Russia, Ukraine and Turkey are currently being eyed critically by financial market investors, as the performance of currencies and local currency bonds in particular shows. That Russia is in the same basket with very vulnerable emerging markets is surprising at first.
Ukraine and Turkey are of course the usual suspects in market studies that try to identify the most vulnerable emerging or frontier markets in terms of macro fundamentals over the next 12-24 months in globally challenging conditions, together with countries such as Nigeria, South Africa or Argentina. Russia does not usually belong to such country samples.
It is therefore all the more interesting to take a closer look at the joint underperformance of these markets in recent days. In part, there are common and overlapping drivers here, although country-specific details should not be underestimated.
In our view, the most important key message here is that Russia is probably the only one of the three countries where the relevant players do not overestimate their (geo)political and economic room for manoeuvre.
The market background in 2021 is substantially different from 2020
In 2020, many emerging markets were able to come through the COVID-19 crisis reasonably unscathed, and national key interest rate and policy decisions did not have such a major impact on the financial markets – at least if they were within bounds and no such obviously wrong decisions were made, as in some cases in Turkey.
On the one hand, investors in 2020 tended to concentrate their capital on the large and liquid markets and hardly played aggressive bets in individual asset classes and/or against individual countries. This is less the case in the current market environment of global excess liquidity, continued high investment pressure and also a clearer top-down future macro picture.
And the global baseline scenario is currently certainly a challenging one for emerging markets, with debt at high levels, often without a backstop through almost unlimited national central bank balance sheets as in developed markets, and in an environment where US interest rates may rise further over the next 12-24 months.
And in emerging markets investing we always have to deal with event risks. A lot is currently happening in the "country triangle" of Russia, Ukraine and Turkey. The scale of the Russian troop deployment came as a surprise to many market observers, and this has further strengthened the "sanctions bubble" in Russia.
Russia more in "sanctions bubble"; Ukraine and primarily Turkey challenged in the medium term
Even though the OFZ and the rouble have performed poorly in the short term and this could drag on into Q2, we remain positive here. Russia is currently more in a sort of "sanctions bubble". There is a lot of uncertainty about the possible scope of coming Western/US sanctions.
However, we do not think that market-destroying US/Western sanctions are imminent in the coming months if Russia does not overstretch its geopolitical leeway. And Russia has achieved what it wants: The US is talking to Russia at eye level and it doesn't matter if a few "cosmetic sanctions" are added.
And by the way, the US also wants to find a certain geopolitical approach with Russia again, while maintaining the containment and sanctions policy. That sounds almost like a win-win relationship at first sight.
Moreover, we see a substantial "sanctions premium" in the rouble of 10-15% compared to fundamental values. There should still be uncertainty here in Q2, but ultimately the downside risks should be limited.
Of course, Russia also has substantial backstops, even though we clearly believe that in the case of Russia all relevant actors are right in their thinking about their economic and geopolitical room for manoeuvre anyway. And we clearly do not expect a full escalation in eastern Ukraine that is openly supported by Russia. And in both the case of Ukraine and Turkey, their economic and/or geopolitical room for manoeuvre is possibly overestimated.
Ukraine clearly belongs in the camp of vulnerable emerging markets. Investors are also still slightly over-positioned here and locally we also see tendencies that the room for manoeuvre is partly overestimated. An IMF agreement continues to be delayed, and it looks as if the leadership wants to show their colours more in the conflict in eastern Ukraine.
But in Ukraine there is an important backstop: the central bank. It has distinguished itself as a credible and stability-oriented actor and is consistently pursuing this course. After the interest rate steps taken so far, we see the central bank as determined to follow suit here, in a base scenario and also in risk scenarios.
In addition, we see a certain geostrategic backing of Ukraine by the EU and the US, which could also result in new funds from relevant international financial institutions in order to avoid worst-case scenarios.
External deleveraging in Turkey will continue, NBU is trying to get ahead of the curve
In the case of Russia, recent market swings after the Biden-Putin phone call announcement have also shown how quickly market sentiment can turn in the "sanctions bubble". In addition, in the case of Russia and Ukraine we see partly normal and tactical position rebalancing approaches in the foreground at the moment. In Turkey, we find it difficult to see a credible backstop, while at the same time there is a clear trend to constantly overestimate the economic-financial and geopolitical room for manoeuvre.
Therefore, in case of Turkey, we remain more sceptical in the medium and long term against the background of the experience in Russia and Ukraine in particular.
In these two countries, too, foreign economic actors have questioned their presence in the country in the past and in light of certain disillusionment, which can be clearly seen in the long-term cross-border bank financing of international credit institutions. In Ukraine, there was a long seven-year adjustment process of external deleveraging from 2008 to 2015, with a reduction of exposures by 80-90%. In Russia, we have seen an external deleveraging of international banks’ exposures from 2013 to 2015 in the range of 40-50%.
In the case of Turkey, we have seen exposure reductions since 2016, but in our view we are not yet at the end of the line and are still at moderate declines compared to Ukraine or Russia. And such an external deleveraging process, with simultaneous macroeconomic vulnerabilities and event risks, continues to threaten much uncertainty for investors and the currency.
Moreover, we see no clear allies or backstops in the case of Turkey. The central bank is (again) a political second-hand agent. Turkey will not be going to the IMF before a full disaster scenario. In any case, a first step towards the correct assessment of the action corset would be no interest rate cut this week by the Turkish central bank, indeed rather an at least verbally hawkish bias for the coming months.
Here, the central bank of Ukraine is a model pupil in its statement: "The NBU stands ready to raise its key policy rate more resolutely in order to curb fundamental inflationary pressures, stabilise expectations, and bring inflation back to its target." In any case, the NBU will probably raise the key interest rate again this week, and is still considering further hikes. The key interest rate should possibly go to levels of 9-10% over the next six-nine months.
We do not see any chance that the Turkish central bank will be in a position to follow this route.
RUB stronger, UAH at least temporarily, TRY on a one-way street
And as is often the case, everything comes together. In addition to the country specifics outlined above, global trends also speak more in favour of Russia and Ukraine than Turkey. The strong global cyclical recovery dynamics favour emerging markets, which clearly benefit from rising commodity prices, while energy importers like Turkey and/or countries at the beginning of global industrial value chains suffer from global energy and transport cost increases.
Moreover, we expect a traditional spring revaluation in the UAH rate, caused by seasonal currency oversupply by agricultural producers, as well as an improved financial account balance compared to 2020. Therefore, we see USD/UAH below the 28 level in the coming months, finishing the year around the 28 level.
For the RUB, apart from sanction risks, the fundamental support from the current account will seasonally weaken in Q2. We believe that due to geopolitical pressure the decoupling of the rouble from the oil price will persist in the coming months, which is why we have revised our short-term forecast upwards to 75 in Q2, 73.5 in Q3 eop, and 72.5 at year-end 2021.
We do not think that the Turkish lira will come back any time soon below the USD/TRY 8 level, and would see it at least at the 8.30 to 8.50 level if material policy (space overestimation) glitches can be avoided. But this is not a given in Turkey, compared to Russia.
Gunter Deuber is the Head of Research at Raiffeisen Bank International in Vienna. Local RBI Research teams contributed to this analysis.