Download Russia: Stagnant Stability

Russia: Stagnant Stability
February 17, 2017
by Yacov Arnopolin
of PIMCO
A recent trip to Moscow on the 100th anniversary of the 1917 revolution revealed not a whiff of
revolutionary change in the economy, but rather stagnant growth mixed with structural stability. We
could simply call it “stagnant stability.”
Despite the hit to real incomes, the country weathered the 2014–2015 double shock of collapsing oil
prices and Western sanctions far better than anticipated. Yet the consequences of that crisis are still
felt in the economy: Russia’s current account surplus is likely to settle around 2% (far lower than
earlier in the decade, but still above that of most oil-exporting countries), and real GDP growth is
predicted to eke out 1.5% or so in 2017.
On the bright side, despite the tepid rebound, Russia proved its resilience to shocks, in no small part
thanks to orthodox policymaking by the Central Bank and Ministry of Finance. The latest examples of
what we believe are prudent policies are the freeze on nominal expenditure and a fiscal rule designed
to sterilize oil revenue above $40/barrel and replenish the Reserve Fund by purchasing U.S. dollars in
the market (assuming no budgetary deficit). A strong signal that policymakers intend to prevent
wasteful spending, the measure is even more impressive coming just a year ahead of presidential
elections.
Sanctions: outlook and impact
While the likelihood of U.S. and European sanctions removal is difficult to estimate given the murky
international political climate, we believe there are four key considerations on this front:
1. Sanctions removal is far from assured given U.S. congressional hawkishness toward Russia and
the dimming prospects of pro-Russia French presidential candidate François Fillon. Rather than
a blanket lifting of sanctions, there may be piecemeal adjustments that alleviate the choke on
individual industries.
2. The impact is more likely to be felt via the capital account (additional foreign asset purchases)
than in the real economy. Russia’s investment climate remains subpar given transparency
issues, and restored trade ties with Europe, for example, may not translate into a wave of foreign
direct investment. Banks report lukewarm demand for loans from Russian corporates as they see
a dearth of investment opportunities in the local economy.
3. With over 35% of budgetary receipts, 60% of exports and circa 10% of GDP, the oil and gas
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sector is and will remain the key driver of Russia’s prospects. Just as the introduction of
sanctions proved less dire for the country’s GDP than feared, so will their removal be less of a
boon than hoped.
4. The surge in the ruble and rally in the country’s credit and CDS spreads (see chart) suggest
markets have already priced in a favorable (for Russia) outcome with regards to sanctions. An
actual removal may thus do little to further fuel asset prices.
Investment considerations
For bond investors, however, Russia may appear to be a “safe(r)” haven in times of emerging market
volatility than less stable emerging market countries. Despite its hawkishness and razor-sharp focus on
achieving 4% inflation, the Central Bank is likely to cut rates later in 2017. And even if the ruble’s rally
may be running out of steam, we believe it remains an attractive currency on a carry-to-volatility basis.
chart-russia-yacov
Yacov Arnopolin is an emerging market portfolio manager and a contributor to the PIMCO Blog.
DISCLOSURES
All investments contain risk and may lose value. Investing in the bond market is subject to risks,
including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds
and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer
durations tend to be more sensitive and volatile than those with shorter durations; bond prices
generally fall as interest rates rise, and the current low interest rate environment increases this risk.
Current reductions in bond counterparty capacity may contribute to decreased market liquidity and
increased price volatility. Bond investments may be worth more or less than the original cost when
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redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened
risk due to currency fluctuations, and economic and political risks, which may be enhanced in
emerging markets . Currency rates may fluctuate significantly over short periods of time and may
reduce the returns of a portfolio. There is no guarantee that these investment strategies will work
under all market conditions or are suitable for all investors and each investor should evaluate their
ability to invest long-term, especially during periods of downturn in the market. Investors should consult
their investment professional prior to making an investment decision.
© PIMCO
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