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Russia Escapes Downgrade But Fitch Says Worsening Tensions Hurt Economy

Russian Central Bank Governor Elvira Nabiullina
Russian Central Bank Governor Elvira Nabiullina

Fitch Ratings agency maintained its relatively high rating for Russia on July 3 but said worsening tensions with the West darken the outlook for its economy.

Downgrades from Standard & Poor’s Ratings Service and Moody’s Investors Service earlier this year placed Russia’s ratings in junk territory. But Fitch maintained a triple-B-minus rating, on the brink of junk status, after downgrading Russia one notch in January.

Fitch forecasts Russia’s economy will contract by 3.5 percent this year, extending a deep recession that started last year after Russia's moves to annex Crimea and back separatist rebels in eastern Ukraine.

“Alongside ever-present oil price risks, a worsening in geopolitical tensions remains the biggest risk to the stabilization of the Russian economy," said Fitch Managing Director Tony Stringer.

"An imperfect cease-fire between separatists and the Ukrainian army brokered in February has prevented an escalation in violence in eastern Ukraine. However, the parties to the conflict have made little progress towards fulfilling the Minsk II accords" aimed at achieving a lasting peace, he said.

Fitch predicted that "a renewed upsurge in violence would probably trigger a tightening of sanctions" by the West, throwing Russia's economy even further into recession.

Other ratings agencies also have cited low oil prices, the conflict in Ukraine, and the weakened ruble as reasons for their downgrades and negative economic outlooks.

On the positive side, Fitch said Russia has "a strong sovereign balance sheet and low sovereign financing needs," but those strengths are offset by structural weaknesses such as Russia's exposure to oil price fluctuations, and weak governance, in addition to "geopolitical tensions" arising out of the conflict in Ukraine.

"Commodity dependence is high. Energy products account for almost 70 percent of merchandise exports and 50 percent of federal government revenue, exposing the public finances and the balance of payments to external shocks," Stringer said.

"Governance is a relative weakness. Russia scores badly on World Bank and Transparency International indicators, for example," he said.

"Russia's score in the World Bank's Doing Business survey has improved, but the business environment has long hampered diversification outside the energy sector and encouraged capital flight."

Other factors buffeting Russia's economy include the likelihood of higher interest rates worldwide as the U.S. Federal Reserve moves toward raising rates for the first time in seven years.

In a report last month, Russia's central bank said it has sufficient reserves and flexible monetary policy to ensure the country’s financial stability for now, but a possible interest-rate increase in the United States and unpredictable oil prices means it must remain ready to intervene.

Russian leaders were pleased that Fitch did not downgrade the country into junk territory like the other two rating agencies. Another downgrade by Fitch might have prompted investors to dump Russian stocks and other assets.

"Everything is good, just as we had anticipated," said Konstantin Vyshkovsky, director of the government debt and public financial assets
department at the Ministry of Finance.

Russian leaders have dismissed the dour economic outlook projected by leading rating agencies, arguing that the slew of downgrades in the last year are politically motivated and do not reflect the real market.

Fitch is based in London while S&P and Moody's are based in New York.

With reporting by The Wall Street Journal, TASS, Sputnik News, Reuters, and Bloomberg

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