Russian belligerence damages CIS risk profile

By:
Jeremy Weltman
Published on:

As the political tensions morph into economic problems for Russia and Ukraine, other regional states are becoming embroiled in the crisis, notably Kazakhstan, which had been improving in Euromoney’s Country Risk Survey.

With the impact of Ukraine’s problems and the annexation of Crimea now well-documented, the effects on Russia and other members of the Commonwealth of Independent States (CIS) is becoming clearer.

Ukraine has slipped to 135th (out of 185 countries) in the survey rankings, plummeting 13 places since Q4 2013 and 42 places since 2012, but Russian risk is also rising, lately in response to the capital outflows and the monetary-policy reaction necessary to shore up the rouble.

The likely weakening of Russia’s economy is dragging down Kazakhstan’s score, too, and leaving experts to second-guess Russian president Vladimir Putin’s desires on neighbouring states and the implications.

Russia’s risk score has slipped to 53.6 (out of 100 points) in recent days, a drop of 0.9 since December and a total of 1.4 since 2010.

Such movements, while small, demonstrate the important signalling function of ECR’s crowd-sourcing approach to measuring risk – sufficient, too, to carry the sovereign down three places in ECR’s global rankings this quarter to 57th.

Further downgrades are possible in the coming days as experts taking part in the survey reassess the tensions and take stock of the implications for the region.

Final Q1 results will be released in early April, but an evolving picture suggests an already high-risk region is becoming riskier. Investors are likely to be rightly concerned.

Is Russian credit inappropriately rated?

The atypical monetary policy reaction function employed to support the wobbly rouble has cast doubt over Russia’s economic growth prospects, with the 150 basis points rise in interest rates forcing many forecasters to pencil in a reduced economic growth forecast for this year.

The latest Russia forecast from Iikka Korhonen and his colleagues at the Bank of Finland Institute for Economies in Transition points to postponed investments and just 0.5% real GDP growth in 2014. Several caveats are factored into the prediction, moreover, to allow for further deterioration.

Russia was already weakening before the Crimean crisis took hold, with domestic demand slowing GDP growth to 1.3% last year.

Russian risk is evidently not as severe as Ukraine’s, with its acute financing pressures and debts to Moscow, but all five of Russia’s economic risk indicators were marked down in 2013 – unsurprisingly the economic-GNP outlook the most, with the risk outlook further clouded by Russia’s low scores for corruption, and institutional risk downgraded.

Admittedly there are still options available to the Russian authorities, in the form of increased public spending and/or bank liquidity support to keep the economy afloat, but equally there are downside risks should the political crisis escalate. Capital flight of up to $70 billion has been racked up since December and more is anticipated until the situation stabilizes.

A special ECR survey undertaken to gauge whether Russia’s triple-B ratings are an accurate reflection of its risk profile suggests on balance they are not, though there are clearly some differences in opinion, with a fifth of respondents unsure.

Allan Dwyer, an assistant professor at Mount Royal University, remarks upon the lack of clarity concerning political risk and the rule of law in Russia. Others have added that its economic prospects are less propitious.

The survey was taken just before Fitch placed Russia’s stable triple-B rating on a negative outlook and the sovereign has now fallen in the global rankings below Namibia, already rated BBB- by Fitch.

Wider implications

ECR has previously remarked upon the limited implications for the CEE region, noting the general stability in risk scores for those countries less exposed to Russia and Ukraine through trade and/or financial linkages.

Rankings for the Czech Republic, Slovakia and Poland have generally held firm. There are similarly no great dangers in store for the Baltic countries – Estonia, Latvia and Lithuania – suggest current risk scores.

As ECR expert and senior economist at ABN Amro Arjen van Dijkhuizen notes in his team’s latest research: “We still expect a modest acceleration of [CEE] regional growth this year, to 2.3% from a post-credit crisis low of 1.9% in 2013. This acceleration is export-led, as central Europe will profit from the eurozone’s recovery, with spill-overs to domestic demand.”

By contrast, ECR contributors have singled out Belarus and Moldova for possible political-risk contagion.

Both countries have seen their trend fall in the rankings continue this year. Belarus, down to 147th on a score of 27.1, and Moldova, slipping to 141st on a score of 29.2, were already considered high-risk investments, nestling within the lowest of ECR’s five risk tiers, grouping similarly rated sovereigns.

Focusing in on the CIS – as a geographical region rather than an organization – shows its average score rising, with Ukraine excluded. Yet this is mainly because of slightly raised confidence in tier-four sovereigns Azerbaijan, Armenia and Georgia.

The 74th-placed Azerbaijan, with its solid growth, small budget deficit and strong external balances is easy to explain. The sovereign is suitably insulated, with its abundance of oil keeping the currency stable, but is still recovering from a longer-term score decline since 2010 – affecting most countries in the region.

The more extreme-risk, tier-five sovereigns are seemingly more exposed to the undercurrents of volatility, reliant on Russian trade and an uninterrupted flow of remittances from migrant workers for external financial support. Their score declines have been quite dramatic, too, in recent years, resulting from a mix of economic and political uncertainties.

As Lilit Gevorgyan, senior economist and country risk analyst at IHS Global Insight, remarks: “The heightened antagonism between Russia and the west, should it remain in the years to come, is a further unwelcome development for those former Soviet states that until now have been trying to pursue a more balanced foreign and economic diplomacy, as they may have to choose sides in the new reality.”

Dragging in Kazakhstan

With Ukrainian and Russian risks increasing, it is Kazakhstan, a low-ranking tier-three sovereign – oft-regarded as one of the safer CIS sovereigns – that is looking shakier.

Hitherto Russia’s huge southern neighbour has enjoyed a trend improvement in its risk profile – in fact, it is the only country in the region to do so – but its risk-score has dipped to 50.7 in recent days with uncertainty now taking over.

Already affected by a 15% devaluation of its currency the tenge against the dollar in Q1 to date – raising the spectre of double-digit inflation this year undermining the economy via reduced incomes and private consumption – there are the added risks of worsening exports as Russian sanctions bite, and a hit to the financial sector.

“The slump in domestic demand in Russia could be a source of concern for Kazakh exporters, coupled with a slowdown in Russian investment activity in the country,” notes Gevorgyan.

Time will tell if its highest triple-B ratings are out of sync with reality. ECR score trends are beginning to suggest it might be mispriced.

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