Moody's has downgraded the government of Russia's sovereign debt rating to ‘junk’ status over the continuing crisis in Ukraine, fiscal pressures and the continued erosion of Russia's foreign exchange (FX) reserves, and possible disruptions of timely payments on external debt service.

On Feb 20, Moody's Investors Service said it cut Russia’s debt rating by one notch to Ba1/Not Prime (NP) from Baa3/Prime-3 (P-3), with negative outlook.

“The assignment of the negative outlook reflects the potential for more severe political or economic shocks to emerge, related either to the military conflict in Ukraine or a renewed decline in oil prices, which would further impair Russia's public and external finances,” runs the statement.

“In a related decision, Moody's has lowered Russia's country ceilings for foreign currency debt to Ba1/NP from Baa3/P-3; its country ceilings for local currency debt and deposits to Baa3 from Baa2; and its country ceiling for foreign currency bank deposits to Ba2/NP from Ba1/NP. A country ceiling generally indicates the highest rating level that any issuer domiciled in that country can attain for instruments of that type and currency denomination,” according to the press release.

The downgrade is largely due to the ongoing crisis in Ukraine, the fall in oil prices and the impact of the ruble exchange rate on the country's economic strength and financial stability.

In Moody's view, “the existing and potential future international sanctions, the erosion of the country's foreign exchange buffers and persistently lower oil prices plus high and rising inflation will take a negative toll on incomes as well as business and consumer confidence. As a result, Russia is expected to experience a deep recession in 2015 and a continued contraction in 2016. The decline in confidence is likely to constrain domestic demand and exacerbate the Russian economy's already chronic underinvestment,” reads the statement.

“The monetary authorities face the conflicting objectives of keeping interest rates high enough to restrain the exchange rate and bring down inflation and keeping rates low enough to reinvigorate economic growth and bank solvency. While the interest rate cut in January coincided with a rise in oil prices that cushioned the otherwise negative initial reaction of the exchange rate, a too-rapid reduction in interest rates risks further currency depreciation and higher inflation, which would further compress domestic purchasing power and extend and/or deepen the economic downturn,” says the report.

The second driver for the downgrade is “the expected further erosion of Russia's fiscal strength and foreign exchange buffers”. Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. “The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels,” according to the report available on Moody's website.

The third driver for the downgrade is a possible decision by the Russian authorities that directly or indirectly undermines timely payments on external debt service over the international response to the conflict in Ukraine.

“Moody's would consider stabilizing the outlook on the Russian government rating if the macro-economic and financial market conditions were to stabilize, if the risks of financial market volatility were to subside, and/or if there was a serious prospect of the Ukraine crisis being resolved in such a way that the risk of ongoing or escalating military hostilities and further sanctions were to dissipate,” concludes the review commission.

Sources: https://www.moodys.com