Cole Altom: Hello everyone, I'm Cole Altom, Managing Editor here at Stratfor, and with me today is Mark Fleming-Williams, our Economy Analyst.Today, we're going to talk about our monthly Compass Preview. This month, our attention turns to Russia. So Mark, thanks to the Ukraine crisis, and the sanctions that were imposed because of it, Russia is finding itself more isolated from the West, not just politically, but economically and financially as well. Unsurprisingly, in recent financial news, Moscow has announced that it would create a new credit rating industry. For those of us who don't know what that is, tells us what they are and why they're important?
Mark Flemming-Williams: First of all, they're developing their credit rating industry. They already have a RusRating, which is a very domestic credit rating agency. Why it is important is for two reasons. First, the credit rating industry essentially sets the tone for the investment management industry, in terms of deciding whether or not they're going to buy bonds and shares. The credit rating industry essentialy decides whether or not a company is solvent and how likely it is to default. As a result, if a credit rating agency downgrades a stock, then the cost of obtaining debt for that company goes higher. The other reason why it's important, particularly for Russia, at the moment, 96 percent of credit ratings are done by three American agencies.
Cole: So why is Russia talking about developing this industry right now?
Mark: Well, it's been a rough year for Russia. They've seen geopolitical tensions growing in Ukraine and, as a result, a lot of investors have decided to take their money out of Russia. Along side this, we've seen sovereign credit rating downgrades from Standard & Poor's and Moody's as well as a lot of corporate credit rating downgrades as well. What this means, is that Russian companies and the Russian government are having to pay much more for their debt. For the Russian government, that's not a huge deal; their debt to GDP ratio is only 13 percent, which is minimal compared to their peers. Where it does become a problem, is when you start looking at the corporate and bank bonds. Here, you have $500 billion dollars worth of debt, which is held largely by Western investors.
Cole: It sounds like a matter of funding. Where can Russia find more funding if not the West?
Mark: Well, they have found other sources of funding. In the last five years particularly, Russia has been turning more to China for funding. We've seen China getting more involved in investing in development projects across Russia. The trouble for the Russians, is that the Chinese money is public rather than private. So, rather it being held in the hands' of investors who want to make the best returns for their clients, it is held in the hands of a large, neighboring, potentially threatening nation, which is looking to make strategic investments. So we've seen China's sovereign wealth fund investing in things like oil projects and potash companies, which is quite a strategic mineral. From the Russian perspective, they have access to money but it has strings attached, which could be quite dangerous.
Cole: You say that most of the wealth is publicly held in China. But China's economy is maturing and so too is the growth of private wealth in the country, correct?
Mark: Absolutely, there is a growth of private wealth. At the moment, it's about development of that wealth. So at the moment, the vast majority of private wealth is just held on deposit in commercial banks. 70 percent of the market is just held on deposit. As a result, you have money which isn't being used for adventurous purposes. The good news for Russia is that that this looks set to change in the coming years. The Chinese fund management industry is projected to grow six times in the next five years. We've got a huge, growing amount of capital, which could be devoted to things like Russian bonds, which at the moment, because all of the Western investors have moved out of them, look very cheap. The other aspect of this to bear in mind, is the capital controls aspect. Another reason why Chinese capital has been unable to cross border easily, is the Chinese grip, which is stopping that from happening. At the same time, China is trying to make its currency more international; is trying to turn the renminbi into a second reserve currency perhaps. In order to do that, it will have to loosen up its capital controls. So, the next few years are likely to see a couple of changes where the wind is blowing in Russia's direction.
Cole: Mark, give us a forecast, what does this mean for the credit rating industry?
Mark: We would expect for the credit rating industry to reflect what is happening in terms of the funds management industry. At the moment, we have a Western dominated fund management industry. As a result, 96 percent of credit ratings are done by Western credit rating agencies. As this changes, and we begin to see fund management money arriving in places like China, we expect to see more clout being lent to agencies in China and Russia as they grow in influence and crop up more.
Cole: Mark, thanks very much for your insight today and thank you for joining us. Compass publishes May 4.