Natalia Orlova of Alfa Bank -
Russia should fare better than its emerging-market peers. However, it still may not be able to decouple from international markets. Though oil accounts for 67% of export revenues, Russia's state foreign debt equals only 2% of GDP and its fiscal surplus only 7.7%. It also has reserves sufficient for 23 months of imports. Moreover, with banking assets equal to a mere 60% of GDP and the mortgage market only 3%, the country's economy is not highly leveraged.
High dependence on oil fuelled negative sentiment towards Russia: In the first nine months of this year, some 67% of Russia's export revenues came from oil. Including metals, commodity-related exports now make up about 80% of the total. An increase in revenues financed import growth of 42% on year and $40bn in interest payments on debt. Russia's trade balance will be zero-deficit at $40 per barrel; however, the current account will be zero-surplus at $60.
Russia's economy still looks stronger than most others: Russia's current economic situation is by no mean comparable with 1998 or 1990. With state foreign debt equal to only 2% of GDP, a $190bn stabilization fund and CBR reserves covering 23 months of imports, Russia today has enough resources to mitigate the deterioration of its economic situation. Its budget, with a fiscal surplus of 7.7% of GDP in the first half, is still in much better shape than that of other countries. This suggests that Russia will do better than other emerging markets.
Small financial sector is fairly positive, Russian capital may return from offshore: With banking assets equal to 60% of GDP, corporate loans 30%, retail 10% and mortgages 3%, Russia is unlikely to suffer as much as other emerging markets, where all these indicators are substantially higher. We were also positively surprised by Russia's ability to borrow $71bn in the first half even though debt markets were closed. We believe that this increase in borrowing reflects Russia's offshore capital, which is flowing into the country to support local growth.
Protecting the ruble is crucial to stabilizing banks' liabilities: We reiterate our view that the central bank's most important task is now to prevent panic among retail and corporate depositors. Since the share of foreign currency deposits is now 13.5% versus 40% in 2003, we believe that if the ruble depreciates, retail flight from the ruble may reach $70bn. We therefore believe that the CBR cannot allow the ruble to weaken.
Still dependent on oil: The substantial and rapid deterioration on global financial markets in recent days is spreading panic throughout the emerging market universe in general and Russia in particular. High dependence on oil, seen in previous years as an argument for buying into the Russian stock market, is fast becoming a reason to speculate on the continuing drop in the RTS market and a potential decline in the ruble. Russia's dependence on oil has continued to increase. In the first nine months, the share of fuel in export revenues went up to a new high of 67% versus 61% in 2007. Including metals, commodity-related exports make up about 80% of total exports. The maxim that a $1/barrel increase in oil prices provides Russia with $3bn in additional export revenues a year is still true. This suggests that there has been no change in export volume; rather, the increase in export revenues is mainly the result of higher prices. Owing to strong export revenues, Russia's trade surplus is likely to total $200bn this year, well above the $164bn we had expected. However, strong export-revenue growth masks the surprisingly high 42% on year increase in imports in the first nine months. The 42% on year increase equals some $94bn this year. In 2007, the trade surplus was high enough to cover two and half years of similar import growth if oil prices remained flat. Also, the trade balance will be zero surplus with oil prices at $40 per barrel, and the current account will be zero-surplus with oil prices at $60.
Looking at Russia in relative terms
Even though Russia failed to diversify from its dependence on oil, there are still a couple of reasons to expect it to do well on a relative basis. Firstly, unlike a number of other countries, Russia used recent years to accumulate fiscal savings; it also kept fiscal expenditures under control at 34% of GDP. Secondly, the Russian economy is not as leveraged as a number of other economies; the role of the financial sector is not as important as in other countries.
The Russian government has implemented a very tight fiscal policy in recent years. The heavy taxation of the oil industry that began in 2004 allowed the state to accumulate $190bn in the stabilization fund as of the beginning of August, equal to 11% of this year's estimated GDP. Russia's fiscal surplus of 7.7% in the first half was one of the highest in the world. Moreover, its CBR reserves are sufficient to cover 23 months of imports, the highest indicator in the EM universe. Rounding out this list of strengths is Russia's low sovereign foreign debt, which at only 2% of GDP is one of the lowest in world.
However, the stability of the state was achieved at the expense of the private sector. While oil revenues were replenishing the stabilization fund, the Russian private sector was building exposure to foreign debt. However, even here Russia's $488bn corporate foreign debt is 114%-covered by the CBR's reserves, well above the level of other countries. The Russian corporate sector is not overleveraged by international standards owing to the relatively modest role of financial services. Total banking assets equal only 60% of GDP, total corporate loans only 30%, retail lending 10% and mortgages 3%. Around 50% of Russia's investments have been financed by enterprises' own resources. This aptly illustrates that while Russia will not be able to decouple from deteriorating global economic trends, it will likely do better than its peers.
Furthermore, Russia did surprisingly well in attracting foreign debt in the first half. While international markets were closed to borrowers, Russia managed to attract some $71bn. We believe this strong inflow reflects the significant support provided to local banks and companies by shareholders who had been keeping money outside of Russia. Clearly, recent rumors of the high leverage of some of Russia's largest groups, this resource is not unlimited. However, we still believe that if the financial crisis starts to have an impact on Russia's real economy, some businesses will be able to get support from their shareholders. This is another area where Russia is likely to do better than other countries in the next two years.
The view on the ruble
The decline in commodity prices and appreciation of the dollar resulted in a new round of speculation on the exchange rate market. According to preliminary estimates, the CBR sold $5bn on that market on October 6, to keep the ruble exchange rate unchanged against the basket. This was the bank's second-largest intervention after the $7bn it sold on August 8.
We have noted that the CBR's actions in August were understandable given the desire to penalize foreign investors on Russian markets. However, now the situation is different. In August, the banking sector was in much better shape; now, a more volatile exchange rate could trigger a flight from deposits and decrease banking sector liquidity. We therefore believe that the need to prevent a run on deposits will force the CBR to intervene in the coming weeks. We reiterate our view that supporting the ruble is crucial, as the main threat Russia faces is a deterioration in confidence on the part of local players. A weaker ruble exchange rate is already pushing some Russian companies to delay the repatriation of their export profits. There is an increased risk that private depositors will also start to increase their exposure to foreign currencies. We believe that if the ruble drops, the demand for cash dollars may jump to $70bn. Therefore, exchange rate stability is crucial to preventing panic.
Investor nervousness about the ruble exchange rate stems from the recent announcement of a huge rescue package, which looks likely to total $120bn. However, the only parts of this package that have been made available are a cut in reserves and Finance Ministry auctions. We currently estimate the amount of government deposits with banks at $60bn, up by $25bn in August and September.
From a fundamental point of view, the ruble's exchange rate fair value currently ranges from RUB10R/dollar (monetary base divided by CBR reserves) to RUB27/dollar (monetary mass divided by the CBR reserves), suggesting that the nominal exchange rate is very close to the upper level of the ruble's fundamental value. An additional ruble injection will put pressure on the upper range of this fundamental value (since monetary mass growth will accelerate).
However, this does not call for an immediate depreciation of the ruble since the currency was kept artificially weak in previous years. This is a good indication that from a fundamental point of view, the ruble still has room for appreciation. This strong fundamental upside reflects the high level of CBR reserves (including the stabilization fund), high fiscal surplus and extremely low foreign debt. However, even good fundamentals could suffer if depositors start to panic. Thus, we believe that in order to stabilize markets, the ruble exchange rate will continue to be supported by the CBR.
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