(Bloomberg) -- The dueling judgments handed down by rating companies this year suggest the uncanny recent resemblance between Russia and Brazil may not last.
Two of the biggest emerging markets have taken a similar trajectory after recession in 2015-2016, returning to growth last year and bringing inflation below 3 percent. But while S&P Global Ratings just delivered Russia’s first upgrade since 2006, becoming the second credit assessor to rank it above junk, Brazil had its debt score cut twice in 2018. Both Fitch Ratings and S&P now have Latin America’s biggest economy at three notches below investment grade.
“Investors definitely view Russia as lower risk,” said Kieran Curtis, a money manager at Aberdeen Standard Investments in London with about $14 billion under management. “Fiscally there’s a huge difference between Brazil and Russia. In one country the government’s balance sheet has effectively already recovered from the oil-price shock.”
Rating companies have taken note, pushing the differential in sovereign ranking between the two to the widest in over a decade. Given President Vladimir Putin’s sway over Russian politics, his government was able to hold back spending despite the recession, bringing the deficit to 1.5 percent of gross domestic product last year. But Brazil’s fiscal policy has suffered from what Fitch called its “continuing political malaise,” with the budget gap at over 8 percent in 2017.
The upgrades are “a reward for Russia’s orthodox fiscal policy -- and a positive result that Putin deserves for using his political capital to sustain this fiscal approach,” said Charles Robertson, London-based global chief economist at Renaissance Capital. “The improving rating direction in Russia should mean the markets can have more faith in the inflation direction too as fiscal weakness is often associated with future poor inflation performance.”
Fitch and S&P have both highlighted President Michel Temer’s failure to advance his fiscal overhaul agenda. The administration this month scrapped a plan to vote on the controversial pension bill after struggling for months to gather enough support. Brazil’s October elections are another complication, with some investors unnerved by the poor standing of market-friendly candidates in opinion polls.
The cost of insuring Russian sovereign bonds against default has plunged to a 10-year low since the nation emerged from the oil crash. Russian credit-default swaps are now trading at a nearly 50 basis-point discount to Brazilian securities.
Meanwhile, Putin faces little challenge as he looks to win another six-year term in elections next month. Despite a rebound in crude prices, Russia’s government has stuck with a conservative stance, using a fiscal mechanism designed to insulate the ruble and the economy from oil’s ups and downs and cap spending at a certain level.
What Our Economists Say...Russia needs to take advantage of this near-term stability to push through structural reforms or else stagnation will be a worry for investors further ahead. The challenge will be to loosen the purse strings enough to make a difference, without backsliding on the promise of fiscal responsibility.
--Scott Johnson, Bloomberg Economics
If crude stays at its current level, Russia’s finance minister has said the government may even end up with a surplus of as much as 2 percent in 2018, years before it planned to balance the books. Last year, the budget shortfall was at half the expected level.
That’s helped keep down Russia’s borrowing needs, making it a standout among similarly ranked sovereigns. Fitch estimates the general government debt ratio declined to 15.5 percent of GDP in 2017, among the lowest in the BBB category.
By contrast, Fitch said Brazil faces “a high and growing” government debt burden, which it forecasts will continue to swell after reaching 80 percent by 2019 from 74 percent last year.
Russia’s outlook is far from cloudless. Some of its most senior officials are lobbying Putin to increase the total state debt by as much as 15 trillion rubles ($266 billion) over what’s likely to be his final term in office. Both the Finance Ministry Ministry and the central bank oppose the idea and favor encouraging private investment instead.
The government is also currently discussing a wider plan to increase spending on health, education and infrastructure, but offset the costs by cutting state spending in other areas and optimizing taxes.
“For now Russia has been giving a lesson to Brazil on how to do fiscal well,” said Elina Ribakova, head of EMEA research at Deutsche Bank AG in London. “We know that throwing money to improve the supply side in Russia is not the solution.”
©2018 Bloomberg L.P.