“None of them” was Russian President Vladimir Putin’s response to questions regarding his preferred pension reform option, “Why? Because [raising the retirement age] cannot be pleasing to the overwhelming majority of our citizens”. Indeed, they have proven to be very unpopular. Public outcry against proposed pension reforms – that include raising pension ages from 60/55 to 65/63 for men and women respectively – has been pronounced with tens-of-thousands at various protests since their announcement in mid-June; Putin opinion polls are at their lowest in years. Some indicators put his approval ratings at the lowest in almost four years following the recent sharp drop from above 80% to now ‘just’ 67%.
The economic calendar looks relatively light today (before China GDP, retail and industrial output tomorrow) meaning that traders and markets have been focusing on the weekend’s Western sorties in Syria and a number of other geopolitical pressures. The solemn worsening situation in Syria and its multi-faceted and far-reaching aftermath include: US’s further sanctioning (expected later today) on Russian companies tied to the production of chemical weapons; the discord within UK parliament on whether Theresa May’s prerogative to join US and France airstrikes goes against the spirit of the parliamentary process (including 15 years of convention) and undermines UN Security Council procedures; it hampers the likelihood of success for the forthcoming summit between North and South Korea and the potential meeting of Kim Jong Un and President Trump; puts pressure on Brent oil prices to remain around the current ~$70 range; it emphasises the urgency for the Organisation for the Prohibition of Chemical Weapons (OPCW) to be allowed to investigate the locations of suspected chemicals attacks; it opens further possibilities for Iran and Israel to deepen their conflict in the Syria region; and it still does little to support the people of Syria in the near-term (who are themselves split, with large protests over the airstrikes gathering in Damascus).
In what is expected to be Russia’s most ambitious and pricey (USD 55bn) energy project in modern history, we heard this week that state-owned global energy giant Gazprom is 75.5% the way into completing the 3,000km Power of Siberia gas link to China. The project is expected to be completed “on time” with Russia supplying China with natural gas through the East-Route by December 20, 2019.
The rumour mill suggests that Russia is looking to issue Eurobonds this month; as part of the total USD 3bn debt issuance that Finance Minister Anton Siluanov said could be issued this year. This comes off the back of S&P's one notch upgrade to the country’s long-term rating, to BBB-, bringing it in line with Fitch’s rating; thus the country is now eligible for inclusion in most global investment grade bond indexes so strong demand is expected.
100 years ago on the 6th December 1917 Finland declared independence from Russia. Throughout this year they have been celebrating this heritage and their culture: which includes everything from summer-houses to baby-boxes, from some of the most stable politics in the world to the best education system in Europe. Finland is Aa1/AA+ rated according to Moody’s and Standard and Poor’s. It is rated 4 Star according to our Net Foreign Asset Model, meaning that it has accumulated neither significant Net Foreign Assets nor Liabilities. But from an investor’s view the country offers little value to celebrate over: with a negative sovereign yield curve up to 7 years and with yields less than 1.2% in the 30 year space.
Russian Q3 GDP grew 1.8% yoy which was down from growth of 2.5% yoy in Q2 and slightly weaker than market expectations of 2%. Elvira Nabiullina, the Central Bank Chief, is reported as saying she expects growth to reach 1.8% for 2017 as a whole although the Central bank has been guiding to 1.7-2.2% range, and the Finance Ministry projection has been at the upper end of the range. Moody’s estimate 2017 GDP growth at 1.5%. But all projections represent a significant improvement from GDP growth of -0.2% in 2016.
In what is the first state visit to Russia by a Saudi ruler, King Salman bin Abdulaziz today will meet Vladimir Putin to discuss oil markets, investment deals, the Syrian war and to deepen the nascent friendship between the two largest oil producers in the world. The delegations are tabling $3bn worth of energy deals with the possibility of a collective $1bn energy investment fund and a $1bn Sibur plant in Saudi Arabia; there’s talk of Gazprom Neft and Saudi Aramco establishing joint research projects; and interminable rhetoric on the “promising areas for bilateral co-operation.”
On 22 September Fitch affirmed its rating on Russia’s long-term foreign debt at BBB- and upgraded its outlook to positive from stable.
One of the reasons cited for the positive outlook revision is the improvement in the policy framework underpinned by the flexible exchange rate, ‘strong commitment to inflation targeting’ and a ‘prudent fiscal strategy’ reinforced by the recently approved budget rule. The budget rule uses a conservative oil price of $40 (real) and one positive aspect is that revenues in excess of the budget will be used to rebuild Russia’s fiscal buffers. The external and fiscal position is robust, Fitch estimate the net foreign asset position at a healthy 28% and the economic backdrop has improved: Fitch forecast 2% GDP growth for 2017 and 2.1% for the 2017/2018 period. Although he is still to affirm his candidacy, Vladimir Putin is expected stand for another term as President in the March 2018 elections implying policy continuity.
President Trump signed into law the U.S. government's Countering America's Adversaries Through Sanctions Act on August 2. This gives President Trump the power but not the obligation to impose sanctions not just on Russia but also North Korea, Iran and it also requires Congressional approval to remove them.
However, the US desire to use sanctions as a cornerstone of foreign policy has been met with a mixed global response. For example, European officials although having their own set of sanctions in place against Russia (that has recently been extended to January 2018) were said to be angered by the latest US sanction move and its potential to negatively impact European interests.
In what is said to be Russia’s largest ever bank bailout, last week the Central Bank of Russia moved to prop up Otkritie, after the country’s second-largest privately owned bank suffered a huge run of deposit outflows amid concerns over its loan portfolio and ‘questionable’ business practices. Otkritie is the seventh largest (by assets) of the 10 ‘systemically’ important banks in Russia and was thus considered too big to fail.
The bailout will be funded from the supplementary bank liquidity facility, which was set-up following Russia’s introduction of a new law which allows the central bank to effectively take control of a failing bank (that is worth saving). In this case the central bank has planned to take a minimum 75% stake in Otkritie, however, the exact amount of funding is currently unknown, and the assessment process could take as long as eight months. There is a risk that shareholders of the bank could potentially lose all ownership rights if Otkritie’s capital is negative in the next three months, and all subordinated debt could be written off, according to the Bank of Russia.
This ‘shock’ bailout comes at a surprising time, when Russia is experiencing stable economic recovery (Q2’17 GDP upwardly surprised at 2.5%yoy), and the county’s banking sector is showing signs of stabilising; NPLs appear to have peaked and capital ratios are more robust. The move to ‘save’ Otkritie is considered positive for Russia’s banking sector, which has seen a third of lenders lose their licenses since a purge was initiated in 2014. A good example could be Yugra Bank which had its licence revoked after reportedly falsifying its accounts.
We have never held Otkritie (rated sub-investment grade) and currently do not hold any positions in its largest stakeholders; which include Lukoil and VTB bank. Citing ‘elevated volatility of the bank’s customer deposits, which puts pressure on its liquidity position’, Moody’s placed Otkritie’s rating on review for a downgrade last month. According to the rating agency, the customer deposits fell to ‘18% of the bank's liabilities as of 1 June 2017, largely driven by material outflows as both non-state pension funds and several large corporates withdrew funds.’
We often discuss the merits of quasi-sovereign holdings and the importance of their implicit support from the government. In this example, Otkritie is actually privately owned but systemically important to the country’s banking system; and as such received a bailout. As regular readers know we prefer to hold positions in high quality government-owned securities, which offer sufficient risk-adjusted spread cushion. One example could be a position in Russia state-owned-and-run Vnesheconombank (VEB) 5.942% 2023s. The bank has a very high probability of support from the Russian government, according to Moody’s. The ratings agency goes on to comment that ‘VEB is closely linked to the government, which gives VEB good access to state funding and capital when these are needed to finance various projects of government importance.’ So far this year the bond has rallied over 4 points, and continues to offer an attractive expected return (with yield) above 9.2%, and over two notches of credit cushion.
The U.S. government's Countering America's Adversaries Through Sanctions Act was signed into law by Donald Trump on August 2. For S&P it ‘has no immediate implications for Russia’s sovereign credit rating’ of BB+ positive on a foreign currency basis. Moody’s see the codification of the sanctions into law as credit negative for Russia as their reduction or removal will require congressional approval and may discourage FDI, although they have made no change to their Ba1 (stable) rating. They also see sanctions law as credit negative for Russia’s energy sector and Gazprom (Ba1 stable). The market has also taken a pretty sanguine view of events; at the time of writing US dollar denominated Russian Federation 4.25% 2027 and Gazprom 8.625% 2034 are trading higher on a month to date basis.
Yesterday, at the 172nd OPEC meeting in Vienna, OPEC and some key non-OPEC countries announced the extension of production cuts for 9 months through to 31 March 2018. The earlier agreement had looked for a 1.8 mb/d reduction in production. Khalid Al-Falih, the Saudi Energy Minister, noted that oil inventories are expected to fall below five-year averages before the end of the year but as Q1 is seasonally weak it made sense to push the cuts out until the end of March. Little was said in terms of an exit strategy other than the situation will be reviewed at the end of November and into 2018. Brent crude sold off on the back of this news trading around USD51.75 per barrel the time of writing but oil had rallied strongly ahead of the meeting already factoring in a lot of upside and the announcement did not exceed expectations.
Russian Q1GDP expanded 0.5% yoy, based on the State Statistical Service’s initial estimate, suggesting a return to positive growth in 2017 looks likely after 2 years of negative growth. Interestingly, the Russian Finance Ministry upgraded their forecast for 2017 growth to 2% yoy from 0.6%: this looks a little on the optimistic side although a recovery in consumption is expected. For example, Fitch estimate GDP growth to be 1.4% in 2017 and 2.2% in 2018 and Moody’s forecast a growth rate of 1% in 2017 and 1.5% in 2018.
Late last week Moody's Investor Services raised Russia’s outlook to stable from negative adding Russia’s strategy ‘reflects an ambitious fiscal consolidation strategy incorporating conservative spending and revenue assumptions’. Russia’s Economy Minister Maxim Oreshkin, said there are ‘objective grounds’ for a ratings upgrade.
Moody’s cited an improvement in the economy as well as a fiscal consolidation strategy that should help wean the country off its dependence on oil. That means that all three major agencies have now confirmed the economy is stabilising after almost a two year long recession, the longest in almost two decades.
Consider two countries: one with high public debt and Net Foreign Liabilities rated Baa2 versus one without Net Foreign Liabilities rated Ba1. History has shown that high levels of indebtedness greatly increase financial risks to creditors as investor sentiment becomes more volatile and repayment costs balloon. We believe the risks of this greatly increase when Net Foreign Liabilities exceed 50% of GDP and are typically unsustainable beyond 100% of GDP. Yet there are numerous examples across the world where countries with high levels of indebtedness are rated higher than net foreign creditors or countries with appropriate and sustainable levels of debt. Why is this?
Away from the hard/soft Brexit talks and Trump hiring his son-in-law as a top senior advisor, Turkey appears to have crept back into the headlines as political uncertainty mounts, social and security instability ensue, and the country’s economic outlook looks increasingly bleak.
Politically, the country’s parliament yesterday voted ~⅗ in favour of a constitutional amendment - and can thus hold a referendum in Q2’17 - which could see President Erdogan gain even more presidential power and potentially increase his term to as far out as 2029.
After 77 years could 2016/17 be the year World War II finally ends? For since 1945 Japan and Russia have yet to formally settle the dispute over some ambiguities in the Yalta Agreement concerning a string of islands stretching from Hokkaido to the Russian Kamchatka Peninsula (in particular 4 of them known to Russia as the southern Kuril Islands and to Japan as the Northern Territories). Japan first took control of the nearmost islands in 1855 (and seized the entire string encompassing the Sea of Okhotsk by 1875 and through the 1905 Russo-Japanese War) but the Red Army seized them back in the final moments of WWII.
This week Glencore and the Qatar Investment Authority announced the purchase of a 19.5 percent stake in Rosneft at a price of USD11.3bn in a move that is a positive step for the Russian government’s drive to raise funds from asset privatisation.
Privatisation and increasing the state-owned enterprise dividend payout ratio to 50 percent are one of the routes the government is looking to exploit to fund the budget deficit.
The lambasted South Korean President Park Geun-hye has offered to resign if parliament can achieve a ‘safe transfer of government’. In a televised message the scandalised president told the appalled masses she would ‘step down according to the schedule and legal procedures agreed by lawmakers for the stable transfer of power.’ The rhetoric was quickly dismissed by rival politicians as an attempt to hamper or make superfluous her pending impeachment which could go to a vote as early as this Friday (one could call it an attempt at pulling a ‘Richard Nixon’). Last weekend saw around 2 million take to the streets nationwide to protest against President Park making it the largest such protest in the country’s history.
Given that Russian bonds have been strong performers since the start of 2015, Fitch looks to have made a savvy call by maintaining an investment grade rating, although lowered to BBB-, on the Russian sovereign when its peers cut their ratings to sub-investment grade in a wave of pessimism earlier in 2015. Both Standard and Poor’s and Moody’s slashed their ratings to ‘junk’ following the imposition of sanctions by Europe and the US on the back of the Crimean annexation and the Ukrainian impasse. Thus, it was interesting to see Standard and Poor’s finally upgrade the outlook on Russia to stable on 16 September, although retaining the BB+ long-term foreign currency rating.