Ursa Major

07/11/2014 at 4:47 pm

As we know, the taper tantrum last year had a baleful effect on emerging market assets and currencies. 2014 has turned out rather better for them – with one notable exception: Russia.

It feels like rather a long time since the annexation / independence of the Crimea back in March, and the illegal deposition / welcome overthrow of President Viktor Yanukovych beforehand feels much longer ago still. Yet with the EU menacing further sanctions later this month, economic stagnation in Russia could become recession. The low oil price is not helping; the rouble hit new lows again this week. And so: will Russia be plunged into crisis, as in 1998? Or is this a buying opportunity?

There is no denying the seriousness of Russia’s predicament. Currency weakness of 39% against the dollar since the middle of the year will entail higher inflation, also pushed up by sanctions, and interest rates have had to go up as a result with the Bank of Russia Key Rate up from 5.5% at the start of the year to 9.5% today. Last month alone, the country’s foreign exchange and gold reserves fell by over $28bn as the central bank intervened in the currency market, to little avail. Bond markets have weakened, with the cost of borrowing more than 2% higher in longer maturities than it was at the end of 2013. There is indeed a convincing bear case to be made for the Russian bear.

On the other hand, Russian fundamentals are hardly what they were in ’98. In those days the country’s reserves were below $10bn and its debt to GDP ballooned to just shy of 100% over the course of the crisis. Today Russia has reserve assets of over $428bn and gross debt to GDP on IMF numbers of 14%. In addition, under 30% of its bond liabilities are denominated in foreign currency.

The oil price is of course a concern. But the price of gas has risen, and with winter almost upon us in Europe Russia will be profiting in coming months from increased demand. Crucially, both commodities price in dollars, so the country’s gigantic trade surplus – averaging $19.3bn per month for the six months to August – represents a reliable inflow of hard currency.

We also have the Great Recession as a recent comparator. Brent crude dipped below $40 a few times in 2008-9, the rouble had depreciated against the dollar by over 55% at one point, those reserve assets plummeted from $593bn to $381bn, real GDP fell by 11.2% on the year to Q2 2009, and yet there was no default. GDP was back to its pre-recession peak by the end of 2011. By 2010 the currency had already re-stabilised and during that year reserves increased again by $41.7bn, all while the Brent crude future averaged just over $80, below where it stands today.

Is there, then, a bull case? It seems likely that Russia will weather the current crisis, but betting on this is a different matter. For one thing, much of the asset weakness is down to the currency. Russian equities have actually been rallying, and rose by almost 8% in local terms last week. For the year to date the MICEX price index is only 0.5% down. In dollar terms, however, the market has fallen more than 30%. On a p/e basis it looks cheap relative to other bourses but then it always does because of the country’s governance problems. This year its valuation has held at a higher level than at any other time since the flash crash of 2011.

Taking a punt on the rouble would be a brave endeavour to say the least. And there are as always other financial fish to fry. Russia’s underlying balance sheet and export strength should reassure those concerned about a re-run of the Yeltsin era. But even with the bear in such difficulties it is hard to work up any enthusiasm about taking hold of its paw.



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