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Rating Action:

Moody's confirms Russia's Ba1 sovereign rating; outlook negative

22 Apr 2016

New York, April 22, 2016 -- Moody's Investors Service today confirmed Russia's Ba1 government bond and issuer ratings, concluding the review for downgrade that was initiated on 4 March 2016, and assigned a negative rating outlook.

The key drivers for the decision to confirm Russia's rating at Ba1 are the following:

1. The economy has exhibited resilience to the renewed drop in oil prices early this year thanks to an effective blend of macro policy responses.

2. The fiscal adjustment underway appears sufficient to reduce the 2016-18 deficits to a level that can be financed in the domestic capital markets and through fiscal reserve drawdowns.

The negative outlook reflects the likely further erosion of the government's fiscal savings in the context of Moody's medium-term projections for oil prices. Moreover, a set of policies that would address the economy's low growth potential has been slow to emerge, while the election calendar over the next two years will likely interfere with the implementation of politically unpopular reforms that could achieve a more fundamental budget consolidation.

Russia's country ceilings, which include its Ba1/NP country ceilings for foreign currency debt, its Ba2 country ceiling for foreign currency deposits and its Baa3 country ceiling for local currency debt and deposits, remain unchanged.

RATINGS RATIONALE

RATIONALE FOR CONFIRMATION OF RUSSIA'S Ba1 GOVERNMENT RATING

FIRST DRIVER -- EFFECTIVE MACRO POLICY RESPONSES AFFORD RESILIENCE TO RENEWED DROP IN OIL PRICES

The first driver for Moody's decision to confirm Russia's current Ba1 rating relates to the economy's demonstrated resilience to the renewed drop in oil prices, which has been facilitated by exchange rate flexibility and the authorities' additional fiscal adjustments. The new oil price fall did not add lasting headwinds to the economy, inflation or financial stability, with growth taking only a brief and quite mild additional hit. While the ruble initially depreciated by around 15% in January when oil prices dropped, it has since strengthened in line with the subsequent recovery in oil prices and declining inflation, leading to limited economic disruption.

Another sign of the economy's resilience is that inflation continued to fall despite the temporary fall in the exchange rate. Year-on-year inflation subsided to 7.3% in March -- compared to 12.9% at the end of 2015 -- mainly owing to base effects from the same period of 2015. We expect end-year inflation to be around the same level, assuming relative stability in the exchange rate and the maintenance of tight monetary policy, and to decline further to about 5% by the end of 2017. The central bank has demonstrated its commitment to containing inflation, keeping its policy rate at 11% since last July to anchor inflation expectations, and we expect any loosening to be gradual in light of still-high inflation expectations.

Recent high-frequency indicators such as industrial production, services, construction and agricultural output, suggest that growth is likely to resume after a brief lull in December-January, driven by net exports, which are benefiting from the roughly 30% real effective depreciation of the exchange rate over the past two years. Still, the rating agency expects that household consumption will be a drag on the economy this year; real wages continue to fall though at a slower pace, while employment and unemployment rates have been quite stable.

Based on these recent indicators, which suggest that the impact of the renewed fall in oil prices was relatively mild and short, Moody's has reduced its forecast for the economy's contraction in 2016 marginally to 1.5% from 2%. The rating agency expects to see positive growth in the second half of the year on a quarter to quarter basis that could lead to a better annual outcome as well as positive growth on a yearly average basis in 2017-18, assuming no further terms of trade shock.

Over the course of 2015, the balance of payments adapted almost completely to the fall in oil prices. Even though the value of oil and gas exports continues to fall due to weaker oil prices, significant import compression means that the current account surplus remains large enough to finance a significant share of external debt payments and most capital outflows over the next two years, both of which have shrunk considerably since 2014. It narrowed in the first quarter of 2016, according to just-released statistics, but the capital outflow also declined. Foreign exchange reserves have stabilized since the introduction of the floating exchange rate regime in late 2014 and even moved up slightly recently. Still, at $319 billion, they remain substantially below their recent peak of $473 billion at the end of 2012.

SECOND DRIVER -- ONGOING FISCAL ADJUSTMENT SEEMS SUFFICIENT TO REDUCE 2016-18 DEFICITS

The second driver for confirming Russia's Ba1 rating is the government's fiscal response to the renewed fall in oil prices and its plan to contain its net funding needs by restraining the size of federal budget deficits in the coming years. The government has undertaken a sizeable fiscal adjustment this year. A 10% cut in discretionary expenditures was decided in mid-January, along with a decision later in the first quarter to take a reported 5% cut in the defense budget and to trim ministerial appropriations. In addition, various revenue-raising measures were undertaken, such as increases in excise taxes, a doubling of dividends from state-owned enterprises and the maintenance of oil export duties that had been scheduled to be reduced this year and going forward.

The January-February 2016 federal budget deficit illustrates the effectiveness of the fiscal response. The budget shortfall was cut to 0.9% of GDP from 5.9% of GDP in the same period of last year despite a significant fall in oil and gas revenues to 5.6% of GDP from 9.1% of GDP. The improvement in the deficit reflects cuts in primary expenditure, mainly defense spending. Given the budget consolidation measures being pursued and using Moody's own oil price assumption of $33/barrel for 2016, Moody's expects the federal budget deficit to increase to roughly 3% of GDP this year, followed by deficit roughly half that size in 2017 as oil prices rise toward the government's assumed level of $40/barrel, narrowing the gap between Moody's oil price forecasts and theirs. More substantial fiscal adjustment will depend on the political willingness to undertake reforms in the pension system and elsewhere in the public sector.

The confirmation of the rating also reflects Moody's assessment of the availability of domestic financing for the budget deficit in view of ongoing international sanctions that have limited international debt issuance, and expectations that the government can avoid an early depletion of its Reserve Fund this year. The government's original financing plan for 2016 was to rely on the bond market to finance part of the deficit, or R1 trillion in gross terms, and to use the Reserve Fund for almost all of the remainder.

In Moody's view, the planned issuance levels are credible given its estimates of the banking system's liquidity. In addition, the Russian government announced a privatization program to fill the financing gap as oil revenue prospects fell earlier this year. While the government's motivations for the program are stronger now than in the past, in view of the need to raise financing, Moody's is skeptical that the program will deliver the planned levels of financing: Russia's track record in following through with such sales is poor, with programs announced in both 2009 and 2012 being later abandoned by the government.

RATIONALE FOR ASSIGNING A NEGATIVE OUTLOOK

The negative outlook relates to the lack of a comprehensive strategy to address the quicker depletion of the government's fiscal savings that would occur should deficits remain above 2%-3% of GDP and privatization proceeds not materialize to the extent the government anticipates, which would leave it increasingly reliant on domestic debt financing at rising cost and shortening maturities. Mooted reforms, such as of the pension system, aimed at tackling the underlying causes of fiscal deficits in a low oil price environment, have not yet materialized. Upcoming elections are likely to play a role here, undermining the political will to implement far-reaching structural reform. The parliamentary election will be held in September, and the next presidential election must be held before April 2018.

By the same token, no strategy has yet emerged to address the economy's low growth potential and chronic underinvestment. Many years of dependence on oil and gas receipts have distorted domestic price formation and substantially deterred investment in other sectors of the economy. The longer-term challenges posed by this dependence have become more urgent in a low oil price environment, since the lack of economic dynamism reduces the flexibility of fiscal policy and limits the government's ability to deal with a further shock.

WHAT WOULD CHANGE THE RATING -- DOWN

Moody's would downgrade Russia's Ba1 rating were Russia's credit metrics to deteriorate meaningfully, reducing its room to maneuver in the event of another oil price or other shock. Indicators that might lead Moody's to anticipate such a deterioration would include the exhaustion of fiscal reserves 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. Further stress in the banking system would also contribute to downward pressure on Russia's ratings 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 disruptions to oil production or spurred renewed capital flight or an expansion of existing sanctions would also be credit negative.

WHAT COULD STABILIZE THE RATING AT THE CURRENT LEVEL AND/OR CHANGE THE RATING -- UP

Upward pressure on the rating would derive from the enunciation of a clear and credible economic policy agenda for the medium term, such as the enactment of reforms to sustainably address the underlying sources of economic and fiscal vulnerability and thereby boost the country's growth potential. Such measures might include reducing the economy's heavy dependence on the hydrocarbon sector for growth and public finance revenue, lowering the structural deficit of the pension system and improving the weak investment climate.

GDP per capita (PPP basis, US$): 26,138 (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): 12.9% (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: 38.9% (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 19 April 2016, a rating committee was called to discuss the rating of Russia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's governance and/or management, have materially increased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed.

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 confirms Russia's Ba1 sovereign rating; outlook negative
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