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Sunday, 27 October 2013

Russia and Tapering, continued...

And yet?

Purveyors of the short-term will no doubt home in on the solid country-risk fundamentals that I highlighted in my last blog. In short, the Russia-story since the 90s has been of a transition economy transforming itself from plan to market, backed by an oil-bonanza helped with some semblance of co-ordinated government under Putin after the volatility of the Yeltsin era.
This broad-sweep narrative remains essentially unchanged.  And yet the concerns that Russia’s reliance – and therefore vulnerability – to oil continue to be key to understanding the policy framework, and market risks, on Russia.

Two decades after the Soviet collapse Russia is a less diversified economy than in 1991. Put another way it is more vulnerable to a demand shock for hydrocarbons (principally for oil but also gas in a world of ever increasing shale gas) and terms of trade shocks through falling prices for the hydrocarbons.
The data on growth for the year is likely to show growth between shy under 2%. The IMF’s 1.5% has ruffled feathers in Moscow and expect a little bit more of monetary and fiscal easing to help tick along GDP toward the 2% mark to at very least blow a big raspberry towards the Fund. A positive tail-risk of upside to EU growth should also help propel external demand even though the rest of domestic demand will remain moribund.

From a policy perspective the 2-decade concern about the Dutch-disease effect of a rising real exchange rate remains a longer-term concern even though it has been less of an issue in 2013 given the devaluation of the RUR and Central Bank interventions to defend it to the its target range…sorry inflation target!
The fall in the Current Account this year – and the Trade balance in particular – has been ostensibly around the falling oil revenues. Russia’s budget is based on a $115 barrel of oil and where 1 in 4 jobs is in the public sector. And the reduction in external demand has directly affected the exchange rate – through both the current account decline and increasing volatility on the capital account including a large dose of capital flight but also partly due to a rise in access to the Russian bond market for outsiders – see below.

The large size of the share of the public sector in GDP and employment means that the cyclicity of growth on the back of hydrocarbons is much greater than would otherwise be the case. And explains a much greater focus in the last few months on structural aspects of growth – including statements by the president, PM and the minister of Economy to improve business environment more generally.

Whether we can expect anything of substance I’ll comment upon separately.

As regards the short-term impact on investment in Russia and the impact of the tapering discussion,
  1.  Russia’s greater inclusion in the EM space is more prevalent following the change in law in February that allows for greater participation of foreign investors -  central securities depositories Euroclear and Clearstream were given permission to participate directly in trading of ruble-denominated paper. The Central Bank has grumbled about keeping its beady eye on the situation given greater potential volatility on the domestic bond market and the exchange rate – and  I concur: Russia will be hit by the financial wave of portfolio outflow from EM.
  2.  But also expect a reversion of flows once the dust settles and country segregation amongst the EMs resurfaces– simply on the back of fundamentals over the herd-instinct impulse to bunch Russia to the rest. Its $7bn Eurobonds were 4-times over-subscribed on the back of a strong sovereign balance sheet.
  3.  I don’t expect the half-baked ideas floating in Moscow for de facto rise in public investment to make a serious dent on fiscal policy (again worth a separate piece).
  4.  And monetary side? The key interest rate (repo rate)  will not change – the talk has been to ease financing for SMEs but with exchange rate wobblies of late the CBR will not do this. Instead the CBR has been busy putting in place a batter of interest rate tools to allow it move toward full-fledged inflation target by 2015 and a slight uptock to a 5% inflation target and this will take effect once rubber-stamped by the Duma.

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