Russia: Growth Up, Inflation Down

Russia: Growth Up, Inflation Down

Russia has been front-and-center of the news this summer. Yet Westernsanctions over Crimea, fallout from the investigation into meddling in theU.S. presidential election and last month’s bailout of the nation’s largestprivately held bank have failed to thwart Russia’s emergence fromstagflation.

Assessing the economic and market impact of these events was the goal of arecent trip to Moscow. They’re tied to the central question of whetherRussia’s economic expansion will accelerate sufficiently and possiblygarner investment grade status from the ratings agencies.

Preliminary conclusions:

  • Sanctions:The eerily empty U.S. embassy in Moscow may stand as one of theclearest examples of the political rift with Washington. It’s thedirect result of the tit-for-tat expulsions of diplomats sparked byAmerican accusations of Russian interference in the U.S. presidentialelection. And it’s a sign that Russo-American rapprochement is animpossibility in the near term.

    Nonetheless, confrontation with the West is hardly the center of debate.Instead, Moscow, always rich in rumor, is abuzz over who will run as primeminister, alongside President Vladimir Putin, in elections next March.While Putin’s re-election seems almost inevitable, many view the choice ofprime minister as a harbinger of what may come over the following sixyears. For now, the electoral outcome is not affecting our currentpositional bias in favor of Russian local assets and selected credits.

  • Banking: Russia also faces challenges from within, particularly in its bankingsector. Last month, the central bank stepped in torescue Bank Otkritieafter its off-balance-sheet shenanigans became known. Since our visit,another large financial entity,B&N Bank, faced a similar fate. This has raised questions about vulnerabilities among some otherprivate sector banks.

    These concerns drove a flow of deposits into stronger banks, many of themgovernment-owned. That leaves them ever more liquid and influential in asystem the state already dominates. Russia may have some of the mostcompetent and credible technocrats among emerging market economies. Yetthere’s also the potential for political interference.

  • Ratings:Can Russia get an upgrade to investment grade status? Hopes were raisedafter S&P issued a “positive outlook” in March. Strong economicgrowth has also boosted expectations. Yet the ratings agencies likelywant to see a sustained increase in GDP growth to more than 2%. We pegthe probability of an upgrade by S&P to investment grade at no morethan 50% over the next six months. The odds of an upgrade by Moody’sseem even lower.

The bottom line:

We expect the central bank will continue to reduce rates, perhaps evenaccelerating the pace, helping to spur growth of 2% this year. Nonetheless,questions linger over Russia’s ability to grow faster than 1% to 1.5% inthe absence of greater economic diversification.

Oil market volatility, however, appears to be having little effect on theruble, which often serves as a proxy for oil prices. The currency may gainsupport from the persistent low-yield environment in developing economiesand the carry trade.

While Russia's highly robust balance sheet and recent growth pick-up pointto an investment grade story, ratings agencies may not grant Russia thebenefit of the doubt until the economic expansion becomes more entrenched.We remain upbeat, but cautious.

Yacov Arnopolin is an emerging markets portfolio manager in PIMCO’s London office and a contributor to the PIMCO Blog.

For more on fixed income in emerging markets, see “Emerging Market Local Debt: Growing Depth, Growing Opportunity.”



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