I Don't Think Russia Will Blow Up This Time Around

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Includes: RSX, RSXJ
by: Paulo Santos

Summary

The market seems increasingly convinced that what is happening in Russia is a repeat of 1998.

However, there are significant differences, which I outline.

Based on these differences, I don't expect Russia to default on its public debt. There will, however, be increased defaults among private companies with foreign currency exposure.

Russia (NYSEARCA:RSX)(NYSEARCA:RSXJ) has been in the news a lot, lately. And not for a good reason. The ruble is crashing, crude is crashing, its economy is entering recession, inflation will go higher with such ruble weakness, currency reserves are being spent futilely in trying to defend the ruble … it all seems to be going downhill pretty fast. And that's on top of the sanctions because of the Ukraine situation.

I have, myself, moved to the sidelines due to the crude crashing. But there's also the fear that we might see a 1998 repeat, where Russia actually defaulted. If such scenario happened again, the correct timing to buy Russia would be right after the default, and not in front of it.

However, I now believe that there's good reason to predict Russia will stave off default this time around. Yes, the crude crash will take a bite out of Russia's economy and it won't help public finances either. But in the end, at least a default on public debt seems very unlikely. Let me explain why.

Going into 1998

When Russia was approaching its default back in 1998, it was running a public deficit of 8% of GDP on a cash basis (Source: IMF.org), its public debt represented 75% of its GDP (Source: Worldbank.org), and it also faced an oil shock.

The oil shock was comparable to what's happening now, with Brent crude dropping 49% between October 1997 and June 1998 (Source: EIA). This came as a consequence of the Asian currency crisis and the lower demand it produced, and also led to drops in other minerals where Russia is a large seller.

Furthermore, coming into 1998, Russia had already experienced a deep recession lasting from 1992 to 1996 (Source: IMF, same link as above), of which it saw only very limited recovery in 1997. Thus, not only did Russia have the worst of today (the oil shock) - it also had a lot of problems that simply aren't present today.

Today

The Russia of today is significantly different.

Owing to many years of stability and high commodity prices, along with debt forgiveness and inflation, Russia enters this crisis with barely any public debt (public debt/GDP is 10.45%) and also running a public finance surplus of 0.3% of GDP (Source: EconomyWatch.com).

Sure, these economic statistics are likely to deteriorate as it fights the current crisis, but they're so far from presenting problems that they make a default very unlikely. Countries simply don't default of low public debt figures and with budget surpluses.

On the other hand

There are entities within Russia which are significantly different from what I stated above regarding the public finances. Russia has gross external debt of 35% of GDP, and about half of this is with private companies (with the remaining resting with entities considered as public) (Source: Russian Federation Central Bank).

Among these companies, those that have debt in dollars or euros and close debt maturities are bound to have problems both paying back the debt (inflated by the ruble's weakness) as well as refinancing it. In this case, it's not surprising to see a high number of defaults within those companies.

Conclusion

The Russia of today is much different from the Russia of 1998. At least in terms of budget deficits and outstanding public debt/GDP, the Russia of today is much safer than it was then.

This leads me to predict that while there is a high amount of grief regarding the situation right now, ultimately this time around Russia won't default.

On the other hand, defaults among private companies that have debt in foreign currencies and close maturities are likely to rise meaningfully.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.