Russia’s power play for Ukraine’s Crimea region is putting to flight foreign stock and bond investors, who are rattled by the Kremlin’s overruling of the country’s economic interests in favour of its military ambitions.
Russia’s half-trillion dollars in central bank reserves mean its creditworthiness is not in doubt, and political risk has always been part of the game while investing in Russia.
Yet the move on Crimea, which has earned Moscow global censure and the threat of Western sanctions, will deliver a blow to an already-faltering economy, with US Secretary of State John Kerry threatening “very serious repercussions”.
And perhaps more crucially, it will further deepen investor mistrust of Russian institutions.
Gary Greenberg, the head of emerging markets at Hermes Fund Managers, said a sell-off on Russian financial markets could spiral if uncertainty continued, especially in equities, where foreigners are estimated to hold 70 percent of the market.
“The market’s assessment is that the Russian government is willing to sacrifice both the country’s economy and its international standing in order to bolster its pretensions for a Eurasian union,” Greenberg said, referring to Moscow’s desire for a customs union of ex-Soviet states.
“On the surface this looks like really bad news and it warns of the case for investing in Russia,” he said. “It also looks to me that the economy will worsen from here because of this, so some kind of sell-off is appropriate.”
Moscow stocks have endured the worst bloodbath so far, with a 12 percent plunge on Monday that has wiped almost $60 billion (about R639bn) off the market’s value.
The rouble has plunged to record lows, forcing the central bank to raise interest rates by 1.5 percentage points. Traders estimated it had sold $10bn on foreign exchange markets.
Even Russian sovereign dollar bonds – the most heavily traded emerging debt instruments, according to industry body EMTA – have sold off, their average yield premium to US treasuries rising 2.6 percentage points on the day.
Losses will escalate if Western nations hit Moscow with economic sanctions. Kerry has named asset freezes, visa bans and trade isolation as possible measures.
Whatever the outcome of the crisis, Russia stands to lose the most, Pimco fund manager Francesc Balcells said in a note.
Curbs on holding Russian financial assets, for instance, could make life hard for companies that rely on foreign money for debt and equity funding. Companies face higher borrowing costs and delays on billions of dollars in loans as foreign banks become more wary of lending.
“Russian corporates are among the most active in international debt markets, and Russia has tried hard to open up its local currency debt market to foreign investors, while making inroads in improving the investment climate,” Balcells said.
“A confrontation with the West would erode many of these achievements, driving more foreign investors away.”
The moves are all the more damaging because of the timing. First, Russia’s economy is in trouble, with growth slowing to under 2 percent, inflation up and investment levels stagnant around 20 percent, well below necessary levels. The outlook for oil, accounting for half of budget revenues, is not optimistic.
Second, the past two years have seen investors overcome some of their Russia jitters and pile into rouble bonds, where they own almost a quarter of the market. They had boosted holdings to 900 billion roubles (R265bn) by the end of last year, a nine-fold increase from early-2012, central bank data shows.
Despite emerging market ructions, they have held on to these positions, betting Russia’s reserves will keep the rouble firm. Instead, the rouble is one of the worst performing emerging currencies this year, losing 10 percent against the dollar.
That unexpected weakness could fuel an exodus from foreigners who had not bargained on the losses.
It may be harder to convince equity investors to stay. Over $2bn has fled Russian equity funds this year, Morgan Stanley estimates, after outflows last year of $4.2bn.
Reuters