So Standard & Poor’s finally did what many had expected them to for some time — downgrade Russia’s sovereign debt a notch to ‘junk’ status.
Here are the key points we learned from the ratings agency’s report on the country:
S&P doubts the central bank’s ability to deal with Russia’s economic crisis
With Russia’s banking system increasingly fragile and trust between institutions fraying, the central bank is finding it difficult to transmit policy measures to the real economy. Moreover, the Bank of Russia is currently caught between the conflicting pressures of sharply rising inflation on the one hand due to sanctions on importing Western goods (requiring it to hike interest rates) and a weakening economy that would usually cause it to lower rates.
As the report states:
Fears that depositors were losing confidence in the ruble were well founded
The ruble has tumbled by almost 50% against the dollar over the past year, closely tracking the collapse in the price of crude oil. However, the two appeared to disconnect in December with Russia’s currency briefly moving into free-fall, touching all-time-lows of 80 rubles to the dollar and 100 rubles to the euro.
At that point concerns were raised that the sudden falls could mean a collapse of confidence in the currency leading Russians to withdraw their savings from banks and fuelling the ruble’s drop. This theory appears to have been right. S&P writes (emphasis added): “We also understand that during 2014 the Russian public had been converting
rubles into foreign currency, thereby fuelling depreciation.“
The problems in the banking system are far, far from over
Russia’s banks hold a total $US192 billion of external debt, around 70% of which is dollar-denominated, and that bill is getting ever larger as the ruble continues to slide against major currencies.
The government has already been forced to inject $US2.4 billion into financial institutions last month, including state-owned lenders VTB and Gazprombank. That bill is expected to rise with analysts suggesting that bailouts could cost the government a further $US40 billion this year.
German Gref, head of Russia’s largest lender Sberbank, estimates that lenders may need to boost provisions to cover mounting debt costs by as much as $US50 billion if oil stays around its current $US45 a barrel level. For major lenders which enjoy state support this funding gap is unlikely to be an insurmountable problem, but for smaller banks in Russia’s regions it could prove a death knell.
Here’s why — more and more loans that are sitting on Russian bank balance sheets are likely to fall into difficulty as 2015 wears on. Although larger banks are likely to be bailed out by the state, a number of smaller institutions may not be so lucky:
Russia looks set to continue burning through its currency reserves
Russia’s international reserves have fallen to $US385 billion at December 31 from $US509 billion at the start of 2014, as the central bank has bought rubles in an effort to soften the currency’s decline against the dollar and the euro. This has raised concerns that, if sanctions continue and the country’s reserves fall further, it could threaten the country’s ability to import crucial goods and services.
Russia’s former finance minister and current chairman of the Committee of Civil Initiatives Alexei Kudrin raised alarm bells last month when he wrote a blog in the daily newspaper Kommersant warning that available reserves could barely cover six months of imports at current prices.
“Six months of Russia’s imports are worth approximately half of the current level of international reserves, which are valued at around $US454 billion. If we subtract the reserves used to insure the government’s budget, the remaining value of reserves only slightly exceed the amount needed to pay for six months of imports.”
Six months is seen by some as the critical level to insure the Russian population against the possibility of severe hardship in case the crisis deepens and the Russians are deprived of foreign goods. (Russia imports a large amount of staples including butter, cheese, and meat.) S&P think that this level may already have been breached and indeed reserves are likely to continue to fall for the next few years.
Overall the message from S&P is that Russia’s economic crisis is now entering a critical phase. Earlier today Prime Minister Dmitry Medvedev described the downgrade of Russia as “a political tool in its purest form”. Yet the reality of a weakened economy is hard to disguise behind the rhetoric.
As testament to this, the Russian government passed an anti-crisis plan today that will that will freeze the level of state spending. The plan targets a budget surplus by 2017 (assuming an average of $US70 a barrel for crude oil) and the government is also preparing structural reforms “so that we do not burn recklessly through Russia’s sovereign reserves”, according to Finance Minister Anton Siluanov.
Whether these will be enough to prevent the downturn from turning into a full-blown financial crisis is yet to be seen.