Russia seems less top-of-mind among economy watchers these days. But the country has succeeded in stabilizing its markets and appears poised to weather the worst of a recession.
A key to Russia’s story is the central bank’s foreign exchange repurchase (repo) operations earlier this year, which provided massive support for Russian external liabilities by removing uncertainties over “Russia Inc.’s” ability to repay U.S. dollar-denominated debt.
Essentially, banks were allowed to pledge corporate debt (mostly from systemic companies from a predetermined list and including U.S. dollar-denominated paper) in exchange for foreign currency from the Bank of Russia’s reserves at a very low cost. The result was that corporates with heavy debt amortizations used bonds as collateral to raise cheap foreign currency financing and repay external debt (via local banks), and many banks used the repos as a means to fund profitable carry trades, i.e., they borrowed U.S. dollars from the central bank as cheaply as Libor+50 basis points (bps) and bought Russian corporate eurobonds at spreads much higher than that.
The repo operation was an important crisis-containment tool, as it broke severely negative market technicals and implicitly signaled the money-good nature of these bonds in the eyes of the Russian government. As other countries face turbulence, we think this example could be suitably adjusted to other economies experiencing negative technicals that have damaged market confidence well beyond what the quality of the underlying credit would merit ‒ for example, in Brazil.
Another supportive factor in Russia was the coordinated response by all the key policy officials, including the strong support of the president and the Duma. This meant all parties were cognizant of the risks in not containing the situation and were working toward the common goal of stabilizing the markets and the economy. We have not seen that yet in Brazil, and until we do, it is likely that its macro picture and markets will continue to deteriorate.
Looking ahead in Russia, we expect GDP to contract between -4.0% and -3.5% this year and -0.5% in 2016. Meanwhile, the disinflation trend is set to continue, and because the impact from the ruble’s weakness has been relatively contained, the central bank likely will continue to cut interest rates at a moderate pace.
Importantly, the combination of massive corporate deleveraging due to economic sanctions on Russia and an improvement in the balance of payments, which stems from lower imports and more currency flexibility, has provided a very powerful backdrop for Russian external debt. We expect the improvement and strength in Russia’s external balance sheet to continue as the current account surplus improves and the corporate sector continues to deleverage.
For more on emerging markets, please read our cyclical outlook.