The Daily Update - Russia

The latest proposed Russian budget spans a 3 year projection period from 2017-2019 and continues to target fiscal consolidation. The deficit forecast for 2016 is 3.7% of GDP assuming the Rosneft privatisation goes ahead; without this it would be 4.5%. The deficit is then forecast to narrow to 3.2% of GDP in 2017, 2.2% in 2018 and 1.2% in 2019. These forecasts are conservative as they are based on an oil price of USD40/bbl which is below where oil prices are currently trading. It is also assumes that sanctions remain in place until the end of the forecast period but with Donald Trump now elected as the US President it has opened up the possibility of improved relations and sanction reductions.

To get to the budget deficit target expenditure cuts are required but these appear to be mindful of the upcoming 2018 Presidential Election. 2017 revenue is forecast as RUB 13.4tn (15.4% of GDP) and RUB 14.8tn (15% of GDP) in 2019 while GDP is forecast to increase from RUB 86.8tn to RUB 98.7tn over the same period. Expenditure is expected to fall from RUB 16.2tn (18.7% of GDP) in 2017 to RUB 16tn (16.2% of GDP) in 2019. Military spending is one area that has been targeted for cuts; forecasts show it falling from 3.3% of GDP to 2.8% in 2019.

In terms of funding the budget deficit Russia has announced its intention to continue issuing a modest USD7bn per annum in Eurobonds. Given the low government debt levels there is clearly scope to increase foreign and domestic debt issuance although there is also still some scope to tap the Reserve funds and raise funds from the privatisation program. In 2017 the Reserve fund will be tapped for RUB 1.151tn but it will then be exhausted. The National Welfare Fund will provide RUB 659.6bn in 2017 rising to RUB1.14bn in 2018 and then easing to RUB 136.8bn. There seems to be a reluctance to raise revenue through higher taxes: tax rates in Russia are low with a corporate tax rate of 20 percent and income tax of only 13 percent but perhaps given economic weakness and the 2018 Presidential Election this avenue has not been exploited.

Russia is now pressing ahead with its privatisation program. The approval of the purchase of the government’s 50.08 percent stake in the oil and gas company Bashneft by Rosneft will net ~USD 5.2bn (RUB 329.7bn). The government is also looking to sell down a 19.5% stake in Rosneft (taking its holding down to 50.1 percent) for which the minimum price has been set at USD11.2bn. According to Alexei Ulyukayev, the Economy Minister, the price reflects the market value on October 11 of the stake of USD11.7bn with a 5 percent discount. The government is targeting to complete the sale by December 5 2016 and then the proceeds will be transferred to the government coffers by the end of the year. Interestingly, the government has also included a fifty percent dividend payout ratio in the budget for state-owned enterprises which is above current levels.

Fitch rate Russia BBB- and note ‘Fiscal buffers are weakening, but remain strong relative to the peer group and are a key support for the investment grade rating. Fitch expects that deficit financing will exhaust the Reserve Fund in 2017 and a subsequent erosion of the National Wealth Fund. Debt financing will be stepped up, but from a low base. Net general government debt is forecast at 9.4% of GDP at end 2018, compared with a projected 'BBB' median of 33.8%.’ The Russian economy seems to be passing the worst in that GDP growth is now forecast to return to positive territory: Fitch forecasts -0.6% in 2016, 1.3% in 2017 and 2% in 2018.

Despite the Ukrainian debacle and economic sanctions Russian Eurobonds have been among the better performers over the past couple of years. Stratton Street uses NFA analysis to select for strong creditors (i.e. those with net foreign assets or net foreign liabilities less than 50% of GDP) to invest in, rather than being beholden to an index where the issuers with the most debt but not necessarily strong credits have larger weightings. This analysis has stood us in good stead as it was clear to us that Russia’s balance sheet given its strong NFA position of 11.5 percent of GDP (2011) would be strong enough to weather a downturn and the bonds were mispriced. Stellar returns over the past 24 months have closed out some of this valuation anomaly and we have reduced exposure rotating into more undervalued credits. But we note the removal of sanctions could pave the way for ratings upgrades.