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The effects of the Russian economy and low oil prices on the CIS region “An analysis of how the Russian currency and oil prices affect remittance channels, local economies and their Fx” Prague, 6 November 2015 1 Historical Perpective : Foreign Exchange 2 * For Belarus and Tajikistan ; Jan2001=100 I. 1998 Russian Crisis II. Between the Two Crises I. Trade Links with Russia II. FDIs versus Remittances III. 2014 Russian Crisis I. Situation in Russia II. Impact on Remittances III. CIS currencies IV. Vulnerability of the Financial Sector to FX 3 1998 Russian Crisis • Fixed exchange rate regime between the ruble and foreign currencies • Fragile fiscal position, political crisis • External shocks – Asian crisis, world commodity prices dropping, rubble under speculative attack • Result: severe banking, currency and sovereign debt crisis • September 1998 – currency corridor removed, making the ruble a freely floating currency 4 I. 1998 Russian Crisis II. Between the Two Crises I. Trade Links with Russia II. FDIs versus Remittances III. 2014 Russian Crisis I. Situation in Russia II. Impact on Remittances III. CIS currencies IV. Vulnerability of the Financial Sector to FX Title | Date 5 Trade Links to Russia Net Goods Exports to Russia (%GDP) Net Goods Imports from Russia (%GDP) • Vast majority of the CIS countries are net importers from Russia • Moreover, mostly widening merchandise deficits to Russia • Increasing vulnerability to Russia or just a general widening of the merchandise deficits? 6 Trade Dependency with Russia 2000 vs 2013 Exports to Russia (% of Total) Imports from Russia (% of Total) • Most CIS actually had weaker merchandise links with Russia in 2013 than in 2000. 7 Balance of Payments • Remittances play a crucial role in making the large merchandise deficits sustainable • Rather low foreign direct investment inflows BUT important capital link in the banking sectors! Remittances • Russia is by far the biggest origin of the remittances in the CIS region, or at least in countries where remittance play an important role 9 I. 1998 Russian Crisis II. Between the Two Crises I. Trade Links with Russia II. FDIs versus Remittances III. 2014 Russian Crisis I. Situation in Russia II. Impact on Remittances III. CIS currencies IV. Vulnerability of the Financial Sector to FX 10 Overview of Situation in Russia November 2013 - Gradual depreciation of the rubble against both EUR and USD started (before Russian-Ukraine conflict emerged and when oil prices were high) March-April 2014 – Effect of Russia’s annexation of Crimea and the first round of US and EU sanctions against Russia July 2014 – December 2014 – falling oil prices, speeding up pace of rubble’s depreciation temporarily halted by a massive FX intervention January 2015 – S&P’s downgrade of Russia’s credit rating and subsequent escalation of the Donbass conflict in Ukraine 11 Remittances Development Growth of Remittances (USD, YoY, in percent) 40 20 0 -20 -40 -60 -80 13Q1 Armenia Belarus Georgia Kyrgyzstan Kazakhstan Moldova Tajikistan 13Q2 13Q3 13Q4 14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 • Remittances denominated in USD have been tumbling along with the nominal depreciation of rubble • Increased vulnerability given the declining trade links with Russia 12 International Reserves * As of February 2015, no newer data available. • While all CIS currencies have depreciated wrt to USD, the national banks have also lost a substantial share of their Foreign Exchange Reserves Sources: IMF, World Bank 13 Nominal Exchange Rates Appreciation • However, the Russian rubble has weakened even more wrt the USD, leaving all the CIS currencies relatively stronger with respect to the rubble in nominal terms • So what is the conclusion? Sources: Bloomberg 14 Real effective exchange rate Has the nominal depreciation been sufficient to help adjust the external imbalances? Sources: Bloomberg, TCX 15 I. 1998 Russian Crisis II. Between the Two Crises I. Trade Links with Russia II. FDIs versus Remittances III. 2014 Russian Crisis I. Situation in Russia II. Impact on Remittances III. CIS currencies IV. Vulnerability of the Financial Sector to Fx 16 High levels of debt in foreign currency High vulnerability to external shocks Public and private sector debt denominated in foreign currency as % GDP Sources: IMF, national authorities via CEIC, BIS and EBRD 17 Too much private sector debt in foreign currency Very high company and household FX burden Corporate and household debt denominated in foreign currency as % GDP Sources: IMF, national authorities via CEIC, BIS and EBRD 18 Persistent NPLs mean lower credit growth and subdued investment impending economic development Bank nonperforming loans to total gross loans (%) Sources: World Bank 19 Increasing NPL’s expose the most banks in dollarized economies to a “perfect storm” 2014- Bank nonperforming loans to total gross loans (%) Public & private debt denominated in foreign currency (as % GDP) Sources: World Bank and EBRD Systemic under-supply of local currency financing FX risk is very high and increasing Loan impairments increasing and credit crunch unfolding – systemic risk increasing/perfect storm (Moody’s – July 2015 Announcement ) Large majority of SMEs do not export. When an SME borrows in FX, it bears significant currency risk. Other borrowers tend not to have Fx earnings Bank funding from domestic sources. Generally limited local currency deposits and very limited institutional sources Bank funding from cross-border sources is primarly in USD/Euro and 90% from IFI’s/MIV’s Bank funding in FX necessitates the banks lend to SMEs in the same currency as their funding (FX) Local currency loans incur much lower NPL ratios (EBRD) 22 Conclusion Compared to ’98 Russian crisis, we are now dealing with: Significantly higher role of remittance inflows, mainly coming from Russia Trade links with Russia have weakened Important capital link to Russia in the CIS banks, running currency mismatches Consequences: Increased vulnerability of CIS countries to external developments that are out of their scope of influence (oil prices, performance of Russian economy,...) Exposure of banking sector to source of funding in HCY and solvency of borrowers in foreign currencies has increased the vulnarability of these countries to external shocks What to do? Promote the usage of local currencies and prevent clients who do not earn HCY to borrow to take a hit on brutal Fx re-adjustements. 24