Link to Fitch Ratings' Report: Russia - Rating Action Report
Fitch Ratings-London-22 September 2017: Fitch Ratings has revised the Outlook on Russia's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to Positive from Stable and affirmed the IDRs at 'BBB-'.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The revision of the Outlook to Positive reflects the following key rating drivers and their relative weights:
Russia continues to make progress in strengthening its policy framework underpinned by a more flexible exchange rate, strong commitment to inflation targeting and a prudent fiscal strategy, reflected in the recently approved budget rule. This policy mix will result in improved macroeconomic stability and, together with robust external and fiscal balance sheets, increases the economy's resilience to shocks.
After falling below the central bank's 4% target in July (and reaching a historical low of 3.3% in August), inflation will average 4.1% in 2017, down from 7.1% in 2016. Fitch expects the central bank to remain focused on achieving a sustainably low level of inflation through a prudent easing cycle, strengthening transmission mechanisms, cementing institutional credibility and sustainably anchoring expectations. Inflationary risks stem from exchange rate volatility, domestic demand recovery (reflecting a tight labour market) and food price shocks. However, inflation will average 4.5% in 2018-2019, an unprecedented level of low inflation for Russia, albeit still above the 2.1% 'BBB' median.
The budget rule approved in July programmes spending based on a conservative oil price baseline of USD40 (in real terms). In addition, the government will continue to accumulate above-budgeted oil revenues, using FX intervention to prevent real effective exchange rate appreciation, reduce its fiscal oil dependence and rebuild fiscal buffers. Oil revenues are likely to remain around 36% of total revenues, well below the 50% average in 2011-2014. The government is adhering to the rule in the face of positive revenue dynamics, supporting its credibility. Authorities revised down the 2017 budget deficit target to 2.1% from 3.2% of GDP, with additional spending to be financed by above-budgeted non-oil revenues in line with the fiscal rule. The deficit target is 1.4% of GDP for 2018.
Fitch expects the federal government deficit to decline to 2% of GDP, from 3.4% in 2016, and to reach the 0% primary deficit target in 2019. The federal non-oil deficit could therefore decline from 9.1% of GDP in 2016 to 6.2% in 2019, with federal spending declining by 3pp over the same period. Higher growth benefiting non-oil revenue could provide some space to ease real expenditure cuts if needed.
After reaching USD424 billion in early September 2017, continued current account surpluses, moderate capital outflows and higher-than-budgeted oil prices will push reserves above USD500 billion in 2019, returning to end-2013 levels. Russia already has the highest external liquidity ratio in the 'BBB' category, and its net external creditor position has strengthened since 2014 in both GDP and current external receipts terms through the deleveraging of banks and corporates and greater exchange rate flexibility. The sovereign net foreign asset position is solid at 28% of GDP.
Russia's 'BBB-' IDRs also reflect the following key rating drivers:
Government debt remains among the lowest in the BBB category, with federal government debt forecast to increase to 13.4% of GDP in 2017 and 16.3% at the general government level (including sub-national government and guaranteed debt). The new budget rule includes the consolidation of the two existing fiscal savings funds that will represent 4% of GDP combined by the end of 2017. Fiscal buffers remain low compared with other oil producers with similar ratings, but will increase moderately in 2018 and 2019.
The central bank continues the banking sector clean-up process, as well as strengthening supervision and bank resolution frameworks. The central bank's take-over of Otkritie, one of 10 banks then categorised as systemic, prevented contagion and financial markets instability. The intervention is an important test of the authorities' ability to continue cleaning up the banking system and strengthen the resolution framework while maintaining confidence in the financial sector. Fitch considers that risks from the banking system for the sovereign balance sheet currently appear limited.
Growth is reviving, but will remain weak relative to peers. Fitch expects Russia to expand by 2% in 2017 and average 2.1% in 2018-2019 on the back of reduced uncertainty, easing of monetary policy supporting credit recovery, RUB stability and a benign oil price outlook. This compares with a median growth rate of 3.1% for the 'BBB' category. A broader reform agenda to achieve a higher growth trajectory while preserving improved macroeconomic stability remains to be rolled-out after the 2018 presidential elections.
In addition to geopolitical tensions derived from the conflict in Eastern Ukraine, the US Congress broadened and codified existing sectoral and individual sanctions in July 2017. The legislation not only increases the difficulty of easing sanctions, but also creates material risks for further tightening and could constrain the sovereign's financing flexibility if government debt is targeted. The availability of alternative sources of financing, and associated costs, as well as the impact on the sovereign's balance sheet will determine the near-term impact on overall creditworthiness.
President Vladimir Putin remains in a comfortable position to gain a new term in March 2018, although he has yet to confirm his candidacy. Fitch does not anticipate policy changes that would undermine the improved macroeconomic framework, but the elements and pace of the reform agenda post-elections remains uncertain. Russia's ranking in the World Bank governance indicators is well below the peer median.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Russia a score equivalent to a rating of 'BBB' on the Long-Term FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Structural features -1 notch, to reflect geopolitical tensions and heightened sanctions risks since our last review that could constrain future sovereign financing flexibility and could also negatively affect macroeconomic stability, the business environment, and growth prospects.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually or collectively, lead to an upgrade are:
-Increased confidence that sanctions will not affect sovereign financing flexibility.
-Continued improvements in macroeconomic stability derived from strengthened monetary and fiscal policy frameworks.
-Continued strengthening of fiscal and external savings buffers, for example through a sustained recovery in oil prices and windfall revenues.
-Implementation of structural reforms that would boost potential growth.
The main factors that could, individually or collectively, lead to a stabilisation of the Outlook are:
-A rise in geopolitical tensions or imposition of additional sanctions undermining macroeconomic performance and the sovereign's financing flexibility.
-A weakening of the policy framework that undermines macroeconomic and fiscal performance.
-A sustained decline in international reserves.
Fitch assumes that EU and US sanctions remain in place over the long-term, and the risk for further tightening is maintained.
Fitch forecasts Brent crude to average USD52.5/b in 2017 and USD55/b in 2018
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR affirmed at 'BBB-'; Outlook revised to Positive from Stable
Long-Term Local-Currency IDR affirmed at 'BBB-'; Outlook revised to Positive from Stable
Short-Term Foreign-Currency IDR affirmed at 'F3'
Short-Term Local-Currency IDR affirmed at 'F3'
Country Ceiling affirmed at 'BBB-'
Issue ratings on long-term senior-unsecured foreign-currency bonds affirmed at 'BBB-'
Issue ratings on long-term senior-unsecured local-currency bonds affirmed at 'BBB-'
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Source: Fitch Ratings