Financial strength supports Russia rating, reforms needed for faster GDP growth - Moody's
FRANKFURT. March 1 (Interfax) - Russia's Baa1 government bond rating and stable outlook are supported by the country's high financial strength, but constrained at the current level by the country's moderate economic strength, its low institutional strength and its rising, albeit still low, susceptibility to event risk, Moody's Investors Service said in its annual credit report on Russia.
The rating agency's report is an annual update to the markets and does not constitute a rating action. Moody's determines a country's sovereign rating by assessing it on the basis of four key factors -- economic strength, institutional strength, government financial strength and susceptibility to event risk -- as well as the interplay between them.
Russia achieved its strongest score for financial strength, which Moody's assesses to be high based on the government's large assets which could act as a buffer in the event of a fall in oil prices, exchange-rate depreciation and capital flight. Russia's government also has solid fiscal reserves of USD61 billion, enabling it to potentially bridge unfavourable market conditions. Moreover, Russia's general government debt remains very low, having recorded the lowest debt-to-GDP ratio in 2011 (around 10%) among all investment-grade sovereigns. In addition, most of the government debt is issued at fixed rates implying low susceptibility to interest-rate shocks, whilst the average maturity of Russia's government debt is in line with many developed markets, at around 6.8 years. The caveat is that Russia's public-sector owned banks and corporates also have significant amounts of debt, which represent a contingent liability for the sovereign.
Russia's Baa1 sovereign rating also takes account of the country's moderate level of economic strength. The country's GDP per capita in purchasing power parity terms (US$12,700) was close to the median for A3-Baa2 rated countries in 2010. Moreover, the benefits derived from the Russian economy's large scale are offset by the difficulties of diversifying the economy away from commodity exports, which represent over 80% of Russian exports. Looking ahead, the country's dependence on oil and gas means that its economic growth is set to remain rather volatile, as evidenced by Russia's relatively sharp recession in 2009.
Russia also faces economic issues that are related to its fundamental demographic vulnerabilities of an ageing and declining population.
Although the country's susceptibility to event risk is low, Russia faces increased political, economic and financial event risk. Political risk has increased in the context of the current election cycle, while the rise in economic event risk is due to increased vulnerabilities to shocks post-crisis (e.g., much higher oil prices are needed to balance the budget). The increased financial event risk stems from the adverse impact the deteriorating global economic landscape and financial market volatility will have on Russia's operating environment. In particular, Moody's notes that Russian banks will be negatively affected by a system-wide liquidity contraction, slower credit growth and pressured asset quality. That said, whereas the downside risks have increased, Russia's exceptional fiscal shock absorption capacity mitigates the country's susceptibility to risks that may come from political, economic or financial events.
The main factor that constrains Russia's Baa1 rating is institutional strength, which Moody's assesses to be relatively low, reflecting the country's weak governance, rule of law and transparency. The business uncertainties that relate to the impaired rule of law and the high level of corruption deter foreign investment into Russia, particularly from
small- and medium-sized enterprises (SMEs).
Looking ahead, Moody's believes that Russia's medium- to long-term challenges will be (i) to develop economic bases with greater intrinsic stability, such as the manufacturing and services sectors; (ii) to attract enough investment capital to replace its aging infrastructure; and (iii) to provide incentives and carry out important structural reforms so as to address issues such as demographic developments or the efficiency in quasi-state corporations.