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:
Russia does not have a strong enough domestic story to compensate for the commodities export risk
Where will the FDI flow?
For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind. These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms — from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.
So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom. Brazil is sixth from bottom while South Africa ranks two places higher.
At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)
What comes next will be interesting. China grabbed the most FDI in absolute terms in the past decade (around $1.3 trillion or almost half the $2.1 trillion flows to the 21 leading EMs) but RBS notes this is slowing. That’s because China’s low-value manufacturing base is becoming less competitive relative to the rest of Asia and stringent restrictions remain in place in many sectors. Corruption, red tape and general business-unfriendliness prevail. ”The decreasing allure of China from a manufacturing perspective means the country is at risk of suffering a decrease in FDI inflows in coming years,” RBS writes. The bank also notes the nature of FDI into China is changing: half the 2011 flows went to real estate.
On the other BRICS:
Ukraine’s $58 billion problem
Ukrainian officials were at pains to reassure investors last week that no debt default was in the offing. But people familiar with the numbers will find it hard to believe them.
The government must find over $5.3 billion this year to repay maturing external debt, including $3 billion to the IMF and $2 billion to Russian state bank VTB. Bad enough but there is worse: Ukrainian companies and banks too have hefty debt maturities this year. Total external financing needs– corporate and sovereign – amount to $58 billion, analysts at Capital Economics calculate. That’s a third of Ukraine’s GDP and makes a default of some kind very likely. The following graphic is from Capital Economics.
In normal circumstances Ukraine — and Ukrainian companies — could have gone to market and borrowed the money. Quite a few developing countries such as Lithuania recently tapped markets, others including Jamaica plan to do so. Ukraine’s problem is its refusal to toe the IMF line. Agreeing to the IMF’s main demand to lift crippling gas subsidies would unlock a $15 billion loan programme, giving access to the loan cash as well as to global bond markets. But removing subsidies would be political suicide ahead of elections in October. And with the sovereign frozen out of bond markets, Ukrainian companies too will find it hard to raise cash.
So what options does Ukraine have? It could yet sell bonds on global markets. Or it could, as the finance minister sugggested last week, borrow at home in hard currency. But its tiny, illiquid local debt markets are unlikely to attract too many foreign investors. And yields will be ruinous. Ukraine’s 2015 dollar bond is trading with a yield of 9 percent and Ukrainian sovereign dollar debt carries a hefty 870 basis-point premium to U.S. Treasuries, among the highest in emerging markets. Analysts at Capital Economics write:
Issuing debt at interest rates of 8-10% is unsustainable for a country that even on the IMF’s optimistic projections is likely to record average nominal GDP growth (in US$) of only 4.5% a year over the next three years.
The government could also dip into the central bank’s $30 billion reserves. But this would be a temporary fix. Also, reserves are already down $7 billion since last August and spending more of this could leave the hryvnia seriously exposed in coming months.
Three snapshots for Thursday
Initial claims for state unemployment benefits slipped 2,000 to a seasonally adjusted 386,000, the Labor Department said. The prior week’s figure was revised up to 388,000 from the previously reported 380,000.
The four-week moving average for new claims, considered a better measure of labor market trends, rose 5,500 to 374,750.
Brazil’s central bank raised its key interest rate for a fourth straight time on Wednesday as it seeks to rein in persistent inflation, and indicated more rate increases could be on the way soon. This follows a 50bps rate cut from India earlier in the week.
BRICS: future aid superpowers?
Britain’s aid programme for India hit the headlines this year, when New Delhi, much to the fury of the Daily Mail, described Britain’s £200 million annual aid to it as peanuts. Whether it makes sense to send money to a fast-growing emerging power that spends billions of dollars on arms is up for debate but few know that India has been boosting its own aid programme for other poor nations. A report released today by NGO Global Health Strategies Initiatives (GHSi) finds that India’s foreign assistance grew 10.8 percent annually between 2005 and 2010.
The actual sums flowing from India are, to use its own phrase, peanuts. The country provided $680 million in 2010. Compare that to the $3.2 billion annual contribution even from crisis-hit Italy. The difference is that Indian donations have risen from $443 million in 2005, while Italy’s have fallen 10 percent in this period, GHSi found. Indian aid has grown in fact at a rate 10 times that of the United States. Add to that Indian pharma companies’ contribution – the source of 60- 80 percent of the vaccines procured by United Nations agencies.
Other members of the BRICS group of developing countries are also stepping up overseas assistance, with a special focus on healthcare, the report said. BRICS leaders meet this week to ink a deal on setting up a BRICS development bank.
Here are the numbers for the other BRICS (according to GHSi report entitled ”How the BRICS are reshaping global health and development”)
*Brazil is estimated to have provided upto $1.2 billion, mostly to Latin America and Portuguese-speaking African nations such as Mozambique. That’s an annual increase of 20 percent since 2005
*Russia’s foreign aid amounted to $472 million in 2010, mostly to other ex-Soviet states and Africa, four times 2006 levels.
*South Africa brings up the rear with $143 million, up 8 percent a year since 2005. (Click the following graphic to enlarge)
Russia’s new Eurobond: what’s the fair price?
Russia’s upcoming dollar bond, the first in two years, should fly off the shelves. It’s good timing — elections are past, the world economy seems to be recovering and crucially for Russia, oil prices are over $125 a barrel. And the rise in core yields has massively tightened emerging markets’ yield premium to U.S. Treasuries, offering an attractive window to raise cash. Russia’s spread premium over Treasuries hit the narrowest levels in 7 months recently and despite some widening this week it is still some 75 basis points below end-2011 levels.
Initial indications from the ongoing roadshow are for a two-tranche bond with 10- and 20-year maturities, possibly raising a total of $3.5 billion.
But market bullishness notwithstanding, investors say Moscow should resist temptation to price the bond too high, a mistake it made during its last foray into global capital markets in April 2010. Fund managers have unpleasant memories of that deal, recalling that Russia unexpectedly tightened the yield offered by 25-28 bps, making the bond an expensive one for investors who had already placed bids. The bond price fell sharply once trading kicked off and yields across the Russian curve rose around 25-30 basis points. Jeremy Brewin, a fund manager at Aviva said:
Russia has a slightly disappointing reputation.. We all ended up paying a tighter spread than we expected. Everyone is concerned they will get pulled in too tight again.
James Croft, head of emerging debt trading at Mitsubishi-UFJ agrees:
The demand for Russian risk is such that getting this bond away should be no problem. The only impediment that could make the transaction harder is investors’ wariness, based on the negative experience of the last deal back in 2010.
Dear Ms. Rao,
A recent claim successfully put forth by the Russian Government before two French courts (see below) could have drastic financial implications for the Russian State’s budget, stemming from the existence of billions of unpaid russian sovereign debt.
We believe credit rating agencies and emerging debt managers should follow developments in this matter very closely.
The current investment grade ratings enjoyed by the Russian Federation are based on a negligent analysis of inaccurate financial data.
The public accounts of the Russian Federation’s financial position make no mention of (and therefore actively dissimulate) the existence of due debt issued or guaranteed by the Russian State prior to 1917.
It has been put forth to the French Senate (Sénat, Commission des Affaires Etrangères de la Défense et des Forces Armées, rapport no. 150 – 1997 – 1998, projet de loi relatif au règlement définitif des créances réciproques entre la France et la Russie, annexe au procès verbal de la séance du 3 décembre 1997) that the 1997 value of this debt was in excess of 40 billion US$.
If the leading credit rating agencies adjusted the Russian Federation’s public accounts, as they should, to include an additional liability of US$ 40 billion this would no doubt lead to a change in their opinion on that State’s capacity to repay debt, and so to the ratings they issue.
While credit rating agencies and the Russian Federation have both argued wrongly in the past, and still do, that debt issued or guaranteed by the Imperial Russian State is not a full faith and credit obligation of the Russian Federation, they may not be able to do so in the future because recent claims sucessfully put forth recently by the Russian Federation have drastically changed the situation.
By successfully claiming ownership, before two French courts (Tribunal de Grande Instance de Nice in 2009 and Cour d’Appel d’Aix en Provence in 2011), of the Orthodox Cathedral in Nice on the grounds that the building had been paid for out of the Imperial Russian State budget and that the Russian Federation was the successor governement to the Imperial Russian State, the Russian Federation has in fact asked the court to acknowledge what defaulted sovereign bondholders have been saying all along: that the Russian Federation is the successor government to the Imperial Russian State and as such is both entitled to claim its assets and bound to pay off Imperial Russia’s debt.
For more on the matter of negligent sovereign debt rating analysis, please visit our website at:
We thank you for your attention.
The Credit Rating Agency Observatory – CRAO
What chances true democracy in oil-rich Iran?
Truly, oil can be a curse. Having it may enrich a country (more likely its rulers) but it does not seem condusive to democracy. And the more oil a country produces, the less likely it is to make the transition to democracy, according to research from investment bank Renaisssance Capital.
So as Iran goes to the polls today, what are the chances it will become a democracy? (Iran itself could argue, reasonably enough, that it is the most democratic country in the region — everyone over the age of 18, including women, are allowed to vote, though the choice of candidates is restricted)
Surprisingly, the Renaissance report’s author Charles Robertson concludes, Iran does have a chance to achieve democracy, though probably not this year. He says no oil exporting country that produces more than 150,000 barrels per day of oil per million of population has ever achieved a transition to democracy (note Norway was already a democracy before it found oil). But others which produce less oil have done so, notably Algeria, Gabon, Congo Indonesia, Nigeria and Ecuador (Some of these democracies are clearly flawed). Robertson writes:
This suggests that the Gulf states, Equatorial Guinea, and Brunei willl not change their political systems until their energy wealth dries up. ..Yet Iran’s net exports are 32,000 bpd per million people. This is insufficient to immunise it from democratisation pressures.
If Iran was not blessed with oil however, its per capita income of over $10,000 means it would probably have been a democracy. (Though it is equally possible that without the oil it may not have that wealth) Robertson’s “democratisation database” tells him an autocracy with per capital incomes of $6000 to $10,000 has a 6.4 percent chance of a transition to democracy. If incomes are shrinking the odds rise to 15.5 percent.
“So revolution is clearly not a base case scenario for this year but a plausible risk.”
On the positive side, these income levels generally portend peaceful political change rather than violent upheaval, he says, citing the example of Taiwan and Czechoslovakia which moved to democracy in 1992, as well as transitions in Spain and Greece in the 1970s. But more is at stake in Iran — because of its oil. If a revolution awaits Iran, let us hope it is a peaceful one — the last one in 1979 triggered a huge oil shock that propelled the world into recession.
Emerging beats developed in 2012
Robust growth from the emerging market basket in January was always going to be tough to beat, but research from February’s gains show just how strong these markets are performing against developed ones, and not just from the traditional BRICs either, research from S&P Indices shows.
Egypt has been a prime example. Following a bout of political unrest and subsequent removal of Hosni Mubarak after nearly 30 years in power, Egypt’s market returns have rocketed, climbing 15.3 percent in February on top of January’s 44.3 percent take-off.
Thailand, Chile, Turkey and Colombia are also on the to-watch list as these emerging lights have all flashed double-digit returns in the first two months of this year, while all twenty emerging markets included in the S&P data were up, gaining an average of 6.62 percent, making gains in the year-to-date a mouth-watering 18.95 percent.
Compare that with developed market returns of 4.6 percent in February, led by Nordic countries in particular Norway with (13.8 percent) in February, Denmark (13.5 percent) and Sweden (10.2 percent). Yet returns in developed markets were dragged down by Israel (-1.9 percent) and Greece (-2 percent). Overall developed markets grew 10.3 percent in the first two months of the year.
So taken together – equity markets have gained $1.6 trillion in February, which when added to January’s bullish run, clawing back all $3 trillion worth of losses in 2011 leading to the best start the S&P 500 has had since 1987.
Optimism should be checked, however. High oil prices supported by geopolitical pressure at the prospect of an Israeli strike on Iran’s nuclear facilities and subsequent knock-out of a 3.5 million barrel per day production of crude oil could start to have a negative effect on markets, while Europe still faces high levels of debt and the challenge of reducing deficits, which could create a drag on the growth of emerging economies.
S&P says:
The haves and have-nots of the (energy) world
Nothing like an oil price spike to bring out the differences between the haves and have-nots of this world. The ones who have oil and those who don’t.
With oil at $124 a barrel, the stock markets of big oil importers India and South Korea posted their first weekly loss of 2012 on Friday. But in Russia, where energy stocks make up 60 percent of the index, shares had their best day since November, rising more than 4 percent. The rouble’s exchange rate with the dollar jumped 1.5 percent but the lira in neighbouring Turkey (an oil importer) fell.
Emerging currencies and shares have performed exceptionally well this year. Some of last year’s laggards such as the Indian rupee have risen almost 10 percent and stocks have jumped 16-18 percent. But unless crude prices moderate soon, the 2012 rally in the stocks, bonds and currencies of oil-poor countries may have had its day. Societe Generale writes:
As oil prices are now flirting with $125 per barrel, it is reasonable to start thinking about the potential impact on global emerging markets of an oil price shock and the currencies likely to gain the most from elevated oil prices and those that won’t….Russia appears as the clear winner of a potential oil price shock, and the rouble is therefore the best hedge against this risk
The bank advises its clients to buy the rouble and sell the currencies of oil importing Israel and Hungary. In Asia it suggests selling the Korean won. It also recommended exiting long positions on the Turkish lira.
Russia is the clear winner. Revenues from the energy sector provide half the state’s income and according to the graphic below from SocGen, oil exports account for 15 percent of Russia’s economy. At the other end of the spectrum are Taiwan, Korea and Turkey where oil imports make up between 7-12 percent of GDP.
Discovering the pleasure of dividends in Russia
American financier J.D. Rockefeller said watching dividends rolling in was the only thing that gave him pleasure. But it is a pleasure which until now has largely bypassed shareholders in most big Russian companies. That might be about to change.
Russian firms, especially the big commodity producers, are generally seen as poor dividend payers. So dividend yields, the ratio of dividends to the share price, have been unattractive.
On a trailing 5-year period, the average dividend yield in Russia was 1.8 percent compared to 2.5 percent for emerging markets, notes Soren Beck-Petersen, investment director for emerging markets at HSBC Global Asset Management. That absence of positive cash flow from companies is one reason why Russia has always traded so cheap relative to other emerging markets, he says.
See the following graphics from my colleague Scott Barber (@scottybarber)
But as the graph above shows, the ratio has been improving. Beck-Petersen says it stands now at 2.1 percent for Russia versus 2.7 for emerging markets. Smaller oil companies Bashneft and Surgut pay double-digit dividend yields on their preferred shares. Steelmakers Evraz and Mechel gladdened shareholders last year with decent dividends.
