Page 27 - IFR Opportunities in Russian capital markets

CHAPTER 01
ifrintelligence reports/Opportunities in: Russian Capital Markets
Politics and fiscal loosening
Maybe the biggest danger from the upcoming elections is the fact that the government is likely to loosen the purse strings and boost social spending, which will put pressure on inflation and ruble appreciation.
Fitch said in a note in January: "The IMF forecasts that the general government non-oil deficit could widen to 8.3% of GDP in 2007 from 4.3% in 2004, and Fitch forecasts that the federal government surplus will narrow to 3% in 2007 from 7.5% in 2006. By the end of January a significant loosening of fiscal policy was already clearly underway as money supply grew 48% month-on-month, twice the normal rate.”
Oil price scenarios
There is a consensus among economists covering Russia that domestic growth is extremely robust and almost all the dangers are external. Several banks have tried to forecast what would happen to the equity market if oil prices were to fall precipitously.
However, oil would have to fall a long way and stay low for more than a year to do any real damage to the economy. The government is expecting to spend about US$156bn this year. Even if the price of oil dropped to zero and so wiped out two-thirds of the state's revenue, the whole year's spending would be covered by the US$100bn in the Stabilisation Fund. With a less drastic fall, the fact that Russia's sovereign debt is now so low as a proportion of GDP, the state could afford to borrow its way out of trouble for several years.
UBS carried out the most comprehensive study in December 2006, looking at scenarios with the average price of oil at US$40, US$50, US$59 (UBS' base case) and US$67 (the base case in 2006). See Table 1.9 for details.
Below US$40: The real economy would start to be affected in a serious way only with oil prices below US$40. The reason is that, at that point, both the budget balance and the current account would turn negative. UBS says it is impossible to guess how the state would react to such a scenario.
"Would it open the coffers of the stabilisation fund and start spending from it? Would it start supporting the ruble from a depreciation, etc? Given this ambiguity, the uncertainty of investing in Russia would, in our view, start rising more rapidly. This is not that we would see a crisis but uncertainty and sentiment would be sufficiently affected to cause companies to take a more defensive attitude. Consumption driven by credit creation would also be affected negatively, reducing domestic demand growth further," says UBS.
At US$40: UBS says the net private inflows would fall from their 2006 level to US$30bn. The case for a currency appreciation would be far less obvious and fewer investors would place such a bet, hurting the bonds market.
"Still, we do not think that the CBR would depreciate the ruble ahead of the election just at a time when the population at large has shifted its deposits and cash into rubles," says UBS.
Above US$40, but below US$60: UBS says the main impact would be in the nominal sphere. “Real growth would marginally fall, we believe, to 6% rather than the 7.5% of our base forecast.
"More notable would be the impact on nominal GDP growth. Depending on the oil price Russia's GDP in dollar terms would grow by between 8% and 26% and this rather large range implies that not only oil stocks are sensitive to the price of Brent but also domestically oriented stocks," says UBS.
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