Russia’s Rating at Risk as Era of Deficits Looms

By Alex Nicholson and Paul Abelsky

Sept. 4 (Bloomberg) -- Russia risks returning to a period of entrenched budget deficits that may threaten its credit rating and weaken the ruble as it struggles to emerge from its first recession in a decade.

The country faces “still-substantial risks to public finances due to the severe economic contraction” and financial risks linked to “stress” in the financial industry and liabilities of state-run companies, Standard & Poor’s analysts including Frank Gill in London wrote in a report yesterday.

If the government fails to rein in the shortfall, the credit rating may be cut from its current BBB rating, S&P said.

Russia expects to run a deficit equivalent to 8.9 percent of gross domestic product this year, the first in a decade, after the economy slumped a record 10.9 percent last quarter. The government plans to tap international debt markets to plug future gaps as the wider deficit threatens to spur inflation.

State spending is paced to escalate late in the year with about one third of the total to be disbursed in the fourth quarter, Anton Stroutchenevski, a Moscow based economist at Troika, said in a phone interview yesterday. That may raise the money supply by between 10 percent and 15 percent, leading the ruble to fall by the same amount, he said.

“The government’s budget policy ensures a very high exchange-rate volatility,” he said.

Widening Deficit

The budget deficit widened in the first eight months to the equivalent of 5.9 percent of gross domestic product, Finance Minister Alexei Kudrin told reporters in Moscow yesterday. The shortfall was 4.3 percent in the first seven months.

The government aims to spend an average of between 850 billion rubles ($26.8 billion) and 900 billion rubles a month this year before disbursing 1.5 trillion rubles in December, Kudrin said.

Russia’s budget allocation in the first six months of the year was uneven and inefficient, the country’s Audit Chamber said in a report published on its Web site today.

“The irregularity of budget spending in the course of the year reduces the efficiency of budget funding and leads to a failure to meet budget targets to the full extent,” the state financial watchdog said in the report.

The Finance Ministry and the Economy Ministry haven’t done enough to “diversify the sources of state revenue and optimize their structure,” the chamber said.

Energy

Energy products, including crude oil and natural gas, accounted for 65.5 percent of exports in the first half, while metals made up 12.1 percent. Levies on oil and gas producers accounted for more than two thirds of corporate tax payments to federal and regional budgets last year, Troika Dialog says.

The government is unlikely to push through austerity measures to contain the deficit and will instead deplete its wealth funds, using up oil income, said Neil Shearing, emerging Europe economist at Capital Economics.

It won’t be “politically possible” for the government to cut spending and rein in the deficit, Shearing said.

“There will be talk about the need to tighten fiscal policy and address the deficit, but what we’ll end up seeing is the government spending the wealth funds, which will probably run out by this time next year, and then move on to issuing debt,” Shearing said. “We’ll be left with a fiscal deficit for some time to come.”

Tapping Funds

The government is tapping its $85.7 billion Reserve Fund and $90.7 billion National Wellbeing fund, which were built on windfall oil revenue, to pay for an “anti-crisis” program that is worth about 2.5 trillion rubles ($79 billion) when tax breaks, central bank lending and other measures are included.

With the Reserve Fund expected to be drained by the end of next year, Russia will turn to international debt markets for the first time since 1998, seeking to raise $17.8 billion from investors next year. That amount may be trimmed if the economic outlook improves, Kudrin said. Russia expects yields on its bonds to be between 7 percent and 9 percent, he said.

The budget shortfall may narrow to 7.5 percent next year, 4.3 percent in 2011 and 3 percent in 2012, the Finance Ministry said on Aug. 18.

Russia’s current credit rating hinges on low levels of sovereign debt, S&P said. While sovereign debt is expected to remain at 14 percent of GDP by 2012, “contingent liabilities” may amount to a figure as high as or higher than the BBB rating median of 42 percent, the report said.

‘Fiscal Problems’

The country’s debt as a percentage of GDP will more than double by 2012, growing from 6.5 percent in 2008 to 16.4 percent by 2012, the Finance Ministry said on Aug. 19. Government debt will be at 10 percent this year, the ministry estimates.

Russia’s sovereign foreign debt slid to $39.05 billion on Aug. 1 from $39.14 billion a month earlier.

“I think we’ll probably end up in a position where they just keep issuing more and work the fiscal problems out further down the line,” Shearing said.

-- Editors: Tasneem Brogger, Chris Kirkham.

To contact the reporter on this story: Alex Nicholson in Moscow at anicholson6@bloomberg.net.