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. Last Updated: 07/27/2016

THE ANALYST: Rating Downgrade a Case Of Too Much, Too Late




Report cards are a dreadful affair, especially after you've been neck-deep in trouble for three months straight. No one looks forward to getting bad grades, but there is, however, a bizarre fascination watching Russian officials sweat, cringe, and fume at the announcement of any credit rating, let alone a downgrade. Mind you, these are people unaccustomed to any type of criticism, let alone to stomaching lengthy credit reports by a group of foreign analysts who zip in and out of the country on their "fact-finding missions," and who alone have the power, like President Yeltsin's heartbeat, to sting markets.


No country likes the fact that its borrowing costs on world markets is largely dependent upon the perceptions of three Anglo-American rating agencies, but the Soviet mentality, still predominant in the Russian bureaucratic psyche, is particularly incompatible with this internationally accepted practice.


The first bond ratings were implemented nearly 90 years ago by a man named John Moody, and since then have ballooned to cover just about every type of debt. At present there are three world-renowned rating agencies: Standard & Poor's, Moody's (which was bought by Dun and Bradstreet in 1962) and Fitch IBCA, the result of a merger that took place last year between IBCA, the leading European rating agency, and Fitch, a U.S.-based outfit. Almost simultaneously, on Oct. 7, 1996, all three headmasters announced Russia's first debt ratings since the Soviet Union collapsed. Not surprisingly, all the ratings were speculative, which denotes high-yielding debt. That was 18 months ago, and since then, at least economically, much has changed in Russia. The country, therefore, was due for a ratings update. Fitch IBCA titillated investors by leaving unchanged its BB-plus rating, which continues to be the highest of the three. John Moody's offspring, meanwhile, nudged Russian debt down a notch to Ba3, juxtaposing it with Kazakhstan, Jordan, Argentina and Vietnam.


It's not easy to reflect objectively on something as inherently arbitrary as ratings, where the difference between sublevels within a single rating can be almost indistinguishable, but in Russia's case, one can safely assert that Moody's missed the boat on its rating downgrade. The agency was accused by Russian officials and market analysts of attempting to "save face" for a major oversight in Asia, by bringing Russia down a notch. Although this is a valid point, it does nothing to eliminate, or even ease, Russia's financial and economic weaknesses. Curiously, Standard & Poor's displayed more cunning than did Moody's: Instead of changing its rating, S&P's gave Russia a negative rating outlook, giving the agency some breathing room without having to change the actual rating.


The worst phase of Russia's financial crisis is in the past. On this point almost all experts agree. There remain some serious structural flaws in the nation's fiscal system, but improvements are also at hand: A realistic budget has been passed, tax collection is improving, and a new tax code is next on the government's agenda. The nation's current-account balance is coming under pressure due to falling oil prices (as is Mexico's and Venezuela's, both of which have Moody's Ba2 rating), but is still positive, and foreign direct investment could double this year. External debt is approximately $145 billion, or 30 percent of gross domestic product, and domestic debt is still manageable at current levels. Overall, many observers may be surprised to see a stronger-than-expected Russian economy emerge this year once the dearth of cash and excess of barter in the economy -- two phenomena which have stunted growth -- are rectified. In other words, Russia's capital base is getting bigger.


Thankfully, Moody's decision had minimal impact on Russia's securities markets; stocks fell slightly less than 1 percent, and bond prices actually appreciated in the two days following the downgrade. Investors seemed to say that there's nothing in Moody's database that they don't already know. Ratings are useful tools for measuring the risk attached to someone else's debt, and under no circumstances are they to be regarded as market forecasts or, in the case of sovereign ratings, the final word on a country's economic outlook.


More than anything, last week's mixed signals from international credit agencies demonstrated the complex nature of evaluating Russia's financial and economic well-being, and how crucial these next months are for the country's recovery. If the government can stick to its guns over the next three to five months, this Ba3 will be the joke of the industry. The markets are aware of this, and although they have a tendency to overreact, they never lie. Nor do they, like Moody's last week, react to news too late.


Like confused parents wanting only the truth, investors find themselves pinched between the irrefutably experienced headmaster and the spurned student. So much the better. Parents always know their child best.


Gary Peach is the editor of the weekly newsletter Capital Markets Russia.