ba1 balances the country's inherent credit strengths, notably the economy's sheer scale and wealth as well as its healthy fiscal and external positions, against limited economic growth potential. In that regard, the government has not yet implemented a long-promised set of structural reforms, a delay that deters investment and subdues economic activity. Russia's high susceptibility to geopolitical risk, with associated spillover to volatility in the real economy and financial markets, and relatively weak institutions also constrain its sovereign rating.

Russia's country ceilings remain unchanged at Ba1/NP (foreign currency bonds), Ba2/NP (foreign currency bank deposits) and Baa3 (long-term local currency debt and deposits).

RATIONALE FOR CHANGING THE OUTLOOK TO STABLE FROM NEGATIVE

In April 2016, Moody's confirmed Russia's Ba1 rating but assigned a negative outlook to reflect the risk of further erosion of the government's fiscal savings in the context of a lower oil price environment. While there has indeed been some erosion of buffers in the meantime and the government's fiscal performance has fallen short of its own expectations, Moody's now believes that the downside risks identified in April 2016 have diminished to a level consistent with a stable outlook. The stabilization of the rating outlook partly reflects external events, and in particular the increase in oil prices to a level consistent with the government's budget assumptions. The stable outlook also reflects the plans the government has put in place to consolidate its finances over the medium term, and the slow recovery in the economy following almost two years of recession.

FIRST DRIVER: NEW MULTI-YEAR FISCAL STRATEGY IS MORE LIKELY TO CONTAIN DEBT AND PRESERVE GOVERNMENT SAVINGS

The resurrection of the three-year framework for the federal government budget at the end of last year -- the first medium-term fiscal plan since the oil price collapse rendered the 2015-17 program unrealistic -- reflects an ambitious fiscal consolidation strategy incorporating conservative spending and revenue assumptions. The deficit-to-GDP ratio is forecast to narrow by roughly one percentage point per year between 2017 and 2019, which would contain the growth in government debt. Whereas Moody's did not view the 2016 budget deficit goal as realistic because of the government's assumptions regarding oil prices relative to its own projections at the time, Moody's believes that these new consolidation targets are achievable in large part because the government's oil price and revenue assumptions are sufficiently conservative.

Importantly, the government's conservative assumptions increase the likelihood that its fiscal buffers will be preserved going forward, in contrast to the trend expected one year ago when the negative outlook was assigned. The government has stated that it will spend only what was planned in its 2017 budget even though oil prices are higher than the $40/barrel assumed in the budget. In February, the authorities started buying foreign exchange with the "excess" rubles received in oil revenues above that price and are placing the money into deposits at the central bank, which could be used for deficit financing instead of or in addition to its existing foreign currency deposits in the Reserve Fund at the central bank. Should oil prices fall below $40/barrel, the government would use the savings accumulated in this way to fill its revenue shortfall.

SECOND DRIVER: MACRO-ECONOMIC CONDITIONS ARE STABILIZING

The heightened vulnerability to shocks associated with further delays in economic recovery have also eased. The Russian economy is now on the mend after emerging from a two-year recession in the fourth quarter of 2016. The floating exchange rate has proven to be an effective shock absorber over the last two years, cushioning the impact of the terms of trade decline on the economy -- particularly for commodity exporters and the federal government, which still gets roughly 36% of its revenue from oil and gas taxes. The currency has traded within a relatively narrow range after its initial fall in late 2014/early 2015, which together with tight monetary policy is helping to move inflation ever closer to the Bank of Russia's 4% target. The stability of the strong external position looks increasingly assured because the current account balance is smaller but remains in surplus, capital flight is nearly nonexistent and net external debt payments are low although international sanctions remain in place.

Despite the turnaround, Russia's growth potential remains quite weak compared to other countries with similar income levels, a factor that continues to weigh on the rating. Recent revisions to the national accounts data suggest that the 2015-16 recession was shallower than previously thought, with a contraction of 2.8% in 2015 instead of the previously estimated 3.7% and a modest 0.2% fall in real GDP last year, against Moody's expectations of a contraction closer to 1%. These statistics indicate that the economy's output gap is similarly lower than previously estimated, implying that the recovery will be mild compared to the rebound after the global financial crisis. In the absence of structural reforms that address high poverty levels, the declining working age population and the multitude of factors that constrain investment, the rating agency expects potential growth will remain at 1.5%-2%.

RATIONALE FOR AFFIRMING RUSSIA'S Ba1 RATING

FIRST DRIVER: LARGE AND RELATIVELY WEALTHY ECONOMY WITH VERY STRONG DEBT METRICS

Russia's fundamental credit strengths include its large size and comparative wealth as well as its strong public and external finances. Even after the steep depreciation of the ruble cut the size of the economy by 40% in dollar terms, Russia is the 13th largest economy in the world and the fifth largest in Europe. At $25,965 in 2015, its GDP per capita in purchasing power parity (PPP) terms, which is a proxy for the average wealth of its citizens, came to well above the global median of $18,276 and exceeded the median for either Ba- or even Baa-rated countries.

The Russian government's debt is low at 16.1% of GDP at the end of 2016, and its debt affordability is strong. The growth in the debt-to-GDP ratio is expected to be contained thanks to the fiscal consolidation plan for 2017-19, and reserve assets would be gradually replenished if the government maintains its policy of reducing its dependence on oil and gas receipts. The Bank of Russia's substantial foreign currency reserves, which include the government's remaining liquid foreign currency deposits, provide ample cover for external payment obligations. Russia's net international investment position (NIIP) is in surplus, a position that improved further to about 25% of GDP in 2015 from 15% of GDP in 2014 due primarily to the revaluation of foreign assets after the depreciation of the ruble. Among 'Baa-Ba'-rated sovereigns, Russia and only three other countries have positive NIIPs.

SECOND DRIVER: HIGH GEOPOLITICAL RISKS AND INSTITUTIONAL WEAKNESSES ARE FUNDAMENTAL RATING CONSTRAINTS

Despite its fiscal and external strengths, Russia's significant geopolitical risks continue to weigh on the country's creditworthiness, notably the ongoing conflict and territorial disputes in Ukraine, which suggest that a restoration of Ukraine's territorial integrity will be very difficult to achieve and which led to international financial sanctions, but also Russia's heightened involvement in Middle East conflicts such as in Syria.

The strength of Russia's institutions is assessed at 'low' in our rating methodology. The Worldwide Governance Indicators (WGIs) for Russia show a relatively weak standing in comparison to other Moody's-rated sovereigns, with two key indicators in the lowest quintile of all the countries in Moody's sovereign rating universe, i.e. for rule of law (16th percentile) -- which in our view speaks particularly to property rights -- and for perceptions of corruption (13th percentile). The overall WGI scores compare unfavorably even to Ba-rated peers or to countries with the 'low' institutional strength assessment, except for government effectiveness. Notably, 2015 data shows a deterioration in all WGIs, which is likely explained by the consequences of the Ukraine crisis. Business uncertainty stemming from the weak rule of law and the high level of corruption remains a deterrent for investment in the country.

WHAT WOULD CHANGE THE RATING -- UP/DOWN

Russia's rating would come under upward pressure if the government were to enact reforms that would sustainably address the underlying sources of economic and fiscal vulnerability, and thereby raise the economy's growth potential. In this regard, reforms discussed by policymakers include reducing the country's dependence on the volatile oil and gas sector, lowering the structural deficit of the pension system and improving the investment climate through corporate tax reforms.

We would downgrade Russia's Ba1 rating if we concluded that the country's credit metrics had deteriorated to the extent that its capacity to absorb another oil price shock or other shocks were materially diminished. Indicators that might lead us to anticipate such an erosion in creditworthiness would include an exhaustion of fiscal savings or a material reduction in foreign currency reserves, sharply rising yields on government debt or deficits large enough to require monetization by the central bank. Stress in the banking system would also contribute to downward pressure on Russia's rating because the government needs a stable source of domestic financing in order to fund its budget deficits, especially in the context of ongoing international sanctions. Finally, deterioration in the domestic or regional political environment that resulted in an expansion of existing sanctions or spurred capital flight would also be credit negative.

GDP per capita (PPP basis, US$): 25,965 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): -2.8% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 12.9% (2015 Actual)

Gen. Gov. Financial Balance/GDP: -3.4% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 5.1% (2015 Actual) (also known as External Balance)

External debt/GDP: 38.0% (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 14 February 2017, 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 have improved, reflected by the Russian economy's emergence from recession. The issuer's fiscal or financial strength, including its debt profile, has strengthened, following the resurrection of the medium-term fiscal strategy and implementation of conservative revenue assumptions.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. 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 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

No Related Data.
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