Moody's Sounds Alarm on Russian Fiscal Woes Draining Buffers

  • Public finances are under pressure from oil slump, recession
  • S&P, Moody's lowered Russian sovereign rating to junk in 2015

The pillar of Russian creditworthiness is looking more rickety by the day to Moody’s Investors Service.

“What once has been the country’s strongest asset, which was the government’s very strong financial position, is now under significant pressure,” Kristin Lindow, senior vice president at the credit-ratings company, said Wednesday in an interview in Moscow. “It doesn’t have a lot of debt, but it also is actively depleting its saving buffers, with very littleprospect in the medium term of rebuilding them.”

The country’s public finances have been in the spotlight as the government debated fiscal adjustments for an economy clobbered by international sanctions and a sell-off in oil, which has paralyzed investment and consumer demand. Next year’s budget deficit is set to reach 2.4 trillion rubles ($39 billion), or 3 percent of economic output, after Russia rolled back cuts to defense spending during a campaign in Syria, its first military foray outside the former Soviet Union in three decades.

The government is already running its widest deficit in five years in 2015 after the collapse in the price of oil, which together with natural gas contributes almost half of Russia’s budget revenue. The economy of the world’s largest energy exporter is at threat of the longest recession in two decades, with the ruble weakening 34 percent against the dollar in the past 12 months.

Fastest, Worse

“Public finances are now changing the fastest and for the worse,” Lindow said. The government “couldbe forced to do the fiscal consolidation that it’s talking about, but that would further constrain growth, which is already very low.”

To make up the bulk of next year’s shortfall, the Finance Ministry plans to use 2.1 trillion rubles from one of Russia’s two sovereign wealth funds, and may tap an additional 500 billion rubles from it if needed. Russia may exhaust both of its funds in 16 months to two years if it continues to rely on the $144.2 billion reserves without scaling back budget spending, Finance Minister Anton Siluanov has warned.

Junk Rating

Standard & Poor’s and Moody’s cut Russia below investment grade this year following a slump in oil prices and sanctions imposed over Ukraine. Fitch Ratings, the last major assessor that ranks the country above junk, is scheduled to review the sovereign’s BBB- grade on Friday.

Moody’s, which has cut Russia three times in the past 12 months after rating it at Baa1 for six years, says its concerns “have evolved” since the time of its last downgrade in February.

“Now what we have is a situation where the external position is a bit less of a worry and the public finance situation is much more of a creditconcern, because it is not clear in the context of sanctions what the mix of government funding will bein 2017-2018,” Lindow said. “Russia’s two sovereign funds don’t represent as strong abuffer as they used to. They are more vulnerable now to beingdepleted.”

Russia has been overhauling its approach to crafting the budget next year to safeguard reserves. Actions by the government to protect the wealth funds mirror a move by the central bank to shift to a free-floating exchange rate ahead of schedule last November after spending about $88 billion to prop up the ruble. With President Vladimir Putin saying the country won’t “mindlessly burn” cash to defend its currency, the central bank conducted purchases of foreign currency to rebuild reserves between mid-May and late July before suspending them amid another tumble in the ruble.

‘Approximately’ Unchanged

Bank of Russia Governor Elvira Nabiullina said in an interview this week that international reserves will remain “approximately” unchanged through the start of next year, with the central bank monitoring ruble volatility as it waits to resume currency purchases. The stockpile was at $370.2 billion as of Oct. 2, down from last year’s high of $510.5 billion.

The current fiscal plan shows the budget won’t be tightened “enough to eliminate the deficit,”Lindow said, adding that the cost of pensions is putting “clear pressure” on public finances.

Limited room for borrowing is another challenge, according to Moody’s. Russia plans to cut its 2016 limit on foreign borrowing to $3 billion from the $7 billion cap in recent years. Net domestic borrowing is projected at 500 billion rubles.

As debate intensifies over Russia’s budget outlook, speculation that a stabilizing ruble will allow the central bank to resume interest-rate reductions has helped push yields on longer-maturity government bonds to the lowest since November. In the last two months, local government securities have handed investors a return of about 11 percent in dollar terms, the best among emerging markets tracked by Bloomberg. The yield on Russia’s January 2028 ruble note fell 13 basis points on Friday.

“In spite of the very low level of debt, their ability to borrow at the domestic market is very limited, so without access to the international capital market, they can’t simply borrow their way out,” Lindow said.

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