The erosive effects of international trade and transaction sanctions on Russia have now persisted for over 2 years; they were first enacted in March 2014 in response to the annexing of Crimea. Since then the Russian ruble has more than halved in value – though significantly due to the ending of their dollar/euro peg and oil prices also falling more than half – reaching RUB80 per US dollar at the beginning of this year. It has since pushed back to the USDRUB 65 level. Alongside this, the past two years have seen particular market concern over Russian economic growth and their FX reserves – which declined 28% to ~$308bn between April 2014 and April 2015 – as the sanctions began to take effect. All this was frequent front page information.
Yet since then, although sanctions remain and oil continues to price between $30-60BOE, comparatively less attention has been paid to some of the signs of resilience and areas of growth that have emerged across Russia. Russia’s post-oil-boom transformation still has far to go but it seems the dynamic pressures of sanctions and necessity driven reforms are beginning to bear fruit. And although Russian officials seem comparatively muted/cautious in broadcasting improvements internationally, the recent -1.2% yoy GDP figure reflects an improving trend driven by public and private economic reform. Such GDP figures have helped to forestall market concerns and numerous upsides mean the country could return to positive growth within the year.
First, following the 30% decline in FX reserves in the prior 12 months, the most recent 12 months have seen reserves trend upwards 8% to $331bn. Such resilience was mostly unexpected but necessary to bolster market confidence; although this figure is enviable for most advanced economies their accounting methods are somewhat generous and (prior to recent and ongoing reforms) the size of the deficit would have simultaneously eroded such reserves as well as raised the level perceived to be safe by the market.
Second, although the currency’s sharp devaluation and reverberating volatility was damaging, the depreciation has more than mitigated the oil price slump in local currency terms and at the same time increased competitiveness in other export industries. The effects of any increased competitiveness could be amplified when international sanctions are eventually lifted. Third, indeed an increasing number of politicians from France to the US are calling for the reversal of US and EU sanctions. Notwithstanding the interlinked geopolitical concerns there is potential for such a reprieve before the end of the year.
Fourth, instead of falling into the trap of a “resource curse”, Russia’s recent performance has demonstrated its potential in an array of industries. Sectors like IT and Pharmaceuticals grew 28% and 9% respectively in 2015. Earlier this week Maxim Oreshkin, Russian Deputy Finance Minister, commented on how “New drivers for growth have already appeared in the economy: agriculture, chemicals, the food industry and domestic tourism.” However, for investment to increase and for this positive trend to continue: development of the capital markets, growth of non-commodity industries and improvement in the business climate will all have to follow suit.
Some of these positives have been reflected in the markets. Over the past 18 months spreads on Russian Government 30 year dollar bonds have tightened from 520 to 260bps versus US treasuries. Russia’s Ba1/BB+ ratings (though still investment grade according to Fitch) was taken off negative watch last month by Moody’s citing “resilience” and “an effective blend of macro policy responses” as well as the margin of protection afforded by the ability to finance (now reduced) deficits “through fiscal reserve drawdowns”. A number of Russian quasi-sovereign credits still offer some attractive risk adjusted returns but clearly were particularly undervalued over the recent episode. As a net foreign creditor (according to Stratton Street’s NFA Analysis), we remained confident that Russia had considerably more protection against default and adverse conditions than many were asserting. We are glad that they are in the headlines less now and offer more near-term upside potential; but this example demonstrates the importance of equanimity supported by sensible investment parameters which avoid the already heavily indebted.