3 Sep 2009 18:51

S&P affirms Russian Federation at 'BBB/A-3'; outlook negative

MOSCOW. Sept 3 (Interfax) - Standard & Poor's Ratings Services affirmed its 'BBB/A-3' foreign currency and 'BBB+/A-2' local currency sovereign credit ratings on the Russian Federation. Russia's Transfer & Convertibility (T&C) assessment was also affirmed at 'BBB', the ratings agency said in a press release. The outlook remains negative.

"The ratings and outlook reflect still-substantial risks to public finances due to the severe economic contraction, large contingent liabilities to the government associated with continued stress in the financial sector, and the significant foreign liabilities of state enterprises," credit analyst Frank Gill is quoted in the press release as saying.

The body of the press release follows.

Standard & Poor's expects net general government debt levels to increase from negative 14.1% of GDP in 2008 to 13.8% of GDP in 2012, implying that the Russian government will be a slight net debtor by the end of 2010.

These projections embed our expectation that general government deficits average almost 8% of GDP between 2009 and 2011 before narrowing to 4% of GDP in 2012. Our deficit forecasts include the estimated 6% of GDP cost to recapitalize Russia's banking system as well as a cumulative 14% of GDP transfer from the central budget to the pension fund as part of the government's long-term efforts to shore up the finances of the undercapitalized social security system. Over this period public sector borrowing needs will be financed by a combination of rising gross general government debt (albeit only to 14% of GDP in 2012) and the depletion of the two fiscal funds by 2013.

For the next two years, public capital expenditure is already set to be reduced in inflation adjusted terms, largely to finance further increases in social expenditure. As Russia's fiscal stimulus program is focused on hikes to current rather than capital expenditure, the multiplier effects to growth are likely to be limited.

Long-term prospects for the Russian economy remain uncertain. Unless investor confidence is sufficiently restored, the economy is likely to be starved of development capital for the foreseeable future. Resistance to supply side reforms, and the absence of progress on the fight against corruption imply relatively low foreign direct investment inflows over the next half decade. As a result, the outlook for growth, and hence the tax base, remains unclear.

Nevertheless, even by end 2012, with net debt levels at 14% of GDP, Russia's public balance sheet remains superior to the 'BBB' rating median of 42% of GDP, although contingent liabilities are as high or, taking into account the unfunded component of the pension liability and challenging demographics, even higher.

"The negative outlook reflects the possibility of a downgrade if authorities fail to consolidate the primary general government deficit over the next several years from current levels of near 8% of GDP," added Mr. Gill. The rating could also be reduced should the worsening economic environment weaken the government's political mandate, making it more difficult to stabilize the economy, and recapitalize the troubled financial sector.

On the contrary, rapid consolidation of public finances, most probably accompanied by improving terms of trade, would restore strength to Russia's balance sheet, and would be supportive of a stable outlook.