21/2/15: Russian Sovereign Wealth Funds: 2015 drawdowns

In the previous note I covered Moody's downgrade of Russian sovereign debt rating (see http://trueeconomics.blogspot.ie/2015/02/21215-moodys-downgrade-russia-risks-and.html). Now, as promised, a quick note on Russian use of sovereign fund cash reserves (also referenced in the Moody's decision, although Moody's references are somewhat more dated, having been formulated around the end of January).

Back at the end of January, Russia’s sovereign wealth funds amounted to USD160 billion, with the Government primarily taking a historically-set approach (from 2003 onwards) of arms-length interactions with the Funds management. This relative non-interference marked 2014 and is now set to be changed, with the Government looking at using SWFs to provide some support for the investment that has been falling in 2013-2014 period and is likely to fall even further this year.

Fixed investment in Russia fell 2.0% y/y in 2013, and by another 3.7% in 2014. Private investment is likely to fall by double digits in 2015, based on the cost of funding, lack of access to international funding and general recession in the economy. It is likely to stay in negative growth territory through 2016.

Thus, last week, Prime Minister Medvedev signed an executive order deploying up to RUB500 billion from the Reserve Fund. The money will be used, notionally, to cover this year deficits (expected to hit 2% of GDP), thus protecting the state from the need to borrow from the markets. The Fund was originally set up precisely for this purpose - to finance deficits arising during recessionary periods. In other words, this is stabilisation-targeted use of stabilisation funds. The fund is fully accounted for in the total Forex reserves reported by the Central Bank. Latest figures for end of January 2015 showed the fund to have USD85 billion or RUB5,900 billion in its reserves, so this year allocation is a tiny, 8.5% fraction of the total fund. All funds are allocated into liquid, foreign currency-denominated assets.

The second use of SWFs is via the economic support programme that will draw up to RUB550 billion worth of funds in 2015 from the second SWF - the National Welfare Fund (NWF). Part of this funding is earmarked for banks capitalisation, ring fenced explicitly for banks providing funding to large infrastructure investments and lending for the enterprises. The use of the NWF funds is more controversial, because the Fund was set up to provide backing for future pensions liabilities, including statutory old-age pensions. However, the NWF has been used for the economic stimulus purposes before, namely in the 2009 crisis. Currently, NWF holds USD74 billion or RUB5,100 billion worth of assets. Liquid share of these assets, denominated in foreign currencies, is also included in the Central Bank-reported Forex reserves, but long-term allocated illiquid share and ruble-denominated assets are excluded from the CBR reported figures.

Now, per Moody's note issued last night, "The second driver for the downgrade of Russia's government bond rating to Ba1 is the expected further erosion of Russia's fiscal strength and foreign exchange buffers. …Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. …Moreover, under the stress exerted by a shrinking economy, wider budget deficits and continued capital flight -- in part reflecting the impact of the Ukraine crisis on investor and depositor confidence -- and restricted access to international capital markets, Moody's expects that the central bank's and government's FX assets will likely decrease significantly again this year, cutting the sovereign's reserves by more than half compared to their year-end 2014 level of approximately USD330 billion. In a more adverse but not unimaginable scenario, which assumes smaller current account surpluses and substantially larger capital outflows than in Moody's baseline forecast, FX reserves including both government savings funds would be further depleted. While the government might choose to mobilise some form of capital controls to impede the outflow of capital and reserves, such tools are not without consequences. Capital controls, which might include a rationing of retail deposit withdrawals and/or prohibition upon repatriation of foreign investment capital, would weaken the investment climate further and undermine confidence in the banking system."

21/2/15: Moody's Downgrade: Russia Risks and Politics

Moody's downgraded Russian sovereign debt last night from Baa3 to Ba1 with negative outlook. Moody's put Russian ratings on a review back on January 16.

The bases for the downgrade were (quotes from Moody's statement):

1. "The continuing crisis in Ukraine and the recent oil price and exchange rate shocks will further undermine Russia's economic strength and medium-term growth prospects, despite the fiscal and monetary policy responses". In more specific terms, "Russia is expected to experience a deep recession in 2015 and a continued contraction in 2016. The decline in confidence is likely to constrain domestic demand and exacerbate the Russian economy's already chronic underinvestment. It is unlikely that the impact of recent events will be transitory. The crisis in Ukraine continues. While the fall in the oil price and the exchange rate have reversed somewhat since the start of the year, the impact on inflation, confidence and growth is likely to be sustained." As I noted on numerous occasions before, monetary policy environment remains highly challenging. Per Moody's "The monetary authorities face the conflicting objectives of keeping interest rates high enough to restrain the exchange rate and bring down inflation and keeping rates low enough to reinvigorate economic growth and bank solvency."
2. "The government's financial strength will diminish materially as a result of fiscal pressures and the continued erosion of Russia's foreign exchange (FX) reserves in light of ongoing capital outflows and restricted access to international capital markets." I will post a quick note on this matter later today, so stay tuned. Here's Moody's view: "Taking at face value the government's plans to proceed with its planned fiscal consolidation for 2015, Moody's expects a consolidated government deficit of approximately RUB1.6 trillion (2% of GDP) as well as a widening of the non-oil deficit. The deficit would likely be financed by drawing on the Reserve Fund, which is specifically designed for circumstances when oil prices fall below budgeted levels. Moody's also expects that widespread demands for fiscal easing are likely to emerge if, as the rating agency projects, the recession persists into 2016. In a scenario in which the government would turn to borrowing in the domestic market to finance at least a share of these deficits, higher spending could result in an increase of the debt-to-GDP ratio to 20% or more."
3. "The risk is rising, although still very low, that the international response to the military conflict in Ukraine triggers a decision by the Russian authorities that directly or indirectly undermines timely payments on external debt service." In other words, we are facing a political risk. Capital controls and debt repayment stops are two key risks here and these were visible for some time now, especially if you have followed my writing on the Russian crisis.

What's the driver for the negative outlook? Uncertainty. Per Moody's: "The negative outlook on the Ba1 rating reflects Moody's view that the balance of economic, financial and political risks in Russia is slanted to the downside, with scenarios incorporating either an escalation of the Ukraine crisis and/or damage caused by recent shocks being greater than in Moody's baseline scenario. Essentially, the probabilities associated with the downside scenarios are higher than those associated with an upside scenario in which the recession is shorter and shallower than Moody's baseline."


Conclusion: an ugly, but predictable move by Moody's. One can say part of it is down to rating agencies activism in trying to establish some sense of credibility post-Global Financial Crisis, whereby getting tougher on ratings is a major objective, and it is well-served by getting tougher on politically softer targets, like Russia. But one can equally argue that the ratings downgrade is consistent with economic environment and some longer-run fundamentals. My view would be is that we are seeing both, with the balance of impetus tilted toward the latter argument.

16/1/2015: Moody's Get Double Moody on Russia

As I predicted at a briefing earlier today, Moody's downgraded Russia's sovereign debt (expect downgrades of banks and corporates to follow in due course). This was inevitable given the outlook for growth 'dropped down' on us by the agency in their note on Armenia (see here).

Full release on downgrade is here: https://www.moodys.com/research/Moodys-downgrades-Russias-government-bond-rating-to-Baa3-on-review--PR_316487.

The point is - if you believe Moody's outlook for the risks faced by the economy - you should expect full, open (as opposed to partial and 'voluntary') capital controls and debt repayments holidays (for corporate and banks' debts for entities directly covered by sanctions) before the end of the year.

And, you should still expect a good 75%+ chance of a further downgrade upon the review as Moody's struggle to push ahead with projecting a more 'robust ratings' stance to the markets.

Even the best case scenario is for another downgrade and 12-18 months window of no positive reviews.

The impact of these downgrades is narrow, however. Russian Government is unlikely to become heavily dependent on new debt issuance and thus is relatively well insulated against the fall out from the secondary bond market yields spikes. Russian banks can withstand paper losses on sovereign bonds they hold. At any rate they have much greater headaches than these - if oil prices follow Moody's chartered course, who cares what sovereign ratings are assigned. The impact of sovereign ratings and yields on private debt issuance is a bit more painful, as it will hit those entities issuing new debt in dim sum markets, but again, the overall impact is secondary to the bigger issues of sanctions and the freezing of the debt markets for Russian entities.

On the other hand, were the downgrades and markets reaction to push Russians over the line into direct capital controls and suspension of debt redemptions and servicing for entities affected by the sanctions, the impact on Western debt holders will be painful. And the sovereign deficits and debt positions will be fully covered by sovereign reserves.

So the more real the Moody's risks prognosis becomes, the more pain will be exported from Russia our way.