TEXT-S&P report:Russia's economy,ratings vulnerable to oil price

(The following statement was released by the rating agency)

March 26 - A sustained fall in the price of oil could damage the Russian economy and public finances and consequently lead to a cut the long-term sovereign rating on the Russian Federation (foreign currency BBB/Stable/A-3, local currency BBB+/Stable/A-2, Russia national scale ruAAA), says Standard & Poor’s Ratings Services today in the report “Hooked On Oil: Russia’s Vulnerability To Oil Prices.”

“We estimate that a $10 decline in oil prices will directly and indirectly lead to a 1.4% of GDP decline in government revenues,” said Standard & Poor’s credit analyst Kai Stukenbrock. “In a severe stress scenario, where a barrel of Urals oil drops to, and stays at, an average $60, we would expect the general government to post a deficit above 8% of GDP. In that scenario, the long-term ratings on the Russian Federation could drop by up to three notches.”

The price of oil has a huge impact on Russia’s economy, affecting real and nominal GDP, trade, the exchange rate, and above all public finances, the report says.

The rise in oil prices over the past decade has supported an expansionary fiscal policy, while still allowing the country to build up fiscal reserves. Still, fiscal expansion, not least significant countercyclical spending during the recent crisis, has led to a significant increase in expenditures relative to GDP. As a result, despite record revenues from oil in 2011, Standard & Poor’s estimates the general government surplus at merely 0.8% of GDP. To balance the budget in 2012, we think the government will require an average oil price of $120 per barrel (bbl).

With the average price of a barrel of Urals oil reaching $110, 2011 was yet another year of record oil income for Russia’s economy and its public finances, easily exceeding the previous historical peak of $95 in 2008. As of mid-March 2012, the oil price stands even higher at about $125.

This high oil price supports the government’s expenditure levels for now, the report says, Yet, spending pressures, resulting for example from an aging population or to implement a significant part of the spending promises made during the presidential election campaign, will likely fuel the need for rising revenues.

The report examines two stress scenarios: one where the oil price drops to an annual average $80 per barrel over a sustained period, and the other where the oil price drops to $60.

“As our base case is for the oil price to remain above $100, we currently consider the likelihood of the two stress scenarios to materialize over the next two years to be less than one-third,” said Mr. Stukenbrock. “Yet, it is worth noting that only slightly more than two years ago the average oil price was actually $60, and one year later the price averaged slightly below $80.

“In a situation, for example, where Asia in general and China in particular were to see a significant, potentially disorderly economic correction, we believe this could result in a large drop in the oil price, which would then affect Russia particularly severely,” said Mr. Stukenbrock.