Explainer: Russia’s financial health amid a geopolitically driven market sell-off

A sign bearing the logo of the Moscow Stock Exchange is displayed at its office in Moscow, Russia March 10, 2020. REUTERS/Shamil Zhumatov

MOSCOW, Jan 21 (Reuters) – Russian assets are under pressure as investors worry about a possible extension of U.S. sanctions or new EU measures targeting officials, banks and the energy sector if Moscow attacks Ukraine – a move Russia denies planning.

The Russian stock market (.IMOEX) has lost around 20% since hitting record highs in October, the ruble has fallen to more than eight-month lows and benchmark Russian government bond yields OFZ 10-year bonds hit their highest level in almost six years in January. Read more

On Friday morning, Russian assets fell again, as markets await a meeting between US Secretary of State Antony Blinken and Russian Foreign Minister Sergei Lavrov in Geneva later in the day. Read more

Despite the dangerous geopolitics, Russian officials say economic fundamentals are solid and the ruble’s volatility is temporary.

How healthy are Russian finances and what could the authorities do to calm the markets?

RUBLE

The central bank let the ruble float freely in 2014, after waves of Western sanctions followed Russia’s annexation of Crimea to Ukraine, and as it sought to protect gold and currencies.

Under a fiscal rule adopted in 2017 to bolster the National Wealth Fund (NWF), Russia buys foreign currency when oil prices are high and sells when prices fall below $44 a barrel, thereby protecting the ruble from oil price fluctuations.

In 2020, Russia was selling currency, which helped limit ruble losses amid falling oil prices, the COVID-19 pandemic and geopolitical risks.

“As oil and gas prices remain high, we believe the main driver of ruble depreciation is geopolitics,” not macroeconomic fundamentals, Sberbank CIB said.

CURRENT ACCOUNT AND CAPITAL OUTLETS

A historic Russian current account surplus of $120.3 billion, equal to 7% of gross domestic product and driven by high gas prices last year, is supportive of the ruble, ING said.

Still, net capital outflows widened to $72 billion last year, its highest level since 2014 and from $50.4 billion in 2020. “This keeps the local currency undervalued, making it makes it continuously favorable to the balance of trade,” ING added.

INFLATION

While supporting fiscal revenues, a weaker ruble is contributing to inflation, which hit 8.62% in annual terms this week, double the central bank’s target and near six-year highs.

“Given the high volatility in Russian financial markets in recent days, (the) possibility that the central bank will raise its key rate by 100 basis points increases,” Alfa Bank said, forecasting an eighth consecutive hike in February at 9, 5%.

RESERVES AND BUDGET

Russian gold and currency reserves are at an all-time high of more than $630 billion, enough to cover 25 months of imports or Russia’s total external debt of $490 billion, Renaissance Capital said.

Russia ran a budget surplus of nearly $7 billion last year, driven by energy prices and a weak rouble. The NWF’s liquid assets – funds in central bank accounts – reached $113.5 billion, or 7.3% of GDP.

“This can be used for budgeting purposes in times of stress,” Morgan Stanley said.

RUSSIAN OFZ BONDS, STOCK MARKETS

Foreign investors sold 214 billion rubles ($2.8 billion) worth of OFZ treasury bills in November-December, with the share of foreigners among OFZ holders falling by 1.1 percentage points to 19, 5% at the end of the year.

The central bank cannot buy OFZ directly from the market under current laws, but the Finance Ministry said Russian banks could step in and increase their holdings of domestic bonds. Read more

US investors account for about a third of foreign holdings of OFZ, less than the state-owned VTB (VTBR.MM), Russia’s second-largest bank, which has nearly 2 trillion rubles of OFZ in its portfolio. Read more

The Department of Finance canceled bond auctions this week amid high volatility. He says the strong fiscal position allows him to borrow less. Russia enjoys a debt level of 20% of GDP, lower than an average of 60% in emerging markets. Read more

The Russian stock market is 2.4 times cheaper than its emerging market counterparts and nearly 5 times cheaper than the S&P 500, Gazprombank said in a note. It has average dividend yields of 10% and could provide strong returns, with geopolitical escalation providing attractive prices, Gazprombank said.

“But the level of uncertainty is still high,” the bank said.

($1 = 76.7020 rubles)

Reporting by Katya Golubkova additional reporting by Karin Strohecker in London; Editing by Frank Jack Daniel

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