Russia's Downgrade Paints A Horrific Picture Of Economic Collapse

Reuters/StringerA man looks at a residential house that started leaning after a tunnel collapse in the Russian Black sea resort of Sochi March 4, 2013. The house, unnoccupied at the time, began leaning after a tunnel on a nearby road construction project fell in.Fitch has downgraded Russia's credit rating and painted a horrific picture of a struggling economy rocked by a collapsing rouble, falling oil prices, high inflation and declining international reserves.

The ratings agency cut the country to BBB- from BBB with a negative outlook, meaning further downgrades are possible.

But it was the language Fitch used in its reasoning that was most shocking.

Russia's economic outlook "has deteriorated significantly" in just six months, Fitch stated. Gross Domestic Product will shrink 4pc this year, the agency added, far worse than the 1.5pc contraction it previously expected. "Growth may not return until 2017," Fitch said.

Western sanctions, imposed after President Vladimir Putin's took Russia into neighbouring Ukraine, "continue to weigh on the economy" but the plunging oil price is causing just as much, if not more, damage to one of the world's energy giants.

The price of a barrel of Brent crude has collapsed by more than 50pc since the middle of last year as Opec, the group of leading oil-producing nations, refused to cut production amid intense pressure from the US shale revolution.

"Plunging oil prices have exposed the close link between growth and oil price [in Russia]," Fitch wrote.

"Commodity dependence is high: energy products account for almost 70pc of merchandise exports and 50pc of federal government revenue, exposing the public finances and the balance of payments to external shocks," Fitch wrote.

Brent crude was trading at less than $50 a barrel on Friday, down from more than $111 in June last year.

Fitch has predicted that prices will recover to around $70 a barrel this year, a view shared by Igor Sechin, the chairman of Rosneft, which has been hit so hard by the oil price collapse that it has been forced to has request $46bn in state aid to help meet repayments and cover investment.

However, if oil stays significantly below $70 a barrel, "it could precipitate a deeper recession and put further strain on public finances, severely limiting the authorities' room for manoeuvre".

"If oil drops to $45 or lower and stays there, Russia is going to face a big problem," said Mikhail Liluashvili, from Oxford Economics. "The central bank will try to smooth volatility but they will have to let the rouble fall and this could push inflation to 20pc."

The rouble, which has slumped around 20pc since Christmas and was trading at 63 against the dollar on Friday, is in lockstep with Brent crude. Fitch cited the collapsing currency as one of the reasons Russia's banking sector has suffered a major shock, the others being "intense market volatility" and the central bank's decision to hike interest rates from 10pc to 17pc .

That shock move - Bank of Russia's sixth increase in 2014 - took rates to heights not seen since the country's default in 1998, and "is aimed at limiting substantially increased rouble depreciation risks and inflation risks", the bank said.

Fitch expects Russian inflation, which stood at 11.4pc at the end of 2014, to remain in double-digits through this year before falling to 8.5pc by 2016. "The prospects of the [central bank] realising its end-2015 inflation target of 4.5pc now look remote, particularly if the exchange rate falls further, potentially leading to still higher interest rates," Fitch wrote.

This all comes as international reserves "fall faster than Fitch expected".

"Renewed intervention to support the rouble, whether by the central bank or the Finance Ministry, could further reduce reserves."

Russia's government has so far ruled out imposing capital controls to stem the outflow of money, knowing that such a move would go hand-in-hand with the loss of financial credibility.

However, Russia's foreign reserves have dropped to the lowest level since the Lehman crisis .

Central bank data show that a blitz of currency intervention depleted reserves by $26bn in the two weeks to December 26, the fastest pace of erosion since the crisis in Ukraine erupted early last year.

Total reserves have fallen from $511bn to $388bn in a year. The Kremlin has already committed a third of what remains to bolster the domestic economy in 2015, greatly reducing the amount that can be used to defend the rouble.

Fitch ended its scathing assessment of Russia with a look at the country's government, labelling it a "weakness".

"Governance is a relative weakness: Russia scores badly on World Bank and Transparency International indicators, for example. Russia's current predicament has done little to hasten the onset of a more liberal economic policy agenda and raises the risk of greater isolationism. The business environment has long hampered diversification outside the energy sector."

This article was written by Andrew Trotman from The Daily Telegraph and was legally licensed through the NewsCred publisher network.