A bloodbath in Russian credit and a sovereign downgrade last week – as the confrontation with Ukraine escalates, triggering tougher EU and US sanctions – confirms Moscow is hurtling towards a savage recession and credit crunch without urgent redress, say analysts.
Meanwhile, full-on financial warfare from western powers, aimed to sap the lifeblood of the Russian economy, has triggered a debate about the survival power of Russian banks, companies and state operatives that have assumed foreign debt liabilities in recent years.
On Monday, the US announced a new round of sanctions ostensibly targeting Putin’s “inner circle”, though Russian equities immediately rallied as the likes of Sberbank and Gazprombank were spared.
On Friday, Russia’s credit rating was cut to BBB- from BBB by Standard & Poor’s, citing a weaker growth profile and capital outflows that “heighten the risk of a marked deterioration in external financing, either through a significant shift in foreign direct investments (FDI) or portfolio equity investments”.
It maintained its negative outlook on the sovereign, raising the risk of a cut to junk, in what would be an astonishing move given the sovereign’s oft-cited war chest of FX reserves that stand at $473 billion and a low general debt-to-GDP at around 12% to 13%.
Also on Friday, the Central Bank of Russia (CBR) unexpectedly hiked rates from 7% to 7.5%, citing inflation risk. Analysts don’t buy the CBR’s rationale and fear the move indicates expectations that the conflict will intensify.
Timothy Ash, head of non-Africa emerging markets (EM) research at Standard Bank, says: “This is not about inflation trends in the short to medium term. The Russians are hiking rates because they are worried about the impact of sanctions, and capital flight.
“Higher rates will be bad for growth – further affirming the weak Russian story, as the impact of the crisis in Ukraine further impacts on Russia.”
Meanwhile, there has been a bloodbath in the local rates market – even before the aggressive and unexpected rate hike – with a 91 basis point jump in one-year cross-current rates between Tuesday and Thursday, and postponements of local debt sales.
Benoit Anne, head of EM strategy at Société Générale, says: “This is simply a toxic price action, at this point, and it is hard to imagine a quick turnaround.”
|Vladimir Putin, president |
Meanwhile, the Russia 2027 local bonds are trading at 9.50% while the 2030 dollar Eurobond is trading at 5.2%; nevertheless, that latter bond is sinkable, capping the yield.
Anne adds: “Ultimately, the Central Bank of Russia will need to unwind some of the earlier tightening, but at this point it does not have the necessary policy room to do so, given the sharp rise in financial stress.”
Analysts at Morgan Stanley sum up the consensus view that near-term price direction centres on resolution of the conflict, current sanction threats are unlikely to dissuade Moscow from further intervention in Ukraine and the near- to medium- economic costs are likely to be substantial.
“Our economists stick to the view that sanctions are unlikely to impose a cost which forces Russia to comply with western demands in the short run, given Russia’s substantial FX reserves and lack of trade dependency,” they state.
“Nonetheless, they expect a major impact on sanctioned entities and a significant longer-term cost in terms of slow growth and reduced access to external finance.”
Paul McNamara, an EM debt portfolio manager at GAM, says: “This trade is dead for a while. We need sanctions off the table, and we’re sliding the other way.”
Says Evghenia Sleptsova, Russia and CIS analyst, at Roubini Global Economics (RGE): “Regarding the failure to issue of local currency bonds, it is hardly surprisingly, given the escalating geopolitical tensions with Ukraine and more sanctions looming from the US.
“The yields are high, but have been consistently high since early March, and the Russian government seems unwilling to borrow at such a rate. They are also not desperate to borrow, however, as oil revenues in local currency terms have increased and non-oil revenues are still holding up, as consumption has been resilient [on the back of anticipation of further RUB depreciation and concerns over sanctions].”
She adds: “While it is hard to tell for sure, it is also possible that demand for Russian bonds even at this yield level (9.3% for 10 year bonds) is low, as investors are also anticipating further tougher sanctions from the US.”
As Euromoney has reported, the US, and to a less extent the EU, are looking to undermine Russia’s place in the international financial system, raising the spectre of a foreign-currency credit crunch for Russian corporates that have financed themselves in overseas markets in recent years.
According to Morgan Stanley, Russian corporates’ short-term external debts amount to $140 billion, principally in the form of syndicated loans and Eurobonds. What’s more, the total external debt of Russian banks and sovereigns at the end of 2013 was close to $650 billion, representing around 40% of total Russian corporate funding.
Morgan Stanley claims there are close to 100 external loans maturing with an average tranche size greater than $100 million, with an average loan size of corporate syndicated loans at around $380 million, led by banks and the oil and gas (O&G) sector.
However, between mid-March to-date, debt-capital-market bankers note the vanishing pool of institutional players seeking Russia exposure, illiquidity and a shift among western banks to shed syndicated-loan and Eurobond exposure to Russian financials, amid sanction threats, undermining relationship-type loans and trade-finance facilities.
Borrowers such as Sberbank are heading to the Asian market, but spreads and liquidity on offer there don’t compare with the US; VEB is unable to tap new syndicated-loans from western banks; while Gazprombank is shifting its foreign deposits back to the CBR, underscoring the external-financing challenge for even the highest-rated and best-known names.
Nevertheless, even with just $10 billion of international issuance from Russian borrowers year-to-date, analysts at Morgan Stanley are surprisingly sanguine on the outlook for external financing, with an estimated $105 billion of syndicated loans and Eurobonds due by end of 2015.
“The underlying fundamentals of Russian corporates provide some cushion,” they state. “In particular, the sector with the highest external redemptions, the O&G sector, reports relatively low levels of leverage and comfortable balance-sheet liquidity – cash on balance sheet at the end of 2013 covered short-term debt 1.0 times. In addition, the sector [currently] has steady access to export dollars.”
While noting the risk that corporates, in the materials and manufacturing sector, could be subject to sanction in revenue-generating jurisdictions, such as the US, Morgan Stanley is relatively bullish, in part, because Russian corporates have increased the proportion of their FX deposits to 43% of total corporate deposits, as of January 2014, while the CBR is expected to remain a credible, and liquid, backstop for Russian banks.
What’s more, the net foreign asset position of the country’s lenders has improved by more than $150 billion compared with 2008, while the total public foreign debt is around $372 billion compared with $473 billion of reserves.
However, Russian state-owned banks and corporates have sizeable overseas liabilities, as Anders Åslund, senior fellow at Peterson Institute for International Economics, notes in a recent comment piece.
“State banks and other state-controlled corporations are not creditors to the west but big borrowers,” he says. “Companies such as Rosneft have larger debts than their market capitalization, and their debts are held abroad. If they are not able to roll over their large foreign debts, they will be starved of capital.”
The increase in the cost of domestic and foreign capital for Russian companies combined with “lower real wage growth and consumer demand” led Credit Suisse analysts end-March to revise their 2014 and 2015 real growth forecasts to -0.4% and 1.9% year-on-year, respectively, from the 1.3% and 3.1% projected earlier in the year.
The Institute of International Finance (IIF) reckons in an “upside” scenario – a political settlement within the next few months and no further sanctions – real GDP would contract 1% this year before rebounding to a modest 1.5% next year, with total capital outflows for 2014 at $150 billion.
A downside scenario is defined as “tensions spread[ing] across eastern and southeastern Ukraine, leading to their de facto autonomy from Kiev, with Russia providing support to them”, disrupting trade routes, but without sweeping sanctions or widespread hostilities.
In this context, real GDP would decline 3% to 4% in 2014 and another 1% to 2% next year.
Say IIF analysts: “With resident capital outflows likely to jump by 50% relative to the upside, net capital outflows could be as high as $250 billion this year and $100 billion to $120 billion next. Foreign-exchange reserves would drop sharply as a result, reducing the outstanding to just above $200 billion at the end of 2015, or five months of imports.”
For bears, the conflict has emboldened the case against the Russia growth story, with bulls traditionally citing rising consumption prospects, service-sector expansion and commodity wealth.
Says Sleptsova at RGE: “Bottom line: Russia’s oil-dependent, consumption-driven growth model – already flat-lining as a result of a lack of structural reforms, stifling corruption and an unsupportive macroeconomic policy mix – is now being challenged further by the geopolitical crisis with Ukraine.
“Uncertainty over Russia’s next steps with regard to Ukraine and concerns about the ultimate scale and impact of western sanctions will continue to depress sentiment among domestic and foreign investors, eroding Russia’s medium- and long-term growth potential.”
The spillover impact for Europe, aside from gas exports, is likely to be significant. According to Nomura, citing IMF data, in 2012, Russia was the fourth-largest export destination of the EU, representing 7% of total extra-EU28 exports), after the US, China and Switzerland.
“In terms of total trade value, Russia is the third-largest trading partner (as defined by the sum of exports and imports) of the European Union,” it states. “For the euro area, exports to Russia as a percentage of total euro area extra-EU exports have increased gradually since the crisis, to about 6.5% in 2013 – almost back to the level in 2007.”
However, FDI- and bank-transmission stocks could be limited, despite rising economic ties between Russia and western Europe during the past decade.
According to Nomura, for the euro as a whole, the stock of direct investment as a share of the region’s GDP in Russia is low, save for Cyprus, whose FDI stock in Russia is 4% of GDP, Austria (2.8%) and Finland (1.7%).
What’s more, European banks, in aggregate, have little exposure to Russia. Say Nomura analysts: “[Bank for International Settlements] cross-border data show in level terms that France has the largest exposure among western European countries, followed by Italy and Germany.
“However, in terms of exposure to Russia as a percentage of total assets, the Netherlands (0.6%), Italy and France (0.5% for both) are most exposed.”
Even if the spillover impact can be contained, the external market is gradually being closed for Russian borrowers and a savage wave of repricing has hit sovereign risk, undoing years of hard-fought work.