The Daily Update - Russian Upgrade

Finally, on 8th February Moody’s upgraded its Russian sovereign rating to investment grade.  The move takes the LT foreign currency rating to Baa3 (stable outlook) from Ba1 (positive outlook) and moves the rating in line with S&P who upgraded the rating in February last year to BBB- and Fitch who has maintained an investment grade rating (currently BBB-) throughout the 2014 sanctions and lower oil price period. Moody’s stated the main driver for the upgrade ‘is Moody's conclusion that the sovereign's vulnerability to such shocks has indeed materially diminished and no longer constrains the rating to sub-investment grade. More specifically, the impact of likely new sanctions -- which is the most likely source of such a shock in the coming months -- could, in the rating agency's view, be contained without material damage to the country's credit profile.’

Moody’s also note the improvement in the external finances since 2014 noting: ‘The central bank's foreign exchange reserves cover 80% of external debt (including direct investment), compared to 57% of external debt in June 2014.’ Moreover, while there are capital outflows (including debt payments) these were ‘more than covered by the current account surplus, which widened to $115 billion or 7% of GDP’. They also highlight the step up in policy strength with the adoption of the new fiscal rule.

As we have noted before the fiscal rule uses a conservative oil price of $40 (real) and revenues in excess of the budget will be used to rebuild Russia’s fiscal buffers.  Russia’s prudent fiscal strategy has helped keep debt levels under control at ~15% of GDP. Russia has also moved to improve its fiscal profile by increasing the retirement age and increasing VAT. Moves to increase the flexibility of the exchange rate, with an emphasis on inflation targeting model have also increased the strength of the policy framework.

In response to the Moody’s upgrade USD denominated Russian sovereign paper was little changed suggesting the market was already, and in our opinion deservedly, pricing Russian sovereign paper as investment grade. Further sanctions remain a risk. On our models, the Russian sovereign curve looks fully priced for a Baa3/BBB- rating: the Russian Federation 5.625% 2042 trades ~1.6 credit notches expensive. Following the sovereign upgrade and an increase in the country ceiling Moody’s moved to raise the rating on Gazprom to Baa2 (stable outlook). Using this best rating Gazprom 8.625% 2034 trades ~1.5 credit notches cheap on our models. RZD 7.487% 2031 was also upgraded to Baa2 and is trading ~4 credit notches cheap.

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