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. Last Updated: 07/27/2016

Analysts Ignore Real Risks

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The late January decision by Standard & Poor's to raise Russia's sovereign credit rating to investment grade should have been an important milestone in the country's integration into the global economy. Russia had previously been rated investment grade by Moody's and Fitch, but a lower S&P rating was a major blot on its credit quality. Now, Russian bonds can be purchased by institutional investors around the world. The ceiling for Russian private and state-owned companies has been lifted as well, easing their access to capital.

It was a difficult decision. A few days before the upgrade, I talked to a highly placed international analyst at S&P. In his view, his agency's lower rating would allow it to ride out the deterioration of the business climate in Russia. The fact that his colleagues felt the need to raise Russia's rating shows both the limitations of using ratings to assess investment environment and the shortcomings of applying credit analysis tools to countries.

Credit ratings measure the likelihood that creditors will be repaid in full and on a timely basis by a particular debtor. By most financial criteria, Russian bondholders enjoy solid protection. Russia ran a trade surplus of $87 billion in 2004. Monetary and fiscal policy has been responsible, the ruble is supported by $120 billion of hard currency reserves, and political stability has been assured by President Vladimir Putin's regime. And while Paris Club debt is being prepaid, no new sovereign debt has been incurred since the 1998 default. Moreover, Russian bonds have long been traded at investment-grade prices. Rating agencies claim not to be concerned about market prices, but they do not like being out of step with the bond market.

Had Russia been a company, its financial profile would have earned it a much higher rating. But sovereign countries are also subject to political constraints. Most post-World War II sovereign defaults have been political decisions. From a purely economic standpoint, they can be avoided, but at the cost of taking politically untenable decisions. At the same time, governments pursuing political goals are more likely to default or in other ways pressure bondholders.

This is why the timing of S&P's upgrade of its Russia rating is particularly surprising.

Since attacks on Yukos began in 2003, the Putin administration has been steadily moving away from economics and toward politics as the prime driving force of its policies. The government recently decided to keep resource industries off limits to many foreign investors. Russian companies' acquisitions abroad are increasingly driven not by business logic, but by the need to advance the Kremlin's political goals.

Ominously, Putin, judging by his recent pronouncements, wants to keep Russia out of capital markets, perhaps because issuing debt will force his government to play by international rules. While being effectively debt-free may raise Russia's rating, it is a negative development in the long term.

Another significant concern is the stability of the Putin regime. It is a truism of political science that while repressive regimes appear more stable, it is democracy that, behind its messy facade, is more resilient. Putin has been moving Russia away from Western European democracy and toward a mythical Russian version. He has co-opted and pressured all organized opposition, objective news media and independent political institutions, leaving his siloviki regime responsible for everything that happens in the country. To paraphrase Russian author and playwright Mikhail Bulgakov, repressive regimes like Putin's do collapse, but this is only half the problem. The bad thing is that they sometimes collapse very suddenly.

Credit analysts tend to spend more time looking at financial details, sometimes at the expense of common sense. Thus, Brazil, with its remarkable record of political continuity, is rated B+ by rating agencies. Meanwhile, Kazakhstan, a quasi-dictatorship with less than two decades of history as an independent state, has an investment-grade rating. There is definitely something amiss here.

All this has a direct bearing on Russia's credit quality and future ability to service its debt. Political crises are by definition difficult to predict. And even while upgrading Russia's rating, S&P acknowledged the "serious and growing political risk." But the real writing on the wall, which has been clear for at least the past year, seems to have escaped analysts' notice.

Alexei Bayer, a New York-based economist and a columnist for Vedomosti, contributed this comment to The Moscow Times.