Russia’s nascent economic recovery from the 2014-2016 recession and recent stabilisation have been disrupted by fresh US sanctions. The April round has shifted the USD/RUB exchange rate by about 7% weaker, to c.62. The combined impact of the draft bill introduced by a number of US Senators led by Lindsey Graham on 1 August and “Skripal case” sanctions announced last week have had a similar effect, bringing the USD/RUB down by another 7%, to c.67. The recent currency weakness was supplement by an exodus of foreign investor from Russia stocks and bonds.
The timing of the latest sanctions has been particularly unpleasant. They have coincided with the seasonal weakness of Russia’s balance of payments, while energy sales are at a minimum between the heating seasons. Besides, July-August is the period when many foreign investors repatriate annual dividends.
The sanctions have also followed the recent decisions to raise the retirement age and to lift the VAT rate, with the latter expected to raise inflation by about 1 ppt next year, bringing it above the 4% YoY CBR target, albeit temporarily.
On the market-positive side, the Finance Ministry has reacted to the rouble depreciation by scaling down its FX purchases, which have been initially scheduled to set a record in August.
Global EM asset selloff
The global environment amplifies the negative effect. Emerging market assets have been going through a challenging period, characterised by a prolonged selloff.
While the selloff in Turkish assets have been on a much larger scale compared to that in Russia, other EM asset prices globally have also been affected. The EM weakness is largely the result of a shift in investor interest globally towards US assets. The attractiveness of US bonds is supported by Fed’s policy rate hikes, while US stock prices have been supported by rising corporate profits. Accordingly, some weakness in Russian assets (including the rouble) in August has probably been inevitable even without sanctions.
FX performance versus dollar in AugustSource: Bloomberg
Oil prices remain a major factor for the Russian economy. Their relative weakness recently, with Brent trading towards USD70 per barrel, has added to the pressure on Russia’s assets. Importantly, most observers have kept a positive outlook for oil prices, thanks to the strength of growth in the US and a number of other economies. For instance, the US Energy Information Administration expects Brent oil to trade in the range of USD73-80 per barrel in the medium term, with a short-term rise to USD82.
Brent oil forecasts, USD per barrel
Source: Oxford Economics, Energy Information Administration
Short-term macro outlook
In our view, the nature of the freshly proposed US sanctions falls far short of those introduced by the US either earlier this year, or back in 2014. Even this April’s sanctions have carried a stronger impact. As such, we believe the main effect from the recent sanctions has been and will be on the market sentiment.
If introduced, the ban on sovereign debt purchases (initiated by US Senators) would have a significant short-term impact on most Russian asset prices. However, its passage is in doubt. In fact, the US Treasury has assessed such a measure back in January and has opined that it would be counterproductive.
We expect the rouble to retrace most of its recent weakening before the year-end, provided the favourable oil price forecast materialises. While clarity with the US sanctions should help sentiment, the expected pick-up in oil prices will be the key support factor. Besides oil prices and sanctions, other external factors include broad sentiment towards EM assets: escalating trade disputes, particularly involving Chinese products, would very likely extend the recent weakness in EM currencies against the dollar. A common perception (that we share) is that trade tensions are likely to subside following the US congressional elections in early November.
The impact of domestic developments on the RUB is very likely to be less significant than that of external factors. The scale of Minfin’s FX interventions is likely to prove the most significant such factor. We believe that the Finance Ministry will significantly reduce its FX purchases in the coming months. The CBR’s monetary policy (and guidance) will also be important, in particular in reaction to the inflation developments (and their key drivers).
Real estate investment market implications
Higher financial market volatility usually reduces investor activity in Russia real estate. With most of local assets trading in roubles, FX volatility is a particularly influential factor. In the recent weeks, the confluence of several factors has triggered a panicky reaction and resulted in a typical currency overshooting. The recent rouble dips are likely to cause real estate investors to pause deal executions in order to let the currency stabilize and to re-evaluate their deals in light of the changes. We expect this to happen during the next 1-1.5 months.
We view the market reaction to the US-Turkey standoff as excessive, and we do not expect the proposed Russia sanctions to be carried out at full extent. When the market stability returns, we believe so will the investor activity.