Analysis & Opinion

(Adds details, market reaction, finance minister comment)

MOSCOW Oct 24 (Reuters) — Standard & Poor’s ratings agency affirmed Russia’s sovereign rating on Friday at a notch above junk status, warning a downgrade may follow if more sanctions are imposed on Moscow for its role in the Ukrainian conflict.

The agency affirmed the country’s long- and short-term foreign currency sovereign ratings at BBB-/A-3 after cutting them in April. S&P also said another cut might come if Russia’s monetary policy or exchange-rate flexibility weakens.

It maintained a negative outlook on Russia.

The negative outlook reflects our view that we could lower our ratings on Russia over the next 18 months if its external and fiscal buffers deteriorate faster than we currently expect-for example, due to any further tightening of sanctions as a result of the conflict in Ukraine, S&P said in a statement.

If we observed Russia’s monetary policy or exchange rate flexibility diminishing, we could also lower the ratings.

Analysts and senior Russian officials had said a ratings cut by S&P was unlikely, with analysts saying Russia’s macroeconomic fundamentals correspond to an investment-level rating.

Russian Finance Minister Anton Siluanov said on Friday fears of Russia’s sovereign rating being downgraded were exaggerated, and an economic aide to President Vladimir Putin said a downgrade would damage S&P’s reputation.

Following S&P’s decision to leave the rating on hold, Siluanov said it mainly reflected Russia’s large forex reserves and low state debt, as well as consistent policy, the following of a budget rule (and) a positive effect from enacted reforms.

Undoubtedly the decision was influenced by the exchange rate policy of the central bank and the provision of liquidity to the banking system, he added.

JUMPY MARKETS

Markets, however, were jumpy about the possibility of a downgrade, with bond yields and CDS default insurance costs close to recent highs this week.

The rouble took a bad hit earlier on Friday, reaching record lows against the dollar and the euro. That left it down 22 percent against the dollar since the start of the year, its worst since 1998.

The rouble rose following S&P’s decision, but fell back in thin evening trading and remained down on the day. At 1745 GMT the Russian currency was at 41.90 against the dollar, down 0.43 percent on the day but stronger than its all-time low of 42.01 earlier on Friday.

Russian bond yields also tightened. The yield on Russia’s 2030 Eurobond was at 4.721 on Friday evening, having tightened from 4.905 in the morning.

Besides the hit to a country’s image of being rated ‘junk,’ such a downgrade can push its borrowing costs up. Many mainstream investment and pension funds have rules preventing them from buying anything not classed as investment grade.

According to S&P’s own Market Derived Signal (MDS) based on comparisons of various countries’ ratings, CDS and bond prices, markets have been treating Russian debt as junk since early March anyway.

Traders are currently pricing it as if it were a BB, a full two steps below its actual grade, but there has been no further shift down in the MDS in recent weeks, something that often happens before a rating is cut for real.

S&P’s latest rating review on Friday came after Moody’s Investors Service last week downgraded Russia’s sovereign debt by one notch to ‘Baa2′, citing the Ukraine crisis as posing risks to Russia’s medium-term growth prospects. (Reporting by Alexander Winning, Lidia Kellly and Darya Korsunskaya in Moscow and Marc Jones in London; Writing by Lidia Kelly, Alexander Winning and Jason Bush ; Editing by Tom Heneghan)