InvestmentsNov 19 2014

Russia can withstand currency pressure

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Investors should not totally avoid Russia as it can stave off a full-blown currency crisis, according to experts.

The country has been under increased pressure in recent weeks as a fall in the rouble has been exacerbated by a weak oil price and the continued sanctions levied on it by the west due to the Ukraine conflict.

The rouble has experienced double-digit falls against the dollar in the current quarter so far, which has sparked fears of a major crisis in the country.

But economists and fund managers believe factors such as Russia’s low debt-to-GDP ratio will mean the country can withstand the pressure, even if there are challenges along the way.

David Kohl, foreign currency analyst and economist at Julius Baer, said the rouble weakness was caused by “a combination of adverse fundamental factors”.

“The major negative factors are Russia’s declining profitability due to bad corporate governance, lingering capital flight and eroding purchasing power of the currency because of high inflation,” he said.

“Russia’s confrontational policies in Ukraine have worsened these fundamental headwinds and the most recent decline in oil prices has removed the last supporting pillar for the currency.

“The Russian budget for the next year is based on an oil price assumption of $90 [£57.30] per barrel. If the current level of around $85 prevails, some spending might be cut back.”

Mr Kohl added he expected the country’s economy to contract by “more than 0.5 per cent next year”.

Neptune’s Robin Geffen earlier this year echoed this view. The manager has long been bullish on Russia, but in August said he expected the economy to contract by 0.3 per cent in 2014 but return to growth in 2015.

Leigh Innes, manager of the T Rowe Price Emerging Europe Equity fund, said the rouble’s weakness had been affected by sanctions imposed on it by the west. “The impact on the Russian economy will be of slower growth, tighter liquidity in the banking system and higher funding costs, and higher food inflation,” she said.

“These factors have also contributed to rouble weakness. On the other hand, we have seen Russia engage more with other countries in Asia, Latin America and Africa. It could potentially use Asia as a source of funding.”

Alexis Mathieu, manager of the SW Mitchell Capital Emerging European fund, said the recent rouble devaluation had to be seen in the context of falling oil prices and thought the movement “should be seen as normal”.

But he said with inflation picking up, a weaker rouble would negatively impact consumer spending, “something we started to observe in the past months”.

“In the short term, the economy should slow down and growth remain low – as consumer spending is a strong component of GDP expansion,” Mr Mathieu said.

“Over the long term, lower oil prices and a weak rouble might be beneficial for investments – traditionally Russia’s weak spot – as we might see an import substitution effect occurring.

“In the meantime, the country has got the means to assist the transition – thanks to a strong fiscal position, with low debt to GDP and important reserves.”

Mr Kohl agreed, stating he thought Russia “holds sufficient funds to avoid a full-blown crisis, which would include defaults on its liabilities”.

“But the risk that drastic measures like capital controls are necessary to avoid further escalation is rising, which would weigh on sentiment of emerging market investments in general.”

Ms Innes added: “While it is easy to write off Russia overall, we are not going to run away because there is turbulence.

“Given the recent volatility, there are some high-quality companies trading at very attractive valuations. This is providing us with great buying opportunities.”

Mr Mathieu said a natural trade now would be to favour exporters, which are “selling in dollars but incurring local currency costs”, and to “shy away from discretionary companies.

How is Russia reacting?

The Bank of Russia has tried to control the rouble’s strength but last week brought forward plans to announce a revamped foreign exchange policy.

At the start of November, the rouble experienced its biggest weekly drop in 11 years and interest rate rises – which should attract investors to the country – failed to halt the currency’s decline.

This, in the words of Ashmore’s Jan Dehn, looks “close to a free float”, meaning the central bank will refrain from intervening in markets to help the rouble maintain a certain level against the dollar.

The bank has, even on a daily basis sometimes, worked to support the rouble – something which has been even more pressing given the falling oil price and the currency’s inevitable link to the commodity.

Mr Dehn said Russia still retained the right to intervene “if financial stability is threatened”, adding the Russian central bank had “not shied away” from raising interest rates to control inflation.

“A floating currency provides major insulation against oil price shocks, in our view,” he said.

“Russia’s central bank also has $439bn (£280bn) in reserves and the central bank has given fair warning that it could intervene at any time, in any size.”