The crisis in the Ukraine has increased the risks to Russia’s already weakening economy presented by currency depreciation and capital flight, Fitch Ratings says. The situation is still highly unpredictable but Russia’s sovereign credit profile is robust and events so far do not have implications for the country’s ‘BBB’ rating.
Market reaction to Russia’s intervention in Crimea saw the rouble fall 2.2% to an all-time low against the US dollar on Monday, while the MICEX index of Russian shares fell 10.8% and yields on rouble sovereign debt rose sharply. The Central Bank of Russia (CBR) raised its key interest rate by 150bp to 7%, and intervened to support the rouble, selling USD11bn. Losses were partly recovered on Tuesday as tensions appeared to ease.
The rouble has now fallen around 9% against the dollar this year, partly driven by fears across emerging markets about the impact of US tapering, but also on Russia-specific concerns about low growth and the weakening current account surplus, and in anticipation of further liberalisation of the exchange rate regime.
Higher energy prices and a weaker rouble should provide a fillip to sovereign finances by boosting the local-currency value of oil and gas exports, which contribute around half of federal government revenue and current external receipts. This will keep the fiscal deficit within the target of 0.6% of GDP in the budget, making up for a shortfall in non-oil revenue.
Russia’s already strong sovereign balance sheet is characterised by low sovereign debt levels and high international reserves (around USD490bn in late February). Sovereign net foreign assets equivalent to 23% of GDP provide an ample buffer against external shocks, supporting the rating. These are sufficient to cover gross external financing needs more than three times over. The Reserve Fund, the government’s main fiscal buffer, contains USD87bn (4.5% of GDP), giving Russia a cushion against a drop in demand for its sovereign debt. However, the broader economy stands to gain less from a weaker rouble. A lower cost base for commodity exporters may promote some current account adjustment but competitiveness gains for the relatively small non-hydrocarbons export sector will have a limited impact on GDP. We think the economic drag through lower business and consumer confidence and a loss of purchasing power will be more significant.
Russian economic growth has already slipped below the ‘BBB’ category median, with real GDP growth falling to 1.3% in 2013 due to a decline in investment and the inventory cycle. We recently revised our growth forecasts for 2014 and 2015 to 1.5% and 2%, respectively (from 2% and 2.5%), as economic data in January and February showed little sign of improvement. Rising inflation, higher interest rates and potential capital flight all increase the risks to the downside.
Foreign lenders may also seek to scale back their lending to the Russian private sector, with adverse economic consequences.
Private capital outflows exceeded 5% of GDP in 2013 and remain a persistent problem. The Ministry of Economy estimated year-to-date private sector capital outflows had already reached USD17bn – around half their forecast for 2014 as a whole – prior to the crisis.
Capital flight could accelerate, particularly if the threat of economic and financial sanctions increased. While not our base case, were such sanctions to materialise, the potential impact on growth and investment could lead us to review our sovereign rating on Russia. However, it is not clear whether Russia’s European trading partners in particular are prepared to risk the potential disruption to their own economies, and possible Russian retaliation, that sanctions would entail.