Country Ratings: Fresh Approach

1. Country Ratings: Fresh Approach Pavel Samiev, Deputy General Manager,‘Expert RA’ rating agency Tel.: +7(495)225 34 44 E-mail: psamiev@raexpert.ru March 2013

2. There are two superpowers in the world now - the U.S.A. and Moody’s.

3. The U.S.A. may kill you by dropping a bomb, and Moody’s, by downgrading your rating. Which of them is stronger is unclear.

4. Crisis of Rating Models • Three rating agencies dominate the global rating market. By early 2000’s, regulatory authorities started supporting new RAs but the olygopoly maintained. • The indignation with ratings started in the late 1990’s when the major agencies missed the Asian crisis outbreak. • The resentment continued after the securitization crash in 2008 and the European sovereign crisis in 2010. • Despite all errors, the major RAs changed their models just slightly. • Regulatory authorities look for ways to address rating problems, but without much success so far.

5. What Should Change? • Confusion in the sovereign rating value • The sovereign rating assesses political and social risks, instead of governmental creditworthiness • Consequences: understatement of developing country ratings and the companies operating on their territory; overstatement developed nation ratings • Corporate rating is limited by country ratings • Corporate ratings are bound to sovereign ratings or to the ‘country ceiling’ related to the sovereign rating • Consequence: ‘batch’ downgrading of corporate ratings following the downgrading of country ratings • Absence of competition on the sovereign rating market • Ratings of the three U.S.-based agencies are generally recognized and used, in particular in Russia, only • Consequence: reduction in financial sovereignty of economies

6. Yield on governmental bonds, March 2013, % Rating from Fitch as of 01.03.2013 Japan, A+ Switzerland, AAA AA+ Hong Kong, Germany, AAA The Netherlands, AAA Canada, AAA U.S.A, AAA United Kingdom, AAA A+ Czech Republic, France, AAA Australia, AAA AA New Zealand, Italy, A - Mexico, BBB Spain, BBB Portugal, BB+ BBB+ Kazakhstan, Russia, BBB India, BBB - Brazil, BBB Greece, CCC 0 2 4 6 8 10 12 The sovereign rating influences risk premiums on government bonds Source: ‘Expert RA’, based on data of Bloomberg and national stock exchanges

7. The sovereign rating is weakly correlated with debt Gross governmental debt/ GDP as of 01.01.2012, % Rating from Fitch as of 15.02.2013 0 25 50 75 100 125 150 175 200 225 U.S.A, AAA Canada, AAA Germany, AAA France, AAA United Kingdom, AAA Austria, AAA Japan, A+ China, A+ Italy, A - Poland, A - Ireland, BBB+ Kazakhstan, BBB+ Brazil, BBB Spain, BBB Mexico, BBB Thailand, BBB Panama, BBB South Africa, BBB Peru, BBB RF, BBB India, BBB - Indonesia, BBB - Portugal, BB+ Cyprus*, B Ukraine, B Greece, CCC The only exception is the Euro zone countries that asked EEC for bailout and the ratings of which were downgraded prematurely Source: ‘Expert RA’, according to Fitch and IMF data

8. The sovereign rating correlates with GDP per capita GDP per capita under the purchasing power parity in 2011, ‘000 USD Rating from Fitch as of 15.02.2013 0 5 10 15 20 25 30 35 40 45 50 U.S.A, AAA Canada, AAA Germany, AAA France, AAA United Kingdom, AAA Austria, AAA Japan, A+ China, A+ Italy, A - Poland, A - Ireland, BBB+ Kazakhstan, BBB+ Brazil, BBB Spain, BBB Mexico, BBB Thailand, BBB Panama, BBB South Africa, BBB Peru, BBB RF, BBB India, BBB - Indonesia, BBB - Portugal, BB+ Cyprus, B Ukraine, B Greece, CCC The only exception is the Euro zone countries that asked EEC for bailout and the ratings of which were downgraded prematurely Source: ‘Expert RA’, according to Fitch and IMF data

9. Russian sovereign rating is understated • The Russian public debt is low, but corruption is high, doing business is difficult, investors are protected poorly, production per capita is insignificant • Result:ratings of troubled European countries have been higher than that of Russia for a long time Sources: rating agencies’ websites

10. Pressure on Non-Western Company Ratings • Until mid-2011, ratings of major Russian banks (Sberbank, VTB) used to be lower than the rating of one of three troubled Cypriot banks – the Bank of Cyprus • After the Russian default in 1998, VTB had Са rating from Moody’s. However, the bank repaid its debts successfully • No default on bonds of 25 Japanese companies, to which Moody’s Ba or lower rating was assigned in the early 1990’s, has occurred over 5 years, even though, according to the Agency’s estimates, the default probability was 20% and higher* * Packer F. Credit Ratings and The Japanese Corporate Bond Market. Nikko Salomon Smith Barney, 2001.

11. Unreasonably High Ratings A company can get a high rating, provided always that it is a SPVor a subsidiary of a highly rated foreign company, because there is the rating ‘ceiling’ in countries with low ratings Result for countries with low ratings: • Small and unstable foreign-owned companies may be assigned a high rating • Strong and stable national companies canNOT be assigned a high rating

12. The fall in corporate ratings following that of sovereign ones • In December 2012, Moody’s downgraded the rating of the Ukrainian holding ‘Metinvest’, ‘following the resolution to downgrade the ‘country ceiling’ on Ukrainian currency bonds from B1 to B3*’ *Moody’s news release. • In April 2012, S&P downgraded ratings of several Spanish banks in connection with downgrading of the Spain rating • In February 2012, Fitch downgraded ratings of several Italian banks following the downgrading of the Italy rating • Most cases of downgrading the Greece rating by all of the three international rating agencies in 2011/2012 were followed by downgrading of Greek bank ratings

13. Countries and Companies on the ‘Institutional Needle’ • Financial market regulatory authorities in different countries depend on the opinion of foreign companies/ agencies that do not always understand particular features of a given country • To obtain an acceptable rating, countries and corporations should build their policy on Western principles and standards

14. ‘Expert RA’ Approach to Country Ratings ‘Expert RA’ agency classified country ratings into two types: • Government creditworthiness ratings (GCR, sovereign ratings): government creditworthiness assessment; • Credit environment ratings (CER): assessment of the systemic credit risk of a country Goal: not to mix up two different risk types (the credit governmental debt risk and the overall country risk)

15. Application of ‘Expert RA’ Ratings Sovereign ratings (GCR) and credit environment ratings (CER) are used for different purposes: • GCRare necessary to estimate the government bond credit risk (similarly to sovereign ratings from international RAs); • CERare necessary to adjust estimates for companies and banks in international credit rating; • NeitherCER, nor GCRare a ceiling rating for companies and banks

16. Sovereign ratings (GCR) and credit environment ratings (CER) are closely connected but different Institutional development level CER Creditworthiness of business entities Government creditworthiness GCR(sovereign rating) Source: “Expert RA”

17. 100% Institutional development level 75% Financial systemsdevelopment level and risks 50% Economic structure, GDP, unemployment 25% and inflation levels and trends Public debt and 0% public debt management policy Sovereign Credit environment government rating (CER) of countries creditworthiness rating (GCR) Key Assessment Areasin Sovereign Ratings (GCR) and Credit Environment Ratings (CER) Source: “Expert RA”

18. Sovereign Ratings (GCR) and Credit Environment Ratings (CER): Different Focuses • The following factors influence GCRmore: • Debt level, including guarantees and sureties, budget deficit, debt repayment and deficit reduction sources • Quality of the policy aimed at managing the debt level and the budget deficit • The following factors influenceCERmore: • Development levels of institutions and financial markets, level and trends for corporate debt and GDP per capita • Quality of the policy aimed at regulating financial markets and the social policy

19. Credit Environment Ratings (CER): Focus on Sections Unrelated to Public Debt • Additional factors are taken into account inCER when assessing: • Corporate debt level and trends • Level and trends of actual interest rates • Quality of arrangement for financial markets and the level of investor rights protection • Competitive standing of national companies • Stock market dynamics

20. ‘Expert RA’ Country Rating Scale ‘+’ and ‘-’ may be added to ratings from AA to CCC (inclusively), but they are not added to rating ААА and ratings СС and lower

21. Comparison of Ratings from Different Agencies (Countries with Ratings A and Higher) Rating from “Expert RA” is lower than those from Moody’s, S&P andFitch Rating from “Expert RA” is higher than those from Moody’s, S&P and Fitch Rating from “Expert RA” fits into the rating interval from Moody’s, S&P and Fitch * Ratings from the Chinese rating agency Dagongare provided as an additional example of the rating approach that differs from those of Moody’s, S&P and Fitch.

22. Comparison of Ratings from Different Agencies (Countries with Below-A Ratings) Rating from “Expert RA” is lower than those from Moody’s, S&P andFitch Rating from “Expert RA” is higher than those from Moody’s, S&P and Fitch Rating from “Expert RA” fits into the rating interval from Moody’s, S&P and Fitch * Ratings from the Chinese rating agency Dagongare provided as an additional example of the rating approach that differs from those of Moody’s, S&P and Fitch.

23. Sovereign Rating Example: Russia Result: a higherGCR from ERA than from the three international RAs. Dagongand ERA ratings are close. Reason: the low debt level and budget deficit indicators; privatization opportunities Low living standards, poorly developed institutions and low-competition economy have a negative impact but it is more important for CER (CERis ВВВ- in both currencies)

24. Sovereign Rating Example: Belarus Result: a higherGCRfrom ERA than from the two international RAs. Dagongand ERA ratings are close. Reason: the low debt level and budget deficit indicators, privatization opportunities Low institutional development indicators, weak financial markets have a negative impact but it is more important for CER (В+and В in the national and foreign currencies, respectively)

25. Sovereign Rating Example: France Result:a lowerGCRfrom ERA than from the three international RAs. The rating from Dagongis even lower. Reason: the high debt level and budget deficit indicators, their growth, the need to support weak Euro zone countries High living standards, developed institutions and financial markets have a positive impact but it is more important for CER (ААА in both currencies)

26. Sovereign Rating Example: Japan Result: alowerGCRfrom ERA than from the three international RAs and from Dagong Reason: the high debt level and budget deficit indicators, their growth High life quality, developed institutions and financial markets have a positive impact but it is more important for CER (АА- in both currencies)

27. Thank You for Your Attention! Pavel Samiev, Deputy General Manager, ‘Expert RA’ rating agency Tel.: +7(495)225 34 44 E-mail: psamiev@raexpert.ru