Russia: Russia loses its investment grade despite unveiling “anti-crisis” plan
February 11, 2015
The Russian government presented an economic plan on 26 January to shore up the country’s deteriorating economic situation. The government stated that the plan was prepared as a means of responding to the economic crisis brought on by the effect of the recent plunge in global oil prices coupled with ongoing Western sanctions. The “anti-crisis” plan, which totals RUB 2.45 trillion (USD 36.8 billion), is centered on recapitalizing banks and supporting ailing industries, businesses and farmers. The government underlined that the emergency plan would not increase total budget expenditures and that it would cut spending within its 2015 budget by around 10%, while emphasizing that the cuts would not include defense, welfare, agriculture or debt servicing. Further financing for the plan will come from a budgetary reserve, which was contemplated in the budget, as well as from the country’s National Wealth Fund—a sovereign fund totaling around USD 80 billion in 2014. Moreover, around two-thirds of the money for the banking sector (RUB 1.55 trillion) will be met by an issuance of RUB 1.0 trillion worth of bonds.
Whether the plan can effectively cushion the rapid deterioration of the Russian economy remains to be seen. It has various similarities to the measures adopted in 2009 when the global financial crisis hit developed economies and oil prices collapsed, thus prompting a sharp devaluation of the ruble. At that time, the government injected a vast amount of capital into the banking sector to prevent a crisis and provide liquidity to large businesses. Russian authorities have described that program as successful, yet it’s important to note that GDP plummeted 7.8% in 2009.
Ratings agency Standard and Poor’s (S&P) downgraded Russia’s credit rating to junk, from BBB- to BB+ (with a negative outlook), on the same day the government announced its new plan. This is the first time in over ten years that Russia has lost its investment grade status. S&P cited Russia’s weak economic prospects, the impact of a weak ruble on the country’s financial system and Russia’s monetary policy limitations in transmitting the right signals as reasons for the downgrade. S&P said that the Central Bank, “faces increasingly difficult monetary policy decisions while also trying to support sustainable GDP growth. These challenges result from the inflationary effects of exchange-rate depreciation and sanctions from the West as well as counter-sanctions imposed by Russia.” S&P’s move followed the downgrade that Fitch made on 9 January when it lowered Russia’s sovereign credit rating to the lowest investment grade, BBB- (from BBB). Moody’s made a similar move on 16 January and lowered the sovereign credit rating to Baa3 (from Baa2).
The loss of investment grade for Russia means that, in addition to Western sanctions, the government and private firms will be further cut off from global financial markets. The FocusEconomics Consensus Forecast panel expects Russia’s external debt to have totaled USD 600 billion in 2014. The loss of investment grade will increase the cost of servicing debt, as some of it will bear higher interest rates.
Just as Russia’s economy is feeling the impact of external pressures, hostilities between Ukrainian government forces and pro-Russian separatists intensified following a period of lessened violence during the holiday season. The pro-Russian militias’ timing does not seem to coincide with either Russia’s or Ukraine’s current priorities, and local media have suggested that the recent upsurge may actually reflect struggles within the pro-Russian militias. In fact, Russia is focused first on addressing its economic problems as the ruble is falling and the economy is in dire straits. Ukraine is in an even worse financial situation than Russia and is currently in talks with the IMF to secure funding. Moreover, the army would need time to regroup in preparation for a potential pro-Russian separatist push in the spring.
In an effort to calm the conflict, leaders from Russia, Ukraine, France and Germany met at the beginning of the year to discuss the implementation of the Minsk ceasefire, yet talks stalled and a meeting scheduled for 15 January in Kazakhstan to revisit the topic was cancelled. However, German Chancellor Angela Merkel and French President François Hollande held talks with Russian President Vladimir Putin on 6 February in an effort to break the diplomatic deadlock over Ukraine.
Should the violence continue and diplomatic talks fail, the European Union (EU) is likely to prolong, and perhaps even increase, economic sanctions on Russia when they are revisited in July this year. Nonetheless, in mid-January, newly-appointed EU foreign minister, Federica Mogherini, made a statement that suggested that some leaders within the EU are seeking a way to relax the economic penalties. Conversely, the United States has stated that it could very well extend Russian sanctions and re-arm Ukraine in light of recent violence.
Russia’s economic plan is designed support the economy, to prevent a banking crisis and protect businesses and social groups from the worst effects of the recession. However, the plan does not contain any structural reform for Russia to achieve sustainable economic growth in a period of low oil prices. The Russian government is expecting that oil prices will recover, but until they do the National Wealth Fund will not be replenished.
Author: Ricardo Aceves, Senior Economist