Fitch and Moody's downgrade Russia to 'junk' as sanctions bite economy

Fitch and Moody's Investors Service downgraded Russia's sovereign credit rating to "junk" status due to a wave of US and EU sanctions that have been imposed on the country in response to its military offensive in Ukraine.

Moody's cut Russia's long-term issuer and senior unsecured debt ratings six notches to non-investment grade B3 from Baa3 and they remain on review for further downgrade. A B3 rating is given to entities that are undergoing financial instability or may not have adequate cash reserves relative to their business needs and financial obligations, which makes them speculative and considered high credit risk.

Fitch Ratings downgraded Russia's long-term foreign currency default rating to B from BBB. It also placed the country's ratings on a "rating watch negative". On Friday, S&P Global Ratings also lowered Russia’s credit rating to junk, downgrading it to BB+, below investment grade, from BBB-.

While the EU has barred Russia from accessing its capital markets, the cut in ratings will also make it difficult for Russia and Russian companies to raise funding globally. The downgrade of Russia's ratings is driven by "heightened risk of disruption to sovereign debt repayment given the severe and coordinated sanctions and significant concerns around Russia's willingness to service its obligations," Moody's said.

The rating agency also said the cut is also a result of the "likelihood of a sustained disruption to the economy and financial sector from the sanctions that limit access to Russia's international reserves intended to buffer Russia from adverse shocks. The scope and severity of the sanctions announced to date have gone beyond Moody's initial expectations and will have material credit implications".

Russia’s economy has taken a hit after the US and its allies took punitive actions against Moscow following its decision to undertake a military operation in Ukraine. Russian companies and oligarchs in President Vladimir Putin's inner circle face having their assets frozen, while European countries have closed their airspace to Russia's private and commercial aircraft.

Some Russian banks have also been barred from the Swift global financial network, while the US Treasury prohibited Americans from engaging in transactions with the Bank of Russia, the Russian Direct Investment Fund and the country's Ministry of Finance.

Russia’s central bank imposed capital controls on Monday and more than doubled interest rates to 20 per cent, their highest in nearly two decades, to support the currency. The Bank of Russia also restricted the transfer of coupon payments to foreign holders of rouble bonds and kept the Moscow stock exchange closed for a fourth day.

"Severe and coordinated sanctions imposed on Russia together with its retaliatory response in recent days have materially impaired its ability to execute cross-border transactions, including for sovereign debt payments," Moody's said.

"Russia's prohibition on transfers of foreign currency outside of the country in response to the sanctions, which appears at this stage not to apply to repayments of legacy debt, undermines Russia's track record of willingness to service its debt and leaves debt servicing flows highly vulnerable to further intervention."

On Wednesday, Russian lender Sberbank said it is exiting European markets as a result of big cash outflows and threats to its staff and property. On Wednesday, the European Union said it will also ban seven major Russian banks out of the Swift messaging system that facilitates global financial transactions effective March 12. On Thursday, the London Stock Exchange suspended trading of 28 securities linked to Russia.

The Russian rouble tanked as much as 28 per cent, falling to a record low of 118 against the US dollar at the start of trading on Monday, well above its 75 mark. The currency's freefall appeared to come to a halt on Tuesday but it fell again on Wednesday to 107.50 against the greenback. On Thursday it was 97.9 to the dollar at 7.11am UAE time.

The imposition of severe and co-ordinated sanctions led to "a significant confidence shock, which will likely result in a prolonged disruption to the economy and financial sector," Moody's said.

"A sustained depreciation of the rouble will have severe economic consequence in the form of higher inflation, a marked deceleration of economic activity and lower living standards. Significant deposits withdrawals that reduce liquidity in the banking system would add to the risks to financial stability and could require the government to step in to support the banking sector."

The review period for a potential further downgrade will allow Moody's to assess the extent of disruptions to forthcoming sovereign debt repayments, the agency said. It will continue to monitor further indications around Russia's willingness to pay, including the possibility of a further tightening of restrictions on foreign-currency transactions.

Russia has eurobond coupon payments of $117 million due on March 16, which if it fails to make or is delayed in paying, may lead to further changes to its ratings.