Wealthy Nations Daily Update - Russia

On October 16, Fitch Ratings affirmed their BBB- rating for Russia but maintained a negative outlook. While lower oil prices have been a negative factor and the economy has fallen into recession, the current account is expected to increase the surplus to 5-6% of GDP in 2015 compared to 3% in 2014. Fitch’s revised forecasts, which factor in a lower oil price, look for the “economy to stabilise, growing by up to 0.5% in 2016, and rising to 1.5% in 2017”, although a federal fiscal deficit of 2.8% is forecast for 2015. For Fitch “the sovereign balance sheet remains a key support to creditworthiness. Government debt is on course to end 2015 at 13% of GDP and sovereign net foreign assets are estimated at 26% of 2015 GDP.” Given that Russian bonds have been among the best performers this year, Fitch looks to have made a savvy call by maintaining its investment grade rating on the Russian sovereign when its peers cut their ratings earlier in the year.

Added to this, on October 9 the Central Bank of Russia’s published its estimates for external debt repayments and funding sources into the end of 2015. According to these estimates, actual repayments in the September-December 2015 may amount to USD35bn out of USD61bn; the balance is debts that are expected to be carried forward or refinanced. The current account balance for the January-September period amounted to USD49.9bn, an improvement on 2014, and “net private capital outflow in January-September 2015 is tentatively estimated at $45.0 billion, declining to a considerably lower level as compared with the respective period of 2014 ($76.8 billion).” For the September to year end period, the Central Bank “estimates current account balance, which is used as a funding source for external debt repayment, to stand at about $28 billion with oil price at $60 per barrel, about $25 billion with oil price at $50 per barrel, and about $20 billion with oil price at $40-45 per barrel. Besides, the unused balance amounts to about $14 billion of the total $50-billion limit on refinancing operations in foreign currency established by the Bank of Russia.” Based on this, they do not expect “considerable portfolio investment outflow and higher tensions in the FX market.”

On a more encouraging note, Russian companies have started to regain access to the capital markets. In October Gazprom was able to raise EUR1bn via a 3 year Eurobond in an issue that was three times covered. Norilsk Nickel also managed to place an USD1bn 7 year Eurobond. Sanctions still remain in place but there are signs of progress in the Ukraine following the Paris Summit earlier in the month, albeit at a slower pace than might have originally been envisaged when the Minsk II agreement was signed in February.

Admittedly, Russian involvement in Syria remains a unknown. But if elections are held in the separatist regions of the Ukraine and greater autonomy is awarded, and then Russian troops return control of the border to the Ukraine, the basis for renewing the sanctions against Russia will be much weaker. Russian bonds have been stellar performers this year; the yield on Gazprom 8.625% 34 has compressed from 8.55% at the start of the year to 7.17% at the time of writing. Unquestionably, this is an attractive return but then consider the yield was as low as 5.17% at the end of 2012 and before the whole Ukrainian debacle kicked off. At that time the Russian sovereign was rated Baa1 by Moody’s and BBB by S&P and Fitch.

Thus, in terms of what potential surprises the markets could face in 2016 Russia could well be one of them. Angela Merkel and Francois Hollande seem focused on resolving the situation in the Ukraine through elections and the devolution of power to the separatist regions. So what if Minsk II does get implemented? What if then the sanctions are unwound? What if then the ratings agencies, particularly S&P and Moody’s with their sub-investment grade ratings re-rate Russia to investment grade again?

In a world searching for yield 2016 could well see further impressive returns from Russian Eurobonds.