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64 Opinion MACRO ADVISER:
Investors into Russia should brace for
a turbulent 2018
Despite the relentless headlines about what Russia may or may not have been up to during the US presidential elections, or Brexit and other EU elections for that matter, and the country’s involvement in Syria, etc, the newsflow from within Russia has been relatively quiet or, at least undramatic, for most of 2017. With the exception of the US sanctions legislation, signed into law on August 2nd and the Opec deal renewal, there have been no major market moving events this year. At least not compared to those over the previous three years.
This year’s relative calm has been reflected in the mood amongst investors; there is a long list of issues for investors to worry about but nothing happened to move markets significantly in 2017 in either direction. Since the start of 2017 (to mid-December) MICEX is off 5% while the RDX Index of Russian DRS is up 1.4%. Of course that flat-lining performance translates into a big under-performance within emerging market portfolios when compared to the 31% gain in the MSCI EM Index.
But what has been a disappointing, albeit relatively calm, year is about to give way to a much more energetic and news-filled six-month period, starting in early February until late July. There will be no ignoring Russia in that period and we can expect to see much greater market volatility than was seen in all of this year. How the events expected in this six-month period unfold, and are reacted to, will determine not only what returns investors will get from the equity and debt markets in 2018 but will also put in place the conditions for the trend in the economy, FDI and risk perception for the following two or three years.
First up will be the two US Treasury Department reports mandated by the US Congress and which must be submitted in late January. One of these is the so-called Section 241 list and the other is the report assessing the implications
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of extending the current sanctions applied to state banks to sovereign issues.
The former will be a public list of individuals and entities that may be the subject of future sanctions. There is no stated intention to apply sanctions automatically but it will form something of a Sword of Damocles over those named and will affect their ability to trade with US counter-parties, at least for some time. That could, at minimum, disrupt trade and investment flows into Russia and activity in the economy.
The second report has clearly dangerous implications. If the credit restrictions were applied, then US funds would have to sell their OFZs and Eurobonds. EU funds would be under
“A relatively calm year is about to give way to a much more energetic and news-filled six-month period”
pressure to do the same because of the also newly introduced threat of secondary sanctions. Foreign investors hold between 35% and 50% of Russia sovereign debt. We have heard from the central bank and the finance ministry that there is a contingency plan in place to soak up those forced to exit but that would substantially drain liquidity from the banking system and, in turn, reduce future lending and badly impact economic growth. There should not be a crisis but the threat of extended stagnation is clear enough.
It is not assumed that the US executive branch, which is responsible for enforcing sanctions, will act on these reports quickly and it may even try to ignore them on the basis
that taking action would make any even modest political engagement with Moscow more difficult. The real test is