Consider the Anti-Hero Credit…


The due-diligence exercise does not end in the ready access to newspaper feature articles, nor does it reside purely in the macro-economic numbers. Country review requires an appreciation of risk tolerance (yours) and an ongoing assessment of how country institutions work (or not) and your considered judgment on the country capacity and inclination to pay. Such is the case with the Russian Federation.

In mathematics, there may be a unique solution to a problem, but there can be different methods toward arriving at that solution. Extrapolating from that, one might ask – can there be more than one way to arrive at a solid “credit”, or more specifically, at a solid “sovereign credit”?

Asking that question, quickly raises another one – Is a solid credit, sovereign or otherwise, something to be just quantified or is it also a measure of quality? If it must be a measure of quality as well, doesn’t that limit the utility of a quantitative estimate?

In our small shop, we think it does, and so we subscribe to the thorough “due-diligence” model of counterparty and borrower review. One should understand the things that drive and inform borrower capacity and resilience, one should also appreciate how inclined a borrower is to honor obligations, both in good times and bad.

In that respect, it’s interesting to think about the places that excite emotion, because visceral reaction can be blinding, or numbing, to what a solid understanding of the credit would warrant. And therein is the inefficiency, that so many well-scrubbed models are seeking to divine.

So, for a moment, let’s consider one sovereign that does excite some reactive furor, certainly among the chattering classes in the United States. Let’s consider Russia for a moment.

While Covid 19 may or may not be the result of some poor business continuity planning at a Chinese bio-safety level 4 lab, much more angst and received wisdom, though, is directed instead at the Russian Federation. The rating agencies are more circumspect about that melodrama, maybe to their credit, and have the sovereign rating on the Russian Federation at indeed just barely an investment grade rating (per S&P at BBB-, Moody’s Baa3, and Fitch BBB).

In the interest of full disclosure, we remain chary of long-dated non-collateralized exposure to the Russia. There still remain, we believe, institutional fragilities that make such exposure speculative.

That said, the strawman Russia receives some very interesting high marks from the IMF in the multilateral’s concluding statement for its “Article IV” review of Russian economic prospects at the end of last year.

The Fund noted the policy reforms implemented during the past decade, their efficacy, and how the ensuing conditions braced Russia to some extent against the Covid onslaught. The Fund notes pithily, “The Russian economy entered the (Covid) crisis with a sound fiscal framework and substantial policy space…”

Elsewhere in their concluding statement, the IMF elaborates on Russia’s “hard-earned” established “fiscal and monetary policy credibility”. But, to round out their statement, the IMF economists report that “(Russian) policy makers will need to sustain efforts to address structural efforts that constrain potential growth.”

And some of the numbers for Russia do look good. Foreign exchange liquidity for the Russian Federation stood at USD 614.1 bln, as per the IMF report – a far cry from the bad old days of GKOs and Russian maxi-devaluation/sovereign default. Fiscal leverage is also posting at just 17.9% of GDP

Just a quick look at the “Economic and Financial Indicators” section of the helpful Economist magazine reveals economic recovery from Covid, with second quarter growth for this year at an annualized rate of 10.5%. Full year growth for the current year is expected to arrive at 4.2%. Annualized inflation posted at 8.1% in October, but is expected to moderate, arriving at an annual rate of 6.6% for the current year. The Economist Intelligence Unit (EIU) forecasts the country’s fiscal balance to register a deficit for this year corresponding to -0.7% of GDP.

The numbers cited and the IMF Article IV prognosis offer a picture of a reasonably salubrious situation for the Russian sovereign credit story, Covid effects notwithstanding. Of course, as we began saying, numbers don’t say, or reveal, everything. Institutions matter – that is, the laws & practice residents observe as they go about their economic, political, commercial and legal lives.

At MMD, we’ve developed a model that looks at independent predictors such as the World Bank World Governance Indicators (WGI) and the association with country default status. Admittedly, this exercise yields an estimate, which is a number, and we mentioned that analysis shouldn’t be predicated solely on a number. We stick to that view. But, that said, estimates, or numbers, can yield insights. For Russia, suspect institutional quality associates with a high likelihood of default status, which is actually borne out in the Russian historical experience.

What is the value in that insight? What that should mean to the investor or lender is that the Russian Federation is more than its media-highlighted agent-provocateur status in the global order, and it is more than the encouraging macro-economic statistics cited in the IMF periodic review. It is a large economy-society-political arrangement requiring ample due-diligence for anyone seeking to do business.

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