Renaissance Capital, Russia -
How important is the US to Russia? We have argued that Russia is not immune to intensifying external shocks, although some increased policy flexibility and a lengthening maturity structure of external debt will provide useful cushions to a sudden-shock scenario, in our view. However, with only a patchy solution to the US debt-ceiling debate likely, we offer more quantitative answers to how higher interest rates and a growth slowdown in the US will impact Russia.
1. US GDP matters to Russian GDP. To investigate this issue, we use statistical methods to estimate the relationship between outputs in Russia and the US. In particular, we forecast the dynamic impact on Russian GDP of an adverse shock to US GDP in a system that also includes other relevant macroeconomic variables, like Russian and US inflation, Russia's policy rate, US 10-year bond yields and the USD/RUB exchange rate. The figure below depicts the relative importance for Russia's GDP of a variation in the remainder of variables for 10 consecutive quarters. While its own random innovation accounts for around half the variability of Russia's GDP, US GDP growth plays a significant role (about 25%) in explaining the variation in Russia's output.
2. A 1% decline in US GDP growth lowers Russia's GDP growth by a maximum of 2%. While most discussions on the US debt-ceiling debate focus on the potential upward effects on US bond yields, the realisation of a default (or downgrade) will certainly entail downward revisions to GDP growth. The figure below shows the response of Russia's GDP growth to a 1% decline in US GDP growth: as shown in the figure, economic activity in Russia responds negatively and the impact of the shock is maximised after three quarters, when the shock shaves close to 2% off growth. The size of the effect is significant, as a worsening US economic outlook is likely to be associated with a general global growth slowdown and, to the extent that Russia is still perceived as a high-beta location, the knock-on effect on Russia's GDP may be sizeable.
3. Higher US bond yields may add up to 60 basis points to domestic OFZ yields. Even if a solution is reached in the US (as we still expect), we think it will most likely be only a patchy one, leading to an increase in US bond yields. To calculate the potential spillover effects onto Russian bond yields, we examine a separate econometric model that relates longer-term OFZ yields to Russia's GDP growth, public debt/GDP levels, policy rates and the 10-year US bond yield.
The figure below shows that, while the model has erred on the high side up to the crisis, it did very well in explaining the crisis period and its aftermath. In the baseline forecasting scenario, we assume broadly constant policy rates of 8%, a gradual increase in the debt level from 10% of GDP in June 2011 to 14% in December 2012, and a constant 3.2% 10-year US bond yield. This results in a modest pick-up in OFZ yields, from 7.13% in December 2011 to 7.5% in 2012. However, if the 10-year US yield were to rise to 4.00% by December 2011 (vs Bloomberg consensus of 3.56%) and to 4.50% by December 2012 (consensus: 4.24%), OFZ yields would reach 7.54% by end-2011 and 8.10% by end-2012. Another scenario of higher Russian policy rates, reaching 8.75% by end-2012, also pushes up domestic yields, but by less than in the event of a US default.
4. The impact of a potential default could be big for Russia if the US effects spread from mere yield increases to a more marked economic slowdown. While the results for the econometric exercise are only indicative, they underscore the spillover mechanisms that Russia could be exposed to. We do not believe Russia will be immune if this tail risk materialises.
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