Current valuation levels of Russian debt and equity do not yet reflect the economic turnaround of Russia
The Russian economy will expand 1.9% in 2018, 1.7% in 2019 and 1.6% in 2020, according to a survey conducted by Bloomberg News.
Is it time to jump back into emerging-markets bonds? UBS Group AG thinks so.
Strategists at the Swiss bank said they would use the recent sell-off to buysovereign debt from Indonesia, Argentina, Russia and Nigeria, in a note Tuesday. They also prefer emerging-market corporate bonds relative to their developed-market equivalents, despite the pair’s growth cycles moving in different directions, according to the report.
“EM’s growth may be coming under question, but its stock variables, such as short term debt owed to foreigners, are in reasonable shape,” the strategists including Bhanu Baweja wrote.
Recovery continues at the start of Q2.
The latest Russian activity figures suggest that GDP growth picked up to about 1.5% y/y at the start of Q2. These data also provide early evidence that the tightening of US sanctions and the fall in the ruble in early April have had little impact on the real economy so far.
The relatively soft start to the year means the risks to our above-consensus growth forecast of 2.5% for 2018 lie to the downside, but we still think the recovery will gather pace over the coming quarters. The pick-up in real disposable income growth, to 5.7% y/y last month, from 4.5% y/y in April, points to stronger consumer spending ahead. And the central bank is likely to resume its easing cycle.
Russian GDP expanded by a weaker-than-expected 1.3% y/y in Q1, but the data do at least confirm that
the economy is recovering from its slowdown in late 2017. And we think growth will strengthen by more
than most expect over the rest of this year
Regional growth strengthened a touch in Q1, driven by an improvement in Russia
Oil prices rose more than 3 percent on Wednesday, hitting 3-1/2-year highs, after U.S. President Trump abandoned a nuclear deal with Iran and announced the “highest level” of sanctions against the OPEC member.
Ignoring pleas by allies, Trump on Tuesday pulled out of an international agreement with Iran that was agreed in late 2015, raising the risk of conflict in the Middle East and casting uncertainty over global oil supplies at a time when the crude market is already tight.
Russia will diversify its international reserves further, President Vladimir Putin said on Tuesday.
“The monopoly of the U.S. dollar is not reliable enough, it is dangerous for many,” Putin told Russia’s lower house of parliament.
Russia held 45.8 percent of its reserves in U.S. dollars as of Jan. 1, 2018, the central bank data showed last week.
The central bank also holds other currencies in state reserves, which last stood at $460.4 billion. A significant part of the reserves is held in gold.
“Fundamentals look solid and the market probably overreacted to the sanctions due to a generally overweight position,” Yerlan Syzdykov, co-head of EM fixed income at Amundi says in research note.
“An EM recovery from here is likely to be about what has sold off the most,” Geoff Kendrick, emerging-markets strategist at Standard Chartered, says in research note. “That is the ruble.”
Russian central bank (CBR) put a stop to monetary easing following five consecutive cuts in interest rates after the latest round of U.S. sanctions jolted the ruble and raised risks for inflation.
The decision to leave the policy rate unchanged at 7.25% was correctly anticipated by most analysts.
According to Capital Economics: “the dovish tone of the accompanying statement supports our view that rates are likely to be lowered further over the rest of 2018. The market’s response to this month’s currency sell-off – it removed almost all expectations for monetary easing over the coming year – seems like an over-reaction.
While there is a growing chance that the policy rate won’t be lowered as far as our current forecast of 6.00%, we think it is premature to change our view. And the key point is that rates are likely lowered further than the markets are now pricing in. Markets had expected 75bp of cuts over a six-month period before the ruble sell-off; they are now pricing in just one 25bp cut in a year’s time.”
This summer’s World Cup could have a total impact on the Russian economy of nearly $31 billion, organizers predicted Wednesday.
A new report on the economic impact of the tournament said the boost for the country’s GDP could amount to between 1.62 trillion rubles ($26 billion) and 1.92 trillion rubles ($30.8 billion) over the 10 years from 2013 through to 2023.
That’s attributed to growing tourism plus large-scale spending on construction, plus later knock-on effects from those government investments. It even suggests the World Cup will encourage Russians to exercise more, so they take fewer sick days.
The World Cup “has a considerable economic effect,” Deputy Prime Minister Arkady Dvorkovich says in the report. “The tournament has already boosted the economic development of the host regions and will continue to have a positive long-term economic impact.”
Investors have good reason to remain cautious on Russia. The latest sanctions stretch wider and deeper than the measures the U.S. and European Union imposed after the Kremlin’s 2014 invasions of Ukraine.
Barron’s named Sberbank one our favorite emerging market stocks for 2017 based on rising oil prices and the expectation for better relations with the U.S.; the shares have since risen 31% (“Our 2017 Picks: Russia’s Sberbank and Mexico’s Cemex,” Dec. 17, 2016).
A rebound of that size from a steep decline could happen again, but Russia’s sovereign debt looks like a better, safer bet than the country’s equities right now. In part that’s because of the uncertainties surrounding the new sanctions. On the other hand, Russia is much better armored against financial attack than four years ago.
Investors should be on more solid ground with Russian sovereign bonds, which ironically seem better protected than private companies from sanctions provoked by actions of the Russian state.
That leaves the underlying credit story, which is that Putin has been obsessed with macroeconomic probity since his scarring experience renegotiating Russia’s Soviet-era debt in the early 2000s. If the Kremlin didn’t default in 2014, it won’t default now. Yet yields on its Eurobonds are in the 5.2% range—about the same as those of its less-proven ex-subject, Azerbaijan—while ruble bonds known as OFZs pay around 7.5%. Ashmore’s Dehn recommends a bet on these, given the support the ruble should get from rising oil abroad and vanishing inflation at home. Servicing on overall Russian debt (see table) will decline in the next year or so.
Buying emerging market bonds isn’t straightforward for retail investors. But Moscow-based Da Vinci Capital launched a London-based exchange-traded fund in February, the ITI Funds Russia-Focused USD Eurobond UCITS fund (RUSB.UK). Or you could try the Raiffeisen Bond Fund RU fund, which is listed in Moscow (RAIFBND.Russia). Moscow’s credit isn’t more solid than Washington’s yet, but it’s more solid than it might seem.
The international rating agency Fitch does not expect “any direct impact on the ratings” of Russian banks due to US sanctions imposed on April 6.
Sberbank PJSC’s board proposed a dividend payout of 36.2% of last year’s profit, up from about 25% in 2016, as the Russian government seeks higher financial contributions from state-backed firms.
President Trump rejected, for now at least, a fresh round of sanctions set to be imposed against Russia on Monday, a course change that underscored the schism between the president and his national security team.
The US sanctions imposed on Russia last Friday have caused turmoil in Russia’s markets today and financial conditions have tightened as a result. But at this stage it doesn’t look like there will be a significant impact on growth in the economy as a whole.
China and Russia have denounced what they described as America’s unilateralism as both sides sought to flag up their increasing rapport.
They have pledged to deepen their political and military ties at a time when Moscow is facing international isolation over the poisoning of a former spy and his daughter in Britain, and China is becoming embroiled in a tit-for-tat over trade with the US.
Chinese State Councillor and Foreign Minister Wang Yi visited Moscow this week for talks with his Russian counterpart and both sides used the opportunity to criticise the US while highlighting their closer military and political cooperation.
The Trump administration is unleashing additional sanctions against seven Russian oligarchs with ties to President Vladimir Putin along with 12 companies they own or control.
The measures announced by the Treasury Department on Friday were also aimed at 17 senior Russian government officials and the state-owned Russian weapons trading company, Rosoboronexport.
Russia is ready to discuss mechanisms of long-term cooperation with OPEC at ministerial meeting planned for end of April in Jeddah, Energy Minister Alexander Novak tells reporters on plane from Moscow to Ankara.
Europe’s largest asset manager is tuning out noise from a deepening diplomatic spat and holding on to a big overweight in Russian bonds and the ruble. Sergei Strigo, the head of emerging-market debt and currencies at Amundi Asset Management, says he “doesn’t see any reason” for the rising geopolitical tensions to damp his bullish view on Russian assets. He took part in the government’s $4 billion Eurobond sale, which came one day after the U.K. blamed Russia for poisoning an ex-spy on British soil.
“We still like Russia as an investment opportunity,” Strigo said from the London offices of the $1.8 trillion asset manager. “With oil prices at these levels, macroeconomic indicators in Russia remain very strong.”
Strigo says he’s watching the situation closely but is much more focused on macroeconomic indicators, such as the Russian central bank’s gradual approach to monetary easing and the rising price of oil. Restrictions imposed on Russia over its annexation of Crimea don’t prevent investors from buying government bonds.
“As long as sanctions don’t impact investing in Russian assets in general, then there is no change,” Strigo said. “We have been overweight Russian assets for a while, that’s a view we are sticking with.”
The United States and its European allies are expelling dozens of Russian diplomats in a co-ordinated response to the poisoning of a former Russian spy in the UK. More than 20 countries have aligned with the UK, expelling more than 100 diplomats.
The Bank of Russia cut the key rate by 25 bps to 7.25%, as widely expected. The accompanying statement reiterated the Bank’s view that the disinflationary factors that have helped to reduce inflation recently will be persistent. It also suggested that the transition to a “neutral” monetary stance
(which it has suggested means a policy rate of 6-7%) “will” be complete this year. Last month’s statement had indicated that this transition “may” be complete by the end of 2018.
Capital Economics’ kept their forecast that policy rate will be lowered to 6.00% by the end of this year.
With almost all the votes now counted, Putin has won 76.7% of the vote, the best result in any of the four presidential elections in which he has participated. Turnout, which was also seen as a gauge of Putin’s support, was a little better than in 2012.
The focus will now turn to the appointment of a new cabinet, which may provide clues about both policy direction and succession plans after Putin (possibly) steps down in 2024. Any announcements of amendments to this year’s budget may signal a shift in fiscal policy, which had been hinted at prior to the election.
On Friday 16th March, RTS index had the quarterly rebalance:
X5 Retail Group (FIVE RX), a food retailer company, was added to the index with a 1.1% weight.
According to VTB Capital X5 Retail’s GDRs may be included in May into MSCI Russia, if its average daily volumes top $2.7MM.
Top 3 index holdings are: Gazprom (14.3%), Lukoil (14.1%), Sberbank (13.0%).
The ITI Funds RTS ETF (RUSE.L) has been rebalanced accordingly.
About 170 global investors submitted $7.5bn bids in Russia’s eurobond placement on Friday, according to VTB Capital, the sole lead manager and bookrunner.
$2.5bn Russia 2047 5.25% Eurobond, buyers were from:
$1.5bn Russia 2029 4.625% Eurobond, buyers were from:
Sale signals Kremlin can still raise cash in western markets, despite sanctions.
On Thursday 15th March, ITIEURBD index had the quarterly re-balance:
PGILLN 5 ¼ 02/07/23 Corp and ALFARU 7 ¾ 04/28/21 Corp were added to the index. GPBRU 4.96 09/05/19 Corp was deleted, being left with maturity below 18 months.
Current index offers 4.6 years duration, 5.8% weighted coupon and 4.2% yield to maturity.
ITI Funds Russia-focused USD Eurobond ETF (RUSB.L) has been rebalanced accordingly and holds 23 securities.
Soccer fans may contribute $2.5b-$4b to internal consumption, resulting in 1-2% private consumption growth y/y in 3Q, according to Nordea.
The European Union on Monday announced the extension of six months of individual sanctions against a number of Russian citizens and companies imposed due to the annexation of Moscow by Crimea and the support of separatists in the conflict in eastern Ukraine. The sanctions, which include restrictions on entry to the EU and the freezing of assets of 150 individuals and 38 companies on the blacklist, will be extended until September 15, the Council of the European Union said.
“Investors are generally overestimating the risk of U.S. and international sanctions on Russia,” Luc de la Durantaye said. “The ruble has one of the highest carry and real rates in our 32-currency universe. Russia also has a current-account surplus, which is helpful in a rising U.S. rate environment.”
A recovering economy and climbing oil prices that offset the drag from international penalties mean the ruble is 30 percent undervalued versus the dollar, according to de la Durantaye. He also thinks the ringgit should be trading 17 percent stronger, even though Wells Fargo Securities LLC last week named it as the currency most sensitive to a potential trade war.
Russian inflation figures for February (2.2% y/y) confirmed that underlying price pressures remain weak and another cut in the central bank’s policy interest rate at the next Board meeting (23 March) is almost certain. Barclays predicts a 25bps cut in policy rate. Capital Economics has penciled the same cut, but sees if anything the risk of a 50bp reduction.
Investment activity growth resumed in January, supported by “easing of borrowing terms” and improvements in investment plans of industrial companies, Bank of Russia says in report on economy.
S&P raised the credit ratings of several Russian companies, including Gazprom (from BBB-to BBB) and Russian Railways (for foreign currency obligations have been raised from BB+ to BBB-), following the increase in the Russian sovereign rating.
The outlook for all ratings is “stable.”
In light of the flattening of Russian sovereign Eurobonds’ curve, as well as corporate and bank issues, BCS is recommending to shift from long-term issues to medium-term ones, as the shrinking premium in duration does not compensate for market risks.
S&P Global Ratings raised its foreign currency long-term and short-term sovereign credit ratings on Russia to ‘BBB-/A-3’ from ‘BB+/B’.
The Positive Outlook reflects continued progress in strengthening the economic policy framework underpinned by a more flexible exchange rate, a strong commitment to inflation-targeting and a prudent fiscal strategy. This policy mix is contributing to improved macroeconomic stability and, together with robust external and fiscal balance sheets, increases the economy’s resilience to shocks.
In Russia, credit rating reviews by S&P and Fitch on Friday (16 February) may be a catalyst for further inflows. Out of the two rating reviews the spotlight will be on S&P which currently attaches a positive outlook to its BB+ (foreign currency) and BBB- (local currency) ratings. An upgrade of the foreign currency credit rating would make Russian hard currency bonds eligible to reenter the Barclays’ Global Aggregate Index and lead to forced buying as a result. By contrast, an upgrade of the local currency rating (either by S&P or by Fitch) would have no index impact at this stage, but might trigger inflows from non-index investors.
Russian Eurobonds may see more than $2 billion of inflows if the nation wins back an investment-grade credit score this month, according to Societe Generale SA. S&P Global Ratings is due to review Russia’s sovereign rating on Feb. 23 as investors including Amundi Asset Management predict it’s only a matter of time before the world’s biggest energy exporter is lifted out of junk. Russia’s foreign debt is still rated investment grade at Fitch Ratings, meaning an upgrade by just one other agency would make it eligible for inclusion in the global benchmarks that international funds follow, such as Bloomberg Barclays and JPMorgan Chase & Co. indexes.
Russia’s economy slowed over the second half of 2017, but the latest data for January suggest that conditions have improved at the start of this year. We expect growth to strengthen over the coming quarters and, indeed, our 2018 GDP growth forecast of 2.5% is above the consensus.
Global demand for oil will grow faster than expected this year, the Organization of the Petroleum Exporting Countries (OPEC) said on Monday, pointing to healthy economic growth around the world. “This close linkage between economic growth and oil demand is foreseen to continue, at least for the short term.”
The Vienna-based group now expects demand for crude oil to rise by 1.59 million barrels per day (bpd), an upward revision of 60,000 bpd from its previous monthly market report.
Oil production outside the OPEC will expand by 1.4 million barrels a day in 2018, about 250,000 a day more than the cartel projected last month.
Share of Russian government Eurobonds, held by foreign investors, increased to 37.9% in 4Q from 36.6% q/q
The Russian central bank’s 25bp cut in its policy interest rate (to 7.50%) today was smaller than we had anticipated, but the decision was accompanied by a very dovish statement that paves the way for significantly more easing this year. We remain comfortable with our forecast for the policy rate to be lowered to 6.00% by the end of the year, which is lower than the markets are pricing in.
33% of international investors held positive view of Russian business climate in 2017, up from 23% in 2016, Kommersant reports, citing survey by FleishmanHillard Vanguard agency and Russian Union of Industrialists and Entrepreneurs (RSPP).
Respondents holding negative view of business climate fell to 22% from 53%, lowest level since 2013.
Survey involved more than 100 companies from the Fortune 500 list.
Germany Economy Minister Brigitte Zypries rules out reconsidering Russian sanctions unless government in Moscow sends a “signal” it will change policy.
Zypries says aware of German eastern state premiers urging government to ease sanctions.
Zypries says interested in maintaining dialogue with Russian government.
Moody’s on Monday affirmed the ratings of Sberbank, VTB, Gazprombank, Vnesheconombank, AIZhK, Roseximbank, State Transport Leasing Company, DeltaCredit and Rosselkhozbank and changed their outlooks to Positive from Stable.
The change in the outlook on Russia’s Ba1 government bond rating to Positive from Stable led to corresponding changes in the outlooks on the local currency deposit, debt, issuer and corporate family ratings of nine Russian financial institutions” the agency said.
The Emerging Market election calendar is busier than it was in 2017 but, whereas elections this year boosted the prospects for economic reforms in some EMs (e.g. Argentina), the likelihood that elections in 2018 produce similar positive shifts is lower. The focus in the early part of the year will be on Russia. The economy is unlikely to be a major theme of the presidential election in March but attention will gradually shift to what happens post-Putin and jockeying among rival factions could have significant economic and market implications.
What to watch for:
Rising oil prices, a drop in inflation, and strong GDP growth have helped Russia to emerge from a recent recession with better economic prospects than it has seen since before the global financial crisis. With stocks in the country remaining remarkably cheap despite offering some of the most attractive dividend yields in the developing world, Russia’s market is fast becoming an increasingly pivotal part of any savvy emerging market investors’ portfolio. This year has seen the end of a two-year recession for Russia. This began in 2014 when its currency - the ruble - collapsed as a result of sanctions imposed by the US government alongside a global drop in oil prices to less than $30 a barrel. In March 2015, during the worst throes of this recession, Russia’s central bank was forced to raise interest rates to as high as 17pc in order to protect its currency as inflation hit an eye-watering 16.9pc. Since then, Russia’s inflation has declined dramatically, hitting a historic low of 2.7pc in October this year, well below the government’s target of 4pc. In line with this, Russia’s government has allowed interest rates to fall back to 8.25pc, with many expecting further cuts in the near future. With the help of stabilising crude oil prices, which have returned to more than $50-a-barrel since the recession, Russia’s GDP growth has also bounced firmly back into positive territory in 2017. Indeed, in the second quarter it hit 2.5pc, its fastest rate in nearly five years. Russia’s government remains confident that GDP growth will come in at least 2pc for the whole of 2017 before extending to 2.5pc next year. Its stock market - the RTS - was among the top emerging market performers last year, delivering impressive dollar returns of 50pc. It has continued to rise in 2017. But with markets failing to account for these economic improvements in their valuation of the country’s markets, shares remain highly discounted; the economist, Robert Shiller recently claimed that Russia has one of the lowest price-to-earnings ratios in the world, at around half that of its emerging market peers. In the final quarter of last year, Russia received a welcome boost as a result of the election of Donald Trump as US president. With Trump in tow, many felt that sanctions introduced in 2014 as a result of Russia-Ukraine crisis were much more likely to be lifted, and shares soared. Although relations between Russia and the US remain frosty for now, many have pointed to the country’s recent decision to make the ruble a floating rate currency as an effort to properly open up to foreign investment. The nation is throwing more weight behind structural reform. A particularly interesting development came in April, when its government demanded that state-owned companies pay out half of their profit in dividends this year. Although the move was chiefly driven by a need to cover the federal budget, it also came as a boon to private investors in affected companies. Perhaps coincidentally, the move falls in line with a general trend of increasing Russian dividend payouts in recent years. Since 2014, dividends on a $100 dollar investment have risen from around $2.5 to $3-4, making the country one of the most lucrative hunting grounds in the world for income investors.
With more than half of the RTS index comprised of oil companies and Russia itself currently positioned as a leading exporter of natural gas, the country’s short-term outlook is likely to remain relatively stable if analysts’ expectations of a broadly flat oil market are correct. But now that the days of $100 oil have passed, an alternative way of getting exposure to the country’s large dividend yields can be found in its increasingly wealthy population and jump in consumer spending. With inflation currently in a trough and low interest rates turning consumers away from saving, household spending increased by 4.3pc in the second quarter of 2017, while retail sales have snapped out of a record 27-month period of contraction and rose to near-three-year highs. When a 150-million strong population decides to spend more on luxury goods, services and holidays, the beneficiaries will be sectors such as housebuilding, retail, and air travel rather than commodities. A particularly effective way of gaining exposure to this trend while remaining part of the country’s commodity narrative is through an exchange traded fund (ETF) which directly invests across the whole Russian stock market. By exposing themselves to both commodity and non-commodity stocks, investors can potentially cash in on more than one investment trend while limiting downside risk in the event of another drop in oil prices. With much of Russia’s growth story yet to fully pan out, a diversified exposure to the country’s market trends as they continue to develop is the perfect way to cheaply broaden income streams within a wider emerging market portfolio.
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