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Crimea Punishment Does Little To Deter Russian Economy

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Includes: AKSJF, ERUS, GZPFY, LUKFY, LUKOF, LUKOY, NILSY, OCRNL, OGZPY, RNFTF, RSX, RSXJ, RUSL, RUSS, SBRCY
by: Interactive Brokers
Summary

The Russian Federation has been recently enjoying a bout of positive economic momentum, with its sovereign credit profile bolstered by improvements in the country’s ability to withstand certain external shocks.

Since 2014, the U.S., the EU, among other countries, introduced sanctions against Russia and some of its corporations in response to military intervention in Ukraine and the annexation of Crimea.

Overall, while the sanctions had taken a toll on the country’s energy sector, certain of Russia’s major oil companies now appear to have decent financial and operational health.

The market’s perceived confidence in many of the country’s energy sector firms has recently been on an upward path.

Investors will receive further color about Russia’s economic activity in the week ahead, including service sector business activity and inflation, following the introduction of an increased VAT in January.

Interactive Brokers - Emerging Markets: The Week Ahead (Mar 4 - 8)

The Russian Federation has been recently enjoying a bout of positive economic momentum, with its sovereign credit profile bolstered by improvements in the country’s ability to withstand certain external shocks.

Since 2014, the U.S., the European Union, and certain other countries, introduced a series of sanctions against Russia and some of its domestic corporations, including energy giant Gazprom (OTC: OGZPY) and state-owned Gazprombank, in response to Russia’s military intervention in Ukraine and annexation of Crimea.

Among a long list of other actions, U.S. President Donald Trump’s administration in April 2018 implemented new sanctions, including a state-owned Russian weapons trading company, which, according to The White House, had provided military equipment and support to the Government of Syria, enabling the regime’s ongoing attacks against Syrian citizens.

Overall, while the sanctions had taken a toll on the country’s energy sector, to date, certain of Russia’s major oil companies appear to have enough financial and operational health to withstand moderate shocks, amid higher revenues and ongoing deleveraging.

Indeed, the market’s perceived confidence in many of the country’s energy sector firms has recently been on an upward path.

Over the past three months, five-year credit default swap (CDS) spreads have narrowed dramatically, with Gazprom around 31bps tighter to almost 178.5bps, Rosneft Oil (OTC: OJSCY) tighter by about 27.5bps to 226bps and Lukoil (OTC: LUKOY) having narrowed a little more than 33bps to just north of 182bps.

Meanwhile, spreads on Russia’s sovereign five-year CDS have tightened almost 36.5bps over the past three months to a little more than 131bps.

Getting an upgrade

Against this backdrop, Moody’s Investors Service earlier in February upgraded Russia’s sovereign credit rating to an investment-grade ‘Baa3’ from a junk status ‘Ba1’.

The ratings agency noted that the improvement in the country’s credit profile reflected the positive impact of recent policies to strengthen the nation’s “already robust” public finance and external metrics, as well as to reduce vulnerability to external shocks, including fresh sanctions.

Moody’s analysts Kristin Lindow and Yves Lemay said that “the impact of likely new sanctions -- which is the most likely source of such a shock in the coming months -- could, in the rating agency's view, be contained without material damage to the country's credit profile,” in part as fiscal consolidation and shifts in government debt borrowing sources mean that “the government's borrowing plans could, if needed, be executed domestically.”

Lindow and Lemay added that sanctions-related uncertainties had already driven cross-border financing of Russian entities sharply lower, with non-resident holdings of Russian sovereign domestic debt down by roughly one-third since April 2018, and around two-thirds of remaining non-resident holdings are denominated in rubles. Moreover, they said, “with the introduction of the fiscal rule and oil prices above the budget's breakeven price, the budget is currently in surplus so the government's net borrowing needs are in any event very small.”

Shortly after lifting the country’s credit rating, Moody’s, among other ratings actions, also upgraded 12 Russian non-financial corporates to ‘Baa2’ from ‘Baa3,’ including nine companies in the oil and gas, steel and mining sectors, given their “particularly strong credit metrics with a substantial share of foreign-currency revenue and strong liquidity profiles.” These, Moody’s said, “gives them a degree of resilience at times of sovereign stress.”

The iShares MSCI Russia ETF (ERUS), which has among its top holdings Lukoil, Gazprom, MMC Norlisk Nickel (OTC: NILSY) and Sberbank (OTC: SBRCY), has retraced roughly 12.7% of its losses from its latest 52-week low set December 24.

Notes from the Calendar

Investors will receive further color about Russia’s economic activity in the week ahead, beginning in earnest with a report on business services:

Tuesday, March 5

  • Markit Services PMI (Feb)

Russian service sector business activity expanded further in January, with the rate of growth accelerating from the prior month, due in large part to the effects of a higher VAT.

The IHS Markit Russia Services Business Activity Index posted 54.9 in January, up from 54.4 in December.

Due to the Russian government’s increase in the Value Added Tax (VAT) from 18% to 20% at the start of 2019, input prices quickened to the sharpest rate since September 2008.

The improvement in output was buttressed by a sharp upturn in new business, and the fastest rise in new export orders since that series began in September 2014.

IHS Markit economist Siân Jones said that a “faster rise in new business supported a solid rate of job creation among service providers. Of key importance at both the sector and composite level was the recent hike in VAT.”

Jones added that input price inflation “faced by service providers spiked to its fastest in over a decade. Encouragingly, service sector firms were able to raise output charges at the quickest rate since December 2014.”

Wednesday, March 6

  • CPI (Feb)

By mid-week, investors will receive an update on Russia’s rate of inflation after having edged higher in January 2019 by 0.7 pp to 5.0%.

According to the Bank of Russia, the uptick in the consumer price index (CPI) was expected, coming as a result of the VAT rise from January 1. Also, in January 2018, consumer price growth was atypically low – under the impact of temporary factors from the food supply side.

The Russian central bank characterized the contribution of the VAT increase to annual consumer price growth in January as “moderate.” Furthermore, the bank said, prices are completing their adjustment to the ruble’s weakening of the second half of 2018.

According to the Bank of Russia’s outlook, the VAT increase and the 2018 weakening of the ruble will temporarily accelerate annual inflation, which will peak in the H1 2019 and run at 5.0-5.5% by the end of 2019.

The bank added that quarterly year-on-year CPI is set to decelerate to 4% as early as H2 2019. Annual inflation will return to 4% in H1 2020, “when the effects of the ruble’s weakening and the VAT rise peter out.”

The Bank of Russia earlier in February elected to keep its key rate at 7.75%, with somewhat increased expectations about household and business Inflation.

Thursday, March 7

  • Vehicle Sales (Feb)

Rounding-out the week’s activity, Russia is set to release February’s figures for vehicle sales after a drop in the prior month. Sales fell 103,064 in January from 175,240 in December, unchanged year-on-year.

Investors will also likely be eyeing progress on the global trade front, as well as cues about monetary policy from developed countries’ central banks, the price of crude oil, as well as developments around the UK’s plans to exit from the EU and the U.S.’s relationship with North Korea, among other geopolitical risks, for any potential adverse impacts on Russia’s economic momentum.

Note: This material was originally published on IBKR Traders' Insight on February 26, 2019.

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