While Standard & Poor’s and Fitch Ratings consider whether Russian President Vladimir Putin’s military incursion into Ukraine warrants a sovereign downgrade, investors have already cut the nation’s bonds to junk.
The cost to insure the government’s debt against non-payment climbed to a 10-month high of 278 basis points in March, topping that of countries rated three steps lower by S&P. Based on the price of credit-default swaps, Costa Rica and Guatemala are among the countries deemed a safer investment, even as the two nations’ gross-domestic product amounts to about 5 percent that of Russia, the world’s biggest energy exporter.
The ratings companies revised their outlooks on the Russian sovereign to negative from stable last week, while affirming the rankings at BBB, their second-lowest investment grades. Putin’s annexation of Crimea may lead to higher capital outflows and weaken the country’s “already deteriorating economy” as the U.S. and European Union ratchet up sanctions, S&P said.
“It is a warning shot to Russia that it could get lots worse if they invade Ukraine,” Marco Ruijer, who helps oversee about $8 billion in emerging-market bonds at ING Investment Management in The Hague, said by e-mail on March 21. “Russia could lose its investment-grade status. Some investors could then be forced sellers.”
The credit-rating outlook cuts “raise questions” and appeared to have been politically ordered, Putin’s spokesman Dmity Peskov told reporters on March 21. Both rating companies denied such motivation in separate statements the same day.
Ignoring expanded sanctions targeting his officials and billionaire allies, Putin signed legislation last week completing the process for the Black Sea peninsula of Crimea and the city of Sevastopol to join Russia as two new regions.
The cost of protecting Russian debt against default using credit default swaps is higher than Costa Rica, Hungary, Guatemala and Portugal, all BB rated credits at S&P. The swaps cost more than Nigeria, whose rating is three levels below investment grade by S&P at BB-.
The U.S. and the EU extended a list of Russians and Ukrainians facing asset freezes and travel bans last week and for the first time targeted a Russian bank. U.S. President Barack Obama also signed an executive order authorizing, though not implementing, sanctions affecting parts of Russia’s economy.
There is a “material risk” of violence between pro- and anti-Russian protesters spreading to other cities in eastern Ukraine, which would lead to further sanctions, S&P said.
Russia will probably dip into a recession in the second and third quarters, Vladimir Kolychev and Daria Isakova, economists at Moscow-based VTB Capital, said in a March 17 note. “Domestic demand is set to halt on the uncertainty shock and tighter financial conditions,” they said, cutting their 2014 estimate to zero growth from 1.3 percent last year.
The country had capital outflow of $60 billion in the first quarter of the year, similar to the level for the whole of 2013, according to S&P estimates. Households are converting their savings into dollars after the ruble weakened 9 percent this year to 36.0960 against the dollar today.
Russian five-year CDS stood at 265 basis points at 6:17 p.m. in Moscow today, an increase of 73 basis points this month and compared with a low of 128 basis points in May, data compiled by Bloomberg show.
“Ten percent to 20 percent” of the increase in the swaps price is due to expectations the country’s rating will be downgraded, Konstantin Artemov, who manages $500 million of fixed-income securities at Raiffeisen Capital in Moscow, said by e-mail on March 21. “The rest is just panic.”
The yield premium investors demand to hold Russia’s dollar bonds over Treasuries decreased 5 basis points, or 0.05 percentage point, to 318 today, according to JPMorgan Chase & Co. indexes. The spread, which peaked at 350 on March 14, has averaged 222 over the last 12 months, the data show.
“By the end of the year, Russia will probably have the lowest investment-grade rating from all three agencies,” Leonid Ignatyev, head of fixed income research at BCS Financial Group in Moscow, said by phone.
In almost half the instances, yields on government bonds fall when a rating action by Moody’s Investors Service and S&P suggests they should climb, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back to the 1970s. When S&P downgraded the U.S. government in 2011, bonds rose and pushed Treasury yields to record lows.
“We are politically neutral and independent, and have to remain so at all times in order to do our job,” S&P’s press service said in an e-mail to Bloomberg on March 21. Fitch said it’s an “entirely independent provider of credit ratings and any suggestion to the contrary is patently false.”
Russia is a “safe borrower” with “one of the lowest debt burdens” regardless of its credit ratings, Ravil Yusipov, deputy general director at CJSC TransFinGroup Asset Management in Moscow, said in an interview in Moscow on March 21.
If foreign investors pull out of Russia’s ruble debt “we’ll be prepared, we want to buy,” Yusipov said. “It’s the benchmark for me, it’s the safest bet.”
World leaders gathered in The Hague today to discuss Ukraine, with Western nations expressing growing concern over a Russian buildup on its neighbor’s border as pro-Kremlin troops seized a Ukrainian base in Crimea.
“The appetite of investors, both domestic and external, to allocate capital when there’s so much uncertainty has dropped,” Dmitri Petrov, a London-based Commonwealth of Independent States and Russia strategist at Nomura Holdings Inc. said. “It’s not surprising that there’s been an upgrade in risk to the Russian economy.”