Page 68 - IFR Opportunities in Russian capital markets

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ifrintelligence reports/Opportunities in: Russian Capital Markets
At the same time, the RTS is becoming more correlated with what is happening in other GEMs. This is a function of Russia's increased weighting in indices such as the Morgan Stanley MSCI index and the rising amount of foreign portfolio investment since Russia was awarded a hat-trick of investment grade ratings by the leading ratings agencies in 2005.
As international traders are increasing their position in Russian stocks as part of their GEM portfolios, a sell-off in one market, as with the rout of China's stocks in February 2007, will have a greater impact on the performance of Russian stocks as traders sell Russia to cover loses in China.
"Since [2000] the best correlation that the RTS has shown is with the trend in the emerging market asset class. Of course, short-term price dips and spikes in the oil price have an immediate knee-jerk reaction in the market because of the heavy weighting of the oil majors, but increasing- ly it is the direction of the GEM asset class that is driving the market. The main reason is because while local investors now dominate daily market activity, the base direction of net buying or net selling comes from the main holders of the free float in the equity market, i.e. international funds”, says Alfa.
Ruble appreciation
The second factor determining liquidity, after oil, is the strength of the ruble, also likely to be heavily influenced by the oil price in 2007. A strong ruble, especially relative to the dollar, will result in higher speculative inflows. That will increase the amount of liquidity in the banking system and reduce the cost of borrowing. If the ruble were to weaken, then the opposite would result.
However, while falling oil prices would reduce liquidity in the banking sector it would also reduce ruble appreciation and reduce the inflationary pressure that would make it easier for the government spend some of its petrodollar windfall of recent years and so maintain growth. This balance of mitigating circumstance would be maintained down to about US$40/bbl, when the state's budget surplus would disappear and force the government to start borrowing to fund the spending gap, so here too the government has significant room to manoeuvre.
Despite lacking sufficient monetary tools to properly control the exchange rate, the CBR has managed to deftly keep both inflation and ruble appreciation in check in 2006.
The real effective rate (REER) of ruble appreciation in 2006 was 7.6%, well within the CBR's target of 9% for the year, and well below the 10.5% the ruble gained against the dollar in 2005. The CBR got off to a good start in 2007, as the REER was 2.8% for the first two months of the year and analysts expect it to be even lower for the rest of this year as the CBR needs to intervene less in the foreign exchange markets as inflation is curbed.
Still, the ruble will continue to strengthen, as economists believe it remains overvalued. The Economist's Big Mac index, released in February, suggests the ruble is overvalued by 43%.
The danger is if the CBR abandons its policy of gradual ruble appreciation, Russia's exporters will be hit by higher prices and domestic producers will suffer from cheaper imports that, combined, could smother Russia's economic growth – the so-called Dutch disease.
So far, economists investigating the situation say that Russia is not yet suffering from the Dutch disease, but time is running out and the CBR needs better tools to manage monetary policy if it is to avoid this problem.
In the meantime, a strengthening ruble will suck in more money form speculative investors, which could accelerate the appreciation of the currency's value.
"We expect that the generally strong ruble will attract increased (and speculative) capital flows into the country, and that should provide a good base for liquidity to support market activity. But the oil price is again the key," said Alfa. "The ruble is more likely to establish a closer correlation with the price of oil in 2007 than it has in the past. The reason is that starting from January global foreign exchange traders will be able to settle ruble trades via the Euroclear system. The fact that this has not been an option historically is one of the reasons why the global FX market has had relatively little influence on the direction of the ruble."
Following the lifting of the last currency controls last year the ruble is a fully convertible currency and can, in theory, be traded by forex deals. Euronext has already set up a system to handle ruble deals; however, by the start of March it had yet to see a single trade.
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