American ratings agency Standard & Poor’s downgrade of Russia's debt from BBB- to BB+, or below investment grade for the first time in a decade, was based on low energy prices and the impact of Western sanctions, writes Prince Michael of Liechtenstein.
Russia's government reserves still cover a multiple of its foreign obligations. Sovereign debt is at 12 per cent of GDP. This is a situation about which any Triple A western country could only dream.
The reason for the downgrade appears to be the following negative dynamic:
A combination of falling oil prices and sanctions will drive Russia to negative growth of three per cent in 2015 and one per cent in 2016. Its balance of payments for the year could show a deficit of some US$200 billion, according to Russia's Finance Minister, Anton Siluanov.
Russia's government is still using reserves of some US$380 billion, but this is more than 20 per cent less than a year ago. Russia's government is cutting spending by some 10 per cent but its military budget will not be reduced. Funds of some US$30 billion will be provided for bank bailouts. Mr Siluanov expects a balanced budget in 2017, based on an estimated oil price of US$70 a barrel.
The Kremlin sees the downgrade as a political move by the US government. The downgrade, and adverse reputational damage to the rouble, could accelerate an already high outflow of currency and investment from Russia.
The dynamics of Russia's economy are unfortunate, but its government is responding by cutting costs. Maybe there was an assumption that sanctions would be tightened, as the US government is now indicating.
Ratings are used widely for investment policies by financial institutions and funds, and are a tool for regulators. History shows they may provide indications but they are far from a really reliable basis for decisions.
We should not forget that all three major ratings agencies, S&P, Fitch and Moody’s rated government bonds, such as Greece, as A grade a few years ago.
It appears that Western sovereign debt receives a beneficial rating from the rating agencies and France is a good example.
France has an AA rating. It has sovereign debt of some 93 per cent of GDP. Its growth rate, depending on the world economy, could be slightly under one per cent in 2015 and some 1.5 per cent in 2016. This outlook appears better, than Russia’s, but its sovereign debt is at a level where it can, at best, be serviced and rolled over, but not be repaid.
Sufficient provisions for retirement payments in France have not been made and disaster will loom if interest rates rise again. The only hope for France is for high inflation which will devalue its debt. But worst of all, the French government is not responding properly and is not making reforms.
A downgrade to a BB+ rating may be justified for Russia. But by comparison an AA rating is not justified for France. Other sovereign debts could also be over-rated.
Investments should be analysed carefully and independently of ratings. Ratings should be studied, but not as the main criteria. Rating changes reflect a perception based on hindsight. When ratings change it is normally already too late to act. Because of the value of the perception, this could have political or economic consequences.