RusEnergy

10-27-2005 RBC News - In view of high political risks and with the 2007-2008 elections in sight, rating agencies could be unwilling to upgrade Russia to the next grade of investment rating Earlier this week, Moody's Investors Service raised Russia's foreign-currency country ceiling for bonds and the foreign- and local-currency rating of Russia's government bonds to Baa2 from Baa3. Markets did not react to the news, but many investors were disappointed as they had hoped for a more significant upgrade. Analysts are full of optimism, saying that Russia's macroeconomic figures enable it to claim a better position in international rankings. In fact, returns on Russian bonds already correspond to level "A" on global rating lists. Experts are making conflicting forecasts. On the one hand, they do not rule out the possibility of further upgrades by two or three notches this year and next. But on the other hand this "bright future" is subject to political risks. With Russia's parliamentary and presidential elections due in 2007 and 2008, more conservative rating services might leave Russia in its present position - in the lowest investment-grade category. In addition to Russia's rising oil revenues, the rating upgrades reflect the country's prudent fiscal policies, stable politics, and an exhibited commitment to pay — and in some cases, pre-pay — outstanding debt, said Moody's, adding that Russia's liquidity and debt ratios have improved dramatically in a relatively short period of time. Although fiscal policies have loosened in 2005 and may well be marginally looser in 2006, Russia should continue to experience no difficulty in making timely debt payments over the next three to five years, even in the unlikely event of a significant downward correction in commodity prices, the agency said. The key challenges facing the Russian government include a need to increase competition throughout the economy; to improve Russia's fiscal federalism and the state's capacity for economic regulation and service provision; and to improve the judicial system and combat corruption, the agency said. At first glance, all of Russia's ratings hinge on oil prices: if oil prices are not high, Russia will be ranked low. Experts agree, to a point. "The correlation is indirect. Had it not been for high oil prices, there would be no early debt payments and a fine budget execution," Alexei Vorobyov, chief analyst at Maxwell Capital financial group, told RBC Daily. "The main parameters taken into account by rating agencies are budget, balance of payments, debt burden and inflation," he added. Some countries with similar economic structures are ranked higher than Russia. "In all countries, the rating depends on something. Among A-list countries, many are heavily dependent on this or that source of revenue. Russia's economy looks more diversified than that of the A-ranked Bahrain," said Denis Matafonov, at Antanta Capital investment company. "Currently, Russia is in the lowest investment-grade category on the lists of the world's three leading rating agencies – Fitch, Standard & Poor's and Moody's. Fitch and Moody's had upgraded Russia by one notch but S&P is not in a hurry to upgrade Russia from the lowest investment-grade ranking. "S&P is the most conservative agency of the three. It also considers political risks, and its statements are more critical," Vorobyov said. But experts say Russia has in fact surpassed its ratings, and could well claim a position in the next investment-grade group, alongside Israel, China and Poland. "In terms of macroeconomic results, Russia confirms its ratings. But by some indicators, such as debt burden, the country corresponds to higher ratings. By debt burden, Russia should be ranked two notches higher, A3 on Moody's list or A- on S&P's ranking," Vorobyov said. Market operators agree and rate Russian stocks accordingly. "In reality, Russia is ranked higher already, for example rated by bond returns and macroeconomic indicators. Moody's is simply catching up with the market," says Denis Matafonov, noting that the spread between returns on Russia's Eurobonds and US treasury bonds was about 150 basis points. Clearly, Russia is closer to ‘mature' countries. "For Mexico, which is ranked "A", the spread is 190 points, the same for A-rated South Africa. For Turkey, ranked "BB", one notch below Russia, the spread is 329 points," he said. It is no surprise that the upgrades left markets unimpressed. "The move was expected, and it hardly had any effect on Russian stocks and bonds," Matafonov says. Vorobyov agrees. "The latest upgrades had been expected, and they are unlikely to affect foreign investors' attitude towards Russia. Stock markets are disappointed: there were rumors that Moody's would raise Russia's rating by two or more notches," he said. Russia's rating will have greater significance for the market when it rises above Baa, Matafonov believes. He hopes Russia might see further upgrades before the end of the year, and the country could be promoted to the desired "A" category next year. "Given the Russian economy's strong dependence on political factors and with elections in sight, rating agencies may not be willing to upgrade Russia to the next category," Vorobyov said. Though some less conservative agencies - Moody's for a start - may do just that. "If this happens, Russia could be upgraded to the "A" category before December 2007, that is, before the elections," Vorobyov reasons. S&P analysts do not comment on possible rating upgrades but they admit that politics could play a vital role in rating decisions. "One of the key contradictions is the combination of high liquidity on the one hand and rather high institutional and political risks on the other hand," Alexei Novikov, analytical director of S&P's Moscow office, told RBC Daily. "These are two key factors determining our opinion on Russia's credit worthiness. It is on them that the rating will depend," he added.