Russia has been front-and-center of the news this summer. Yet Western
sanctions over Crimea, fallout from the investigation into meddling in the
U.S. presidential election and last month’s bailout of the nation’s largest
privately held bank have failed to thwart Russia’s emergence from
Assessing the economic and market impact of these events was the goal of a
recent trip to Moscow. They’re tied to the central question of whether
Russia’s economic expansion will accelerate sufficiently and possibly
garner investment grade status from the ratings agencies.
The eerily empty U.S. embassy in Moscow may stand as one of the
clearest examples of the political rift with Washington. It’s the
direct result of the tit-for-tat expulsions of diplomats sparked by
American accusations of Russian interference in the U.S. presidential
election. And it’s a sign that Russo-American rapprochement is an
impossibility 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 prime
minister, alongside President Vladimir Putin, in elections next March.
While Putin’s re-election seems almost inevitable, many view the choice of
prime minister as a harbinger of what may come over the following six
years. For now, the electoral outcome is not affecting our current
positional bias in favor of Russian local assets and selected credits.
Russia also faces challenges from within, particularly in its banking
sector. Last month, the central bank stepped in to
rescue Bank Otkritie
after 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 other
private sector banks.
These concerns drove a flow of deposits into stronger banks, many of them
government-owned. That leaves them ever more liquid and influential in a
system the state already dominates. Russia may have some of the most
competent and credible technocrats among emerging market economies. Yet
there’s also the potential for political interference.
Can Russia get an upgrade to investment grade status? Hopes were raised
after S&P issued a “positive outlook” in March. Strong economic
growth has also boosted expectations. Yet the ratings agencies likely
want to see a sustained increase in GDP growth to more than 2%. We peg
the probability of an upgrade by S&P to investment grade at no more
than 50% over the next six months. The odds of an upgrade by Moody’s
seem even lower.
The bottom line:
We expect the central bank will continue to reduce rates, perhaps even
accelerating 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% in
the absence of greater economic diversification.
Oil market volatility, however, appears to be having little effect on the
ruble, which often serves as a proxy for oil prices. The currency may gain
support from the persistent low-yield environment in developing economies
and the carry trade.
While Russia's highly robust balance sheet and recent growth pick-up point
to an investment grade story, ratings agencies may not grant Russia the
benefit 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