Russia: Economic outlook darkens due to international sanctions; credit ratings cut to junk
Following months of escalating tensions and a buildup of troops around Ukraine’s borders, on 24 February Russia launched a so-called ‘special military operation’ in Ukraine, de-facto declaring war on its western neighbor. In response to President Putin’s full-scale military invasion of Ukraine, Western countries and their allies unleashed unprecedented sanctions designed to cripple the Russian economy and deter the military operation. As a result, the ruble collapsed to all-time lows, while the economy is set to plunge into recession in the coming months.
The international response to Russia’s invasion of Ukraine has been faster and more decisive than most analysts anticipated. G7 nations rolled out sanctions including cutting selected Russian banks from the SWIFT international payments network and freezing most of the Central Bank’s USD 640 billion reserves held abroad, thus undermining the stability of Russia’s financial system and triggering a huge selloff in ruble. In response to a collapsing financial market—the ruble lost nearly a third of its value on 28 February while the stock market crashed 40% before being shut—the CBR more than doubled its key interest rate to 20.0%, rolled out FX restrictions on the transfer and sale of money, and introduced currency controls, ordering companies to sell 80.0% of their foreign currency revenues.
That said, although sanctions dealt a blow to the financial system, Russia’s key external sector has currently been spared, as noted by Carsten Brzeski, the Global Head of Macro at ING:
“So far, the sanction response to the military escalation has been aggressive and generally coordinated, but careful not to disrupt Russia’s key commodity exports to the main partners. That is probably explained by Russia’s importance to the commodity and financial markets and also by the necessity to leave room for additional pressure should things get still worse”.
Against the backdrop of faltering financial and macroeconomic stability, the three major credit rating agencies sent the country’s long-term ratings deep into junk territory in recent days, all citing the rising risk of default. Moody’s downgraded Russia’s credit rating to ‘Ca’ from ‘B3’, with a negative outlook; S&P Global Ratings slashed the rating to ‘CCC-minus’ from ‘BB-plus’, just a week after dropping it from investment grade; and Fitch Ratings downgraded its rating to ‘B’ from ‘BBB’. Commenting on the decision, analysts at Fitch Ratings stressed the impact of the sanctions on Russia’s macro-financial stability:
“The severity of international sanctions in response to Russia’s military invasion of Ukraine has heightened macro-financial stability risks, represents a huge shock to Russia’s credit fundamentals and could undermine its willingness to service government debt. Developments will weaken Russia’s external and public finances, severely constrain its financing flexibility, markedly reduce trend GDP growth, and elevate domestic and geopolitical risk and uncertainty”.
Looking ahead, both the geopolitical backdrop and the economic panorama are highly volatile. In addition to international sanctions, Russia is facing a global corporate boycott: Scores of international energy firms, shipping companies, credit card issuers and technology companies announced their plans to exit the Russian market, boding poorly for business activity ahead. That said, despite the firm international response, President Putin appears to show little willingness to de-escalate the conflict in Ukraine, thus increasing the risk of prolonged war and heightened long-term economic sanctions.
Kallum Pickering, senior economist at Berenberg, sees Russia becoming increasingly isolated economically:
“As Putin escalates his assault, the West will likely take further steps to isolate the Russian economic system and its financial networks. […] Conditions in the Russian financial system and wider economy are likely to deteriorate further in the days and weeks ahead as the already announced sanctions take their toll and future sanctions add to the sustained negative shock. For the foreseeable future, Russia will remain isolated from the Western world and major global markets.”
Similarly, on the impact of sanctions on the Russian economy, Clemens Grafe, economist at Goldman Sachs, said:
“We think growth will be significantly impacted, and we have reduced our 2022 growth forecast from 2.0% yoy to -7.0% yoy. […]. Financial conditions have tightened to a similar level to 2014, and hence we think domestic demand will contract by 10.0% yoy or slightly more. While exports are, in principle, not significantly restricted by the sanctions so far, we expect them to contract by 5.0% yoy because of the physical disruption of exports through the Black Sea ports.”
Analysts at Fitch Ratings also see sanctions weighing heavily on the Russian economy ahead:
“The shock to domestic confidence and policy tightening will have a sharply negative impact on near-term economic activity. Sanctions will also markedly weaken Russia’s GDP growth potential relative to our previous assessment of 1.6%, partly through constraining the ability to clear trade payments, with 55.0% of Russian exports denominated in U.S. dollars and 29.0% in euros. In addition, trade partners will seek substitutes for imports from Russia, particularly in the energy sector. To a lesser extent, much weaker prospects for foreign investment and technological transfer will also weigh on trade and productivity.”