Rating Action: Moody's downgrades Russia's ratings to B3; ratings remain on review for further downgradeGlobal Credit Research - 03 Mar 2022London, 03 March 2022 -- Moody's Investors Service ("Moody's") has today downgraded the Government of Russia's long-term issuer (local- and foreign-currency) and senior unsecured (local- and foreign-currency) debt ratings to B3 from Baa3. The ratings remain on review for further downgrade. Concurrently, Moody's has also downgraded the domestic currency Other Short Term rating to Not Prime (NP) from P-3.The multi-notch downgrade of Russia's ratings and maintaining the review for further downgrade were triggered by the severe sanctions that Western countries have imposed on Russia, including the sanctioning of the Central Bank of the Russian Federation (CBR) and some large financial institutions, in response to its military invasion of Ukraine (B3 review for downgrade) and retaliatory measures taken by the Russian authorities. The ongoing review was initially triggered on 25 February by the start of Russia's military invasion of Ukraine.The downgrade of Russia's ratings to B3 is driven by the following rating factors:1. Heightened risk of disruption to sovereign debt repayment given the severe and coordinated sanctions and significant concerns around Russia's willingness to service its obligations;2. Likelihood of a sustained disruption to the economy and financial sector from the sanctions that limit access to Russia's international reserves intended to buffer Russia from adverse shocks.The scope and severity of the sanctions announced to date have gone beyond Moody's initial expectations and will have material credit implications. Severe and coordinated sanctions imposed on Russia together with its retaliatory response in recent days have materially impaired its ability to execute cross-border transactions, including for sovereign debt payments. Russia's prohibition on transfers of foreign currency outside of the country in response to the sanctions, which appears at this stage not to apply to repayments of legacy debt, undermines Russia's track record of willingness to service its debt and leaves debt servicing flows highly vulnerable to further intervention. Moody's considers willingness to service debt a Governance consideration under its ESG framework.The significant concerns around Russia's willingness to service its debt are a reflection that Russia's institutional strength has very materially weakened with increasing evidence that the executive faces few checks and balances. This, in conjunction with the higher complexity and technical restrictions that Russia now faces to execute cross-border payments as a result of the sanctions, are commensurate with a sovereign rating no higher than B3. The imposition of severe and co-ordinated sanctions, together with the financial ramifications from the potential delays to sovereign debt repayments, raise the probability of sustained disruption to Russia's economy and financial sector that impairs access to Russia's financial reserves that were built to withstand adverse shocks.The review period will allow Moody's to assess the extent of disruptions to forthcoming sovereign debt repayments, the possibility of any workaround and whether investors are likely to incur losses. Moody's will also continue to monitor further indications around Russia's willingness to pay, including the possibility of a further tightening of restrictions on foreign-currency transactions which -- if they were to include legacy debt -- would formally impose a moratorium on debt repayments.Concurrently, Moody's lowered Russia's local- and foreign-currency country ceilings to B2 and B3 from Baa1 and Baa2 respectively. The one-notch gap between the local-currency ceiling and the sovereign ratings at B3 reflects the increasing unpredictability of the government's actions and high political risk following the invasion of Ukraine that could affect all Russian issuers. The one-notch gap between the foreign-currency ceiling and the local-currency ceiling reflects high transfer and convertibility risks. RATINGS RATIONALE RATIONALE FOR THE DOWNGRADE FIRST DRIVER: HEIGHTENED RISK OF DISRUPTION TO SOVEREIGN DEBT REPAYMENT GIVEN THE SEVERE AND COORDINATED SANCTIONS AND SIGNIFICANT CONCERNS AROUND RUSSIA'S WILLINGNESS TO SERVICE ITS OBLIGATIONSThe high degree of coordination among Western countries to impose wide-ranging sanctions on Russia in response to the invasion of Ukraine is crystallising severe downside risks to Russia's credit profile. The escalating military invasion, the acceleration in the imposition of sanctions on Russia to include the most severe forms that Moody's had outlined previously and the unpredictable actions that the government has undertaken in response to such sanctions has, in Moody's view, materially impaired Russia's ability and willingness to ensure timely repayment of its sovereign debt obligations. Moody's considers there is now a significant likelihood that Russia's ability to repay its sovereign debt obligations will be disrupted by the sanctions.Restrictions on some Russian banks' access to SWIFT coupled with the sanctioning of large state-owned banks and the CBR will effectively block these institutions from participating in the global financial system and make it exceptionally difficult for them to engage in international transactions. For example, the recently outlined sanctions which prohibit engaging in transactions with the CBR and the Ministry of Finance appear to not include any carveouts for sovereign debt repayments. Given compliance risks, non-Russian institutions will be very reluctant to deal with sanctioned or non-sanctioned entities within Russia.As a result, the ability of the government to execute repayments on its international bonds is highly likely to be constrained by the sanctions. Moody's will monitor whether there are any delays in executing the next Eurobond coupon payments of $117 million due on 16 March in deciding on further changes to the ratings. In the event of a missed payment which extends beyond the grace period, a B3 rating would be consistent with the expectation of a close to full recovery for investors (relative to par plus accrued interest).Moreover, Russia's recently announced prohibition on transfers of foreign currency outside of the country in response to the sanctions imposed by Western governments severely undermines Moody's view of Russia's institutional strength and leaves debt repayment flows highly vulnerable to further intervention. The increasing unpredictability of government actions that could further impact Russia's credit profile is a reflection of a lack of checks and balances around the executive and undermines institutional strength and the effectiveness of policies.SECOND DRIVER: LIKELIHOOD OF A SUSTAINED DISRUPTION TO THE ECONOMY AND FINANCIAL SECTOR FROM THE SANCTIONS THAT LIMIT ACCESS TO RUSSIA'S INTERNATIONAL RESERVES INTENDED TO BUFFER RUSSIA FROM ADVERSE SHOCKSThe imposition of severe and co-ordinated sanctions by Western countries has caused a significant confidence shock, which will likely result in a prolonged disruption to the economy and financial sector. A sustained depreciation of the ruble will have severe economic consequence in the form of higher inflation, a marked deceleration of economic activity and lower living standards. Significant deposits withdrawals that reduce liquidity in the banking system would add to the risks to financial stability and could require the government to step in to support the banking sector. The CBR has responded by hiking the key rate to 20%, restricting nonresident deposit withdrawals and requiring the conversion of 80% of foreign-currency export earnings in order to provide liquidity support to the financial system.The risk of macro-economic instability is further elevated by the effect of new sanctions making a very significant portion of Russia's accumulated financial buffers inaccessible. The freeze on the reserve assets of the CBR, the Russian Ministry of Finance and the National Wealth Fund held by Western institutions including in the United States (US, Aaa stable), the European Union (EU, Aaa stable), the United Kingdom (UK, Aa3 stable) and others has significantly reduced the buffers available to cushion the shock. According to data from the CBR, at least 60% of foreign-currency reserves, excluding gold, were, as at end-June 2021, located in countries that have sanctioned the CBR. Although Russia holds around 20% of its reserves in gold, Moody's expects there will be challenges in converting it into hard currency. Weaker liquidity in the banking sector will reduce its ability to provide financing to the government and wider economy amid financial sector disruption and the risk of significant deposit withdrawals.While inflows of foreign currency from the export of Russian oil and gas may provide a cushion to the impact of these severe sanctions, this does not preclude, in Moody's view, the high likelihood of a sustained economic disruption and increased susceptibility to shocks. In addition, a further ratcheting up of the sanctions imposed on Russia by Western countries could very well apply to this vital source of foreign currency and government revenue.RATIONALE FOR REVIEW FOR FURTHER DOWNGRADEToday's rating action reflects Moody's view that there is a significant likelihood of forthcoming sovereign debt repayments being disrupted, and the review period will allow Moody's to assess the extent of such disruptions, the impact on the economy and financial system, and the possibility of any workaround, as well as whether investors are likely to incur losses which may lead to a further downgrade of Russia's ratings.The review period will also allow Moody's to assess any further indication regarding Russia's willingness to repay its debt and the possible tightening of restrictions on foreign-currency transfers outside of Russia to include all debt repayments, which would further undermine Russia's institutional strength and constitute a default under Moody's definition.ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONSRussia's ESG Credit Impact Score is very highly negative (CIS-5), reflecting high exposure to environmental and social risks, and a very highly negative governance issuer profile score.Moody's assesses Russia's exposure to environmental risks as high (E-4 issuer profile score), reflecting high exposure to carbon transition risk given the important role played by hydrocarbons for exports and government revenue. While global transition towards lower consumption of hydrocarbons will proceed over several decades, Russia is likely to see the impact from a shift in policies in the near term as other countries begin to position their economies to reach their own carbon-neutral targets. Russia also faces moderate risks from the management of waste and pollution which can lead to regional tensions.Exposure to social risks is highly negative (S-4 issuer profile score), given that Russia faces socials risks from relatively low income growth which is being exacerbated by the economic impact of the severe sanctions. Social risks are also driven by highly unfavorable demographic trends, which limit Russia's growth potential. A rapidly shrinking population of young workers is likely not only to weigh on the country's aggregate labour input but also reduce the economy's dynamism.The influence of governance on Russia's credit profile is very highly negative (G-5 issuer profile score) and risks are mainly related to weaknesses in Russia's institutions stemming from the lack of checks and balances on the executive, giving rise to the imposition of policies which have severe credit negative implications. The score also reflects weaknesses in the rule of law, property rights and control of corruption, reflected in relatively lower scores on international surveys compared with rating peers.GDP per capita (PPP basis, US$): 28,053 (2020 Actual) (also known as Per Capita Income)Real GDP growth (% change): -2.7% (2020 Actual) (also known as GDP Growth)Inflation Rate (CPI, % change Dec/Dec): 4.9% (2020 Actual)Gen. Gov. Financial Balance/GDP: -4% (2020 Actual) (also known as Fiscal Balance)Current Account Balance/GDP: 2.4% (2020 Actual) (also known as External Balance)External debt/GDP: 31.4% (2020 Actual)Economic resiliency: ba3Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.On 02 March 2022, a rating committee was called to discuss the rating of Russia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's institutions and governance strength have very materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptibility to event risks.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSFACTORS THAT COULD LEAD TO AN UPGRADE OF THE RATINGSGiven the review for downgrade, an upgrade of Russia's ratings is remote. The ratings could be confirmed if Moody's concluded that any disruption due to Russia's inability or willingness to execute sovereign debt repayment proved to be temporary and that close to full recovery for investors was likely. For example, Moody's will assess whether Russia is able to utilize workarounds to ensure the continuity of cross-border payments for sovereign debt.Even in a scenario where geopolitical risks abate and sovereign debt service is restored, the marked deterioration in Moody's assessment of Russia's weak institutional strength is likely to keep the ratings well below investment grade for a prolonged period.FACTORS THAT COULD LEAD TO A DOWNGRADE OF THE RATINGSRussia's ratings could be downgraded if Moody's concluded that forthcoming sovereign debt repayments were disrupted and close to full recovery for bondholders appeared uncertain. Indications that Russia's willingness to service its debt in full and on time has further weakened would also likely lead to a downgrade.Further adverse ramifications for the domestic economy and financial sector from Russia's military invasion of Ukraine and Western governments' resolve to cut off Russia from the international financial system, including a potential ratcheting up of sanctions to apply to Russia's energy sector, which is a vital source of foreign currency revenue, could further weaken Russia's economic resiliency and place downward pressure on the ratings.The publication of this rating action deviates from the previously scheduled release dates in the UK sovereign calendar published on www.moodys.com. This action was prompted by the sanctions imposed on the Government of Russia in recent days by Western countries, including the sanctioning of the CBR, in response to Russia's military invasion of Ukraine and retaliatory measures taken by the Russian authorities.The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. 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