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Strong grain and gas exports look particularly good for the rouble this year. The rouble usually appreciates in winter, supported by high seasonal demand for Russian hydrocarbons. And this winter, the weather has been unusually icy both in Europe and Asia, Russia’s main export markets. The resulting spike in gas prices should support the rouble. The same applies to the high global grain prices and the surge in Russian grain exports ahead of 15 February, when a new grain export duty comes into effect.
Russia’s Fundamentals Have Improved
The economy has also performed better than expected. At -3.1%, the first estimate of Russia’s 2020 GDP growth has bettered both official and market forecasts. It also points to a shallower recession in 4Q, when the economy must have shrunk by 2.5% (vs the 3.4% contraction in 3Q). Russia is proceeding with vaccinating its population with the Sputnik-V vaccine, and the numbers of new daily Covid cases and deaths are falling. The government is also planning to roll out two more vaccines in early spring.
The current account surplus shrunk to ~2.2% of GDP last year, vs 5.5% of GDP in the previous year. Albeit less so than before the Covid pandemic, Russian fundamentals remain supportive of the local currency.
Critically, the oil market hardly provides a reason for the rouble to underperform. In January, Russia negotiated a slight increase in its oil output. Also, Saudi Arabia pledged to cut its oil production unilaterally by 1mn bpd. The most recent monthly OPEC+ ministerial meeting, held in early February, confirmed its members’ commitment to current output quotas. The cartel now forecasts that OECD oil stocks should return to their five-year average this summer. Boosted by these positive developments, Brent has moved up towards $60/bbl.
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Summary
- Russia’s economy is gaining traction, bolstered by vaccine rollout.
- But local assets have underperformed with the threat of sanctions following the arrest of Alexei Navalny.
- A muted response from the US targeting only Russian officials could leave room for positive surprise on the rouble.
Market Implications
- Medium term; positive FX. With harsh sanctions unlikely, the rouble should start to catch up with Russia’s improving macro.
Strong grain and gas exports look particularly good for the rouble this year. The rouble usually appreciates in winter, supported by high seasonal demand for Russian hydrocarbons. And this winter, the weather has been unusually icy both in Europe and Asia, Russia’s main export markets. The resulting spike in gas prices should support the rouble. The same applies to the high global grain prices and the surge in Russian grain exports ahead of 15 February, when a new grain export duty comes into effect.
Russia’s Fundamentals Have Improved
The economy has also performed better than expected. At -3.1%, the first estimate of Russia’s 2020 GDP growth has bettered both official and market forecasts. It also points to a shallower recession in 4Q, when the economy must have shrunk by 2.5% (vs the 3.4% contraction in 3Q). Russia is proceeding with vaccinating its population with the Sputnik-V vaccine, and the numbers of new daily Covid cases and deaths are falling. The government is also planning to roll out two more vaccines in early spring.
The current account surplus shrunk to ~2.2% of GDP last year, vs 5.5% of GDP in the previous year. Albeit less so than before the Covid pandemic, Russian fundamentals remain supportive of the local currency.
Critically, the oil market hardly provides a reason for the rouble to underperform. In January, Russia negotiated a slight increase in its oil output. Also, Saudi Arabia pledged to cut its oil production unilaterally by 1mn bpd. The most recent monthly OPEC+ ministerial meeting, held in early February, confirmed its members’ commitment to current output quotas. The cartel now forecasts that OECD oil stocks should return to their five-year average this summer. Boosted by these positive developments, Brent has moved up towards $60/bbl.
But Rouble Performance Has Lagged Due to Geopolitics
The rise in geopolitical risks is the most likely explanation for the rouble’s disappointing performance in the past few weeks. The markets are on tenterhooks following Joe Biden’s inauguration as the new US president. They await the new US administration’s reaction to the Solar Wind spying scandal and the allegations that Russia paid members of the Taliban for killing American troops in Afghanistan. However, the main reason for investors’ cautiousness is Russia’s treatment of its opposition and the recent brutal crackdown on dissent.
On 17 January, Russian anti-corruption activist Alexei Navalny boarded a plane to return to Moscow from Berlin, where he had been recovering after poisoning with a chemical agent from a Novichok group. Navalny was arrested upon arrival and charged with breaking the terms of a suspended sentence he received several years ago. On 2 February, a Moscow court jailed him for two years and eight months. Although Navalny’s lawyers have appealed the court’s decision, there is little chance of success. From mid-January to 2 February, the rouble depreciated by about 3.5% vs the USD.
Navalny’s arrest and rushed trial provoked large-scale protests across the country. More than 100,000 participants over 100 cities across Russia participated during the weekends of 23-24 and 30-31 January. Police and special forces brutally suppressed the peaceful rallies. Thousands were detained; hundreds await court trials.
Sanctions Threat Will Linger
The EU announced sanctions against Russian officials in connection with Navalny’s poisoning in September. In December, the EU approved its own version of the Magnitsky Act that provides a framework for imposing sanctions on foreign officials for violation of human rights, including banning entry and seizure of assets. The US has had such legislation in place for a while already. To ease Western lawmakers’ task, Navalny published a list of 35 potential targets of Western sanctions, including several officials he blamed for his persecution.
The EU will discuss its response at the EC summit of EU leaders in March. But its members are unlikely to arrive at a consensus necessary to approve the kind of harsh measures that could trigger a sell-off in Russian markets.
But Muted US Response Could Support the Rouble
The US response is a different story. On 4 February, six US senators submitted a draft bill to Congress targeting several (undisclosed) Russian officials. In theory, the US Treasury could impose sanctions against large Russian companies and their owners, as it has done in the past. Navalny’s supporters released a film around the time of his arrest exposing Russian corruption, which provides an ample choice of potential targets.
However, some of the sanctions that the US Treasury has imposed in recent years targeting major Russian businesses have backfired. They had to be softened or retracted because of the damage to global markets and American businesses. Based on this experience, the Biden administration may prefer to maintain harsh rhetoric and target Russian officials rather than large companies integrated into global markets. In this case, investors should gear up for a rouble rally.
Otherwise, Russian Assets May Continue Underperforming
There are signs that these developments may be keeping investors away from Russia’s assets. Russia’s stock market has been on a mostly declining trend since mid-January. OFZ yields have risen in the year-to-date, reflecting a lower appetite for Russia’s local debt – a possible target for further US sanctions. Admittedly, there is another reason: the recent spike in CPI inflation, which exceeded 5% YoY in January. Investors may be expecting that the next monetary policy move will be a hike. The outflows from Russian assets prevent the rouble from regaining ground vs the USD despite the continued support from the fundamentals. The recent relative USD strength must also be contributing.
EM currencies’ performance has been a mixed bag so far this year, reflecting the fluctuating news on new Covid strains and other epidemic-related vagaries. The approval of further fiscal measures in the US will likely generate stronger inflows in EM assets in the coming months. However, these flows may bypass Russian assets if the recent crackdown on the opposition results in further ‘biting’ Western sanctions.
Tatiana Orlova holds a MSc in Economics from the LSE and has worked as an Emerging Market economist and strategist since graduation in 2001. She has been employed in EM research teams in four investment banks covering a diverse range of CEEMEA economies, with a particular specialism in the post-Soviet economies.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)