Fitch, Moody's throw Russia into junk grade over Ukraine invasion
Moody's Investors Service has downgraded Russia's long-term issuer (local- and foreign-currency) and senior unsecured (local- and foreign-currency) debt ratings to B3 from Baa3. The ratings remain on review for further downgrade. Concurrently, Moody's has also downgraded the domestic currency Other Short Term rating to Not Prime (NP) from P-3.
In Moody's methodology, a 'Baa3' rating is the lower limit of the investment grade category, while the 'B3' rating now given to Russia is already deep in the speculative category.
Moody’s assigns its B3 rating for “obligations considered speculative and subject to high credit risk.” B3/B- is a credit rating used by Moody’s, S&P, and Fitch for an issued debt instrument that are at the bottom end of junk bonds. The next stop is the C rating. Obligations rated C are the lowes-rated class of bonds and are typically in default, with litte prospect of recovery of principal and interest. Countries going through a selective default are sometimes given this rating.
In this respect we should note that the central bank of Russia yesterday banned coupon payments to foreign owners of rouble bonds known as OFZs in what it called a temporary step to shore up markets in the wake of international sanctions. Bloomberg said that while initially the CBR clarified that the step was not aimed at stopping the servicing of debt, some investors and economists said the phrasing of the decree could amount to a default.
Fitch Ratings has downgraded Russia's Long-Term Foreign Currency Issuer Default Rating (IDR) to 'B' from 'BBB'. (This is one notch higher than the rating at Moody's.) The ratings have been placed on Rating Watch Negative (RWN).
Last week, the third global credit rating agency, S&P Global Ratings, also removed Russia's investment-grade rating, lowering the country's long-term foreign currency sovereign credit ratings to 'BB+/B' from 'BBB-/A-3' and local currency ratings to 'BBB-/A-3' from 'BBB/A-2'.
The (almost) simultaneous downgrade by Moody's and Fitch on Thursday also means that
Russia is no longer considered a sovereign debtor by international institutional investors.
International practice requires at least two credit rating agencies to have an investment-grade rating for a sovereign or commercial debtor in order for investment firms to consider the debt instruments of that country or company as investment grade.
Downgrade by Moody's
"The multi-notch downgrade of Russia's ratings and maintaining the review for further downgrade were triggered by the severe sanctions that Western countries have imposed on Russia, including the sanctioning of the Central Bank of the Russian Federation (CBR) and some large financial institutions, in response to its military invasion of Ukraine (B3 review for downgrade) and retaliatory measures taken by the Russian authorities. The ongoing review was initially triggered on 25 February by the start of Russia's military invasion of Ukraine."
Moody's said the downgrade of Russia's ratings to B3 is driven by the following rating factors:
- Heightened risk of disruption to sovereign debt repayment given the severe and coordinated sanctions and significant concerns around Russia's willingness to service its obligations;
- Likelihood of a sustained disruption to the economy and financial sector from the sanctions that limit access to Russia's international reserves intended to buffer Russia from adverse shocks.
Key drivers
- 1) SIGNIFICANT CONCERNS AROUND RUSSIA'S WILLINGNESS TO SERVICE ITS OBLIGATIONS
"The high degree of coordination among Western countries to impose wide-ranging sanctions on Russia in response to the invasion of Ukraine is crystallising severe downside risks to Russia's credit profile.
"The escalating military invasion, the acceleration in the imposition of sanctions on Russia to include the most severe forms that Moody's had outlined previously and the unpredictable actions that the government has undertaken in response to such sanctions has, in Moody's view, materially impaired Russia's ability and willingness to ensure timely repayment of its sovereign debt obligations.
Moody's considers there is now a significant likelihood that Russia's ability to repay its sovereign debt obligations will be disrupted by the sanctions.
"Moreover, Russia's recently announced prohibition on transfers of foreign currency outside of the country in response to the sanctions imposed by Western governments severely undermines Moody's view of Russia's institutional strength and leaves debt repayment flows highly vulnerable to further intervention.
"The increasing unpredictability of government actions that could further impact Russia's credit profile is a reflection of a lack of checks and balances around the executive and undermines institutional strength and the effectiveness of policies," said Moody's.
- 2) LIKELIHOOD OF A SUSTAINED DISRUPTION TO THE ECONOMY AND FINANCIAL SECTOR
The imposition of severe and co-ordinated sanctions by Western countries has caused a significant confidence shock, which will likely result in a prolonged disruption to the economy and financial sector.
"A sustained depreciation of the ruble will have severe economic consequence in the form of higher inflation, a marked deceleration of economic activity and lower living standards.
"Significant deposits withdrawals that reduce liquidity in the banking system would add to the risks to financial stability and could require the government to step in to support the banking sector. The CBR has responded by hiking the key rate to 20%, restricting nonresident deposit withdrawals and requiring the conversion of 80% of foreign-currency export earnings in order to provide liquidity support to the financial system."
The risk of macro-economic instability is further elevated by the effect of new sanctions making a very significant portion of Russia's accumulated financial buffers inaccessible.
According to data from the CBR, at least 60% of foreign-currency reserves, excluding gold, were, as at end-June 2021, located in countries that have sanctioned the CBR.
"Although Russia holds around 20% of its reserves in gold, Moody's expects there will be challenges in converting it into hard currency. Weaker liquidity in the banking sector will reduce its ability to provide financing to the government and wider economy amid financial sector disruption and the risk of significant deposit withdrawals.
"While inflows of foreign currency from the export of Russian oil and gas may provide a cushion to the impact of these severe sanctions, this does not preclude, in Moody's view,
the high likelihood of a sustained economic disruption and increased susceptibility to shocks.
"In addition, a further ratcheting up of the sanctions imposed on Russia by Western countries could very well apply to this vital source of foreign currency and government revenue."
Downgrade by Fitch
Severe shock to credit fundamentals:
"The severity of international sanctions in response to Russia's military invasion of Ukraine has heightened macro-financial stability risks,
represents a huge shock to Russia's credit fundamentals and could undermine its willingness to service government debt.
"Developments will
- weaken Russia's external and public finances,
- severely constrain its financing flexibility,
- markedly reduce trend GDP growth, and
- elevate domestic and geopolitical risk and uncertainty.
The Rating Watch Negative (RWN) placed on the ratings reflects "the high degree of volatility in international relations, including the potential for further sanctions tightening and uncertainty over Russia's policy response such as not servicing its debt, and the risk of a more acute loss of domestic economic confidence."
Rapidly tightening sanctions:
"Announced US and EU sanctions prohibiting any transactions with the Central Bank of Russia (CBR) will have a much larger impact on Russia's credit fundamentals than any previous sanctions.
Full implementation could render much of Russia's international reserves unusable for FX intervention, and a large proportion could be subject to asset freezes.
Fitch noted that 32% of Russia's FX reserves are denominated in euros and 16% in US dollars, and more than half are held in countries participating in sanctions (as of end-June 2021). Sanctions also prohibit US transactions with the National Wealth Fund or the Ministry of Finance.
Lower Trend GDP Growth:
The shock to domestic confidence and policy tightening will have a sharply negative impact on near-term economic activity.
Sanctions will also markedly weaken Russia's GDP growth potential relative to the credit rating agency's previous assessment of 1.6%, partly through constraining the ability to clear trade payments, with 55% of Russian exports denominated in US dollars and 29% in euros. "In addition, trade partners will seek substitutes for imports from Russia, particularly in the energy sector (which accounted for USD241 billion or 44% of Russia's exports in 2021). To a lesser extent, much weaker prospects for foreign investment and technological transfer will also weigh on trade and productivity," Fitch said.
The rating agency also noted that
- "Sanctions tightening will also reduce the private sector's ability to refinance its external debt.
- "Contingent liability risks from the banking sector have also increased, although their near-term impact will be mitigated by regulatory forbearance.
- "The collapse in international relations and greater unpredictability in policy-making, in our view, also add to geopolitical risks in the short and medium term.
MSCI Inc., a leading provider of critical decision support tools and services for the global investment community, announced on Wednesday that the MSCI Russia Indexes will be reclassified from Emerging Markets to Standalone Markets status. The reclassification decision will be implemented in one step across all MSCI Indexes, including standard, custom and derived indexes, at a price that is effectively zero and as of the close of 9 March, 2022.
This could lead to further massive capital outflows from the Russian Federation.
Cover photo: Shutterstock
