Russia Affirmed at BBB by S&P as Putin Wait for Upgrade Drags On

Russia had its credit rating affirmed at BBB, the second-lowest investment grade, by Standard & Poor’s, dashing the government’s hopes for the country’s first upgrade in five years before a potential $7 billion bond sale.

Weak institutions and the budget’s reliance on oil revenue continue to offset the country’s robust public finances, S&P, which kept the outlook at stable, said in a statement released today. Russia was last upgraded to Baa1 at Moody’s Investors Service in July 2008.

The world’s largest energy exporter has had its ranking on hold since S&P cut it in December 2008 and Fitch Ratings did the same the next year after crude prices plunged. Russia seeks to boost the debt grade no less than two steps to A- by 2016 and another level to A by 2020, according to a government plan approved in March.

“The ratings remain constrained by structural weaknesses in Russia’s economy, in particular the strong dependence on hydrocarbons and other commodities,” S&P analysts including Kai Stukenbrock in Frankfurt said in the statement. “Further constraints are the weak political and economic institutions that impede the economy’s competitiveness, investment climate, and business environment.”

The extra yield investors demand to hold Russia’s debt rather than U.S. Treasuries sank four basis points to 235, compared with 227 for debt of Mexico, according to JPMorgan Chase & Co.’s indexes.

‘Exhort, Argue’

The move marks a setback for the government as it considers its first Eurobond offering in more than a year. The authorities were prepared to “exhort, argue, explain” that Russia was prime for a bump in the credit rankings, Deputy Finance Minister Sergei Storchak said May 21 as the country’s rating was put under review for a possible change or confirmation.

Russia’s low debt and deficit levels are insufficient to win the country a rating increase because of corruption and weak rule of law, Moody’s said March 28. Fitch Ratings affirmed Russia in August, saying “more reforms” to improve the business climate and governance, as well as to strengthen the financial industry, would be rating positive.

Moscow-based Expert RA awarded the country an A- grade in March. In 2011, President Vladimir Putin called Russia’s rankings an “outrage” that increased borrowing costs for both domestic companies and the government.

Russia sold $7 billion of debt last year, attracting $24 billion of bids. The yield on the country’s dollar bond due April 2042 dropped seven basis points, or 0.07 percentage point, today to 5.295 percent after peaking at 5.755 on June 24.

Opposite Direction

Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December. Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by S&P. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974.

Russia’s economy, which grew 10-fold in dollar terms in 1999-2012, is forecast to expand 2.5 percent this year, S&P said in today’s statement. That would mark the slowest growth since 1999, excluding a contraction in 2009.

S&P said the budget will “gradually” move into deficit, with the fiscal gap reaching 1.7 percent of gross domestic product by 2016. Current-account surpluses will probably disappear by 2015 as rising imports outpace export growth, according to the rating company.

‘Firm Control’

Putin, shaken by anti-government protests that started in December 2011 before his election to a third term in the Kremlin the following year, “retains firm control,” S&P said.

“We do not expect a credible challenge to his rule before the end of his term,” S&P said. “We do not expect the government to decisively and effectively tackle the long-standing structural obstacles to stronger economic growth over our forecast horizon, which include high perceived corruption, comparatively weak rule of law, the state’s pervasive role in the economy, and a challenging business and investment climate.”

The central bank’s leadership change this month isn’t putting the monetary authority’s “wide-ranging operational independence” under threat, according to S&P. Elvira Nabiullina, Putin’s former chief economic aide, became chairman on June 24.

“Exchange-rate flexibility is increasingly providing an important buffer to mitigate the impact of shocks, such as a drop in the oil price, on the Russian economy,” S&P said. “The effectiveness of monetary policy is constrained by a comparatively small ruble fixed income market.”

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