Global Investing

Perfect storm brewing for the rouble

A perfect storm seems to be brewing for the Russian rouble. It has tumbled to four-year lows against a euro-dollar basket. Against the dollar, it has lost around 7 percent so far this year, faring better than many other emerging currencies. But signs are that next year will bring more turmoil.

While oil prices, the mainstay of Russia’s economy, are holding up, Russian growth is not. It is running at 1.3 percent so far this year and capital outflows continue unabated — $48 billion is estimated to have fled the country in the first nine months of 2013 compared with $55 billion in 2012. Russia’s mighty current account surplus has shrunk to barely nothing and could fall into deficit by the middle of next year, reckons Alfa Bank economist Natalia Orlova. Finally, the rouble can no longer count on the central bank for wholehearted day-to-day support. FX market interventions cost the bank $3.5 billion last month  but it also shifted the exchange-rate corridor upwards six times, indicating it is keen to move to a fully flexible currency.

Orlove also estimates that around $150 billion in overseas debt payments are due in 2014 for Russian corporates. She adds:

This is going to be an issue and given that the central bank is actively promoting inflation targeting, the market should prepare for higher rouble volatility.

There is one other major risk. Russian rouble bonds have become the must-have component of every emerging bond portfolio after Moscow made its debt eligible for processing via the major Western clearing houses Euroclear and Clearstream. As a result foreigners’ share of the Russian bond market has rocketed to over 25 percent from around 5 percent in early-2012.

Russia — the one-eyed emerging market among the blind

It’s difficult to find many investors who are enthusiastic about Russia these days. Yet it may be one of the few emerging markets  that is relatively safe from the effects of “sudden stops” in foreign investment flows.

Russia’s few fans always point to its cheap valuations –and these days Russian shares, on a price-book basis, are trading an astonishing 52 percent below their own 10-year history, Deutsche Bank data shows.  Deutsche is sticking to its underweight recommendation on Russia but notes that Russia has:

“become so unpopular with the investor community that it is a candidate for the ‘it’s so bad it’s good’ club as evidenced by the very cheap valuations and long-term  underperformance.

Is the rouble overhyped?

For many months now the Russian rouble has been everyone’s favourite currency. Thanks to all the interest it rose 4 percent against the dollar during the July-September quarter. How long can the love affair last?

It is easy to see why the rouble is in favour. The central bank last month raised interest rates to tame inflation and might do so again on Friday. The  implied yield on 12-month rouble/dollar forwards  is at 6 percent — among the highest in emerging markets.  It has also been boosted by cash flowing into Russian local bond market, which is due to be liberalised in coming months. Above all, there is the oil price which usually gets a strong boost from Fed QE.  So despite worries about world growth, Brent crude prices are above $110 a barrel. Analysts at Barclays are among those who like the rouble, predicting it to hit 30.5 per dollar by end-2012, up from current levels of 31.12.

All that sounds pretty bullish. But there are reasons why the rouble’s days of strength may be numbered. First the QE effect is unlikely to last. As we argued here, QE’s impact will be less strong than after the previous two rounds. Analysts at ING Bank point out that in 3-6 months after the launch of QE2 oil prices gained 40 percent, pushing the rouble up nearly 10%. This time oil won’t repeat the trend this time, and neither will the rouble, they say:

Oil falls. So does the Russian stock market

Russian equities have had their worst week since early-December, with losses of over 6 percent. But don’t look too far for the reason — world crude futures have fallen to three-month lows around $114 a barrel on worries that U.S. and world economic growth may not be picking up after all.  They too have fallen 6 percent so far this week. Check out the following graphics showing how Russian stocks and its currency move in lock-step with oil prices:

If anything, the falls on Russian assets are outpacing the weakness on global crude oil markets in recent months, possibly because the jitters that caused last December’s massive falls have not been entirely overcome. Anti-government demonstrators are no longer hitting the streets but  with President-elect Vladimir Putin to be sworn in next week, fears are the  Kremlin may prefer squeezing more cash from energy companies to implementing the reforms the economy desperately needs.  Latest plans flagged on Thursday  to raise oil and gas extraction taxes would seem to confirm these worries and are hitting energy sector shares — half the Moscow index.

All this has widened Russian stock valuations to almost record levels against the broader emerging equity set.  But that is unlikely to entice buyers if the oil price stays where it is — after all half of Russia’s revenues come from oil and it needs an oil price of around $120 a barrel  to balance its budget. Chris Weafer, chief strategist at Troika Dialog puts it succinctly: