Recently, there has been a lot of discussion about the Standard & Poor downgrade of Russian bonds. But, does it really matter? What do credit ratings of bonds even mean? Let’s start with the basics. What is a bond? Bonds are a form of loan, which are a form of debt. ((What Is a Bond?, Wall St. J., http://guides.wsj.com/personal-finance/investing/what-is-a-bond/ (last visited Feb. 2, 2015).)) To create a bond, individuals loan money to companies, municipalities, or governments, and the institution promises to refund the individual with regular interest payments—creating a bond. ((Id.)) While cities may sell bonds to fund various public works projects, governments often sell bonds to pay for their growing debt. ((Id.)) Bonds, often, provide a safer and more consistent investment than the volatile, high-risk investment of stocks. ((Id.)) Generally the longer the duration of the bond, the longer the amount of time the issuer has to pay back the creditor, and thus the higher the yield. ((Id.))
Standard & Poor (S&P), a credit-rating agency, reviews and grades various bonds based on S&P’s analysis of the risk of each institution’s bond. ((Credit Ratings Definitions & FAQs, Standard & Poor, http://www.standardandpoors.com/ ratings/definitions-and-faqs/en/us (last visited Feb. 2, 2015).)) The grading scales across rating agencies are not entirely consistent, but each agency uses a mixture of letters to denote the riskiness of a bond. S&P uses a rating system from ‘AAA,’ denoting the highest likelihood a bond issuer will be able to repay their debts, to ‘D,’ meaning that the debtor will default on their debts to bondholders. ((Id.)) In evaluating bonds, S&P says that their “ratings express relative opinions about the creditworthiness of an issuer or credit quality of an individual debt issue, from strongest to weakest, within a universe of credit risk. The likelihood of default is the single most important factor in our assessment of creditworthiness; the bonds are junk.” ((Id.))
Now that the basics of bonds and credit ratings are laid out, let’s move onto the downgrading of Russia’s sovereign bonds. For the first time in a decade, Russia’s sovereign credit-rating has been downgraded to “junk” by S&P. ((Anna Andrianova & Ksenia Galouchko, Russia Credit Rating Is Cut to Junk by S&P for the First Time in a Decade, Bloomberg Bus. (Jan. 26, 2015, 1:11 PM), http://www.bloomberg.com/news /articles/2015-01-26/russia-credit-rating-cut-to-junk-by-s-p-for-first-time-in-decade.)) Amid global sanctions and dropping oil prices, Russia’s government bonds are seen as “below investment grade . . . as policy makers struggle to keep economic growth alive amid sanctions and falling oil prices.” ((Id.)) Russian bonds are now rated, by S&P, below the sovereign bonds of nations like Bulgaria and Indonesia. ((Id.)) S&P explained its decision to downgrade Russia’s bonds saying “that Russia’s monetary policy flexibility has become more limited and its economic growth prospects have weakened . . . [and they see] a heightened risk that external and fiscal buffers will deteriorate due to rising external pressures and increased government support to the economy.” ((S&P Downgrades Russia to Junk, Fin. Times (Jan. 26, 2015), http://www.ft.com/intl/ fastft/267682/sandp-junks-russia).)) Two other well-known credit rating agencies, Moody’s and Fitch, currently rate Russia at their lowest investment grade level, and are expected to follow S&P in classifying Russian bonds as junk soon. ((Id.))
What does the bond downgrade mean for Russia and beyond? Following stark decreases in oil prices and stronger sanctions from President Vladimir Putin’s actions in Ukraine, many investors have slowed in their investments for the Russian ruble, as well as Russian stocks and bonds. ((Andrianova & Galouchko, supra note 9.)) Since some investors are barred from owning debt that is not at investment grade, rated speculative, or junk grade, these potential investors are no longer able to invest in Russian debt in some instances. ((Id.)) Though this potentially affects all investors investing in Russian bonds, Russian corporate borrowers will likely most heavily feel the junk-grade of Russian bonds. ((S&P Downgrades Russia to Junk, supra note 12.)) Furthermore, due to the sanctions and depressing oil prices, Russia’s economy is going towards a severe recession; S&P projecting an average of 0.5% growth of the Russian economy for the next three years. ((Andrew E. Kramer, S.&P. Cuts Russian Debt One Notch to Junk Level, Bloomberg Bus. (Jan. 26, 2015), http://www.nytimes.com/2015/01/27/business /international/sp-cuts-russian-debt-one-notch-to-junk-level.html?_r=0.)) S&P also remarked that economic pressure could continue to grow for “Russian corporations and banks that have foreign currency debt service requirements without a concomitant foreign currency revenue stream,” causing greater problems for Russian institutions. ((Id.))
While the Russian government has tried to wave off the downgrading of its sovereign debt by S&P, this downgrading by just S&P could have dramatic and far-reaching effects across Russia. ((Id.)) Furthermore, Russia has tried to thwart the ratings issue by pointing to its lack of formal recognition of Western rating systems for many bank transactions, and working with China to create a joint, new ratings agency. ((Id.)) However, as Russia continues to ignore the ratings given by Western credit agencies, the ruble continues to plunge alongside the sovereign bonds, falling seven percent after the rating was announced. ((Id.))
Only time will show what the long-term effects of the S&P rating downgrade will mean for the Russian economy, and Russia as a whole.