Behind Brave Face on Sanctions, Russia Is Already Adjusting

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(Bloomberg – – Olga Tanas – June 23, 2017)

They are only discussed. They may not even be implemented. But the new sanctions under consideration in the U.S. Congress have already become a factor the Bank of Russia can’t ignore.

While Governor Elvira Nabiullina dismissed sanctions as having little impact on Russia, the looming threat of wider measures was probably among the reasons why policy makers opted for a smaller cut in interest rates last week, according to Morgan Stanley and Raiffeisenbank. Separately, the U.S. Treasury on Tuesday broadened its list of individuals and companies penalized for the annexation of Ukraine’s Crimea peninsula in March 2014.

The chill in geopolitical relations is adding to an increasingly adverse backdrop for policy makers by threatening to stoke capital outflows, with oil prices falling into a bear market this week and the ruble going on the world’s worst run against the dollar in June. The central bank delivered a smaller dose of monetary easing in a quarter percentage-point step last Friday after a bigger decrease in April.

“One reason they opted for just 25 basis points was uncertainty over the geopolitical setting,” said Timothy Ash, a senior emerging-market sovereign strategist at Bluebay Asset Management in London. “Russian policy more generally is in ‘war economy settings,’ keeping defenses elevated, and putting a high price on durability and resilience for the long-haul battle with the West.”

The U.S. Senate’s bill proposes adding restrictions to the ability of banks and energy companies to raise capital, and allows for new sanctions on state-owned entities in the rail, shipping, metals and mining industries, as well as energy pipelines. The draft doesn’t include restrictions on sovereign debt or derivatives, but orders a report on what impact such limits might have.

The legislation stalled in the House this week over a procedural dispute after getting overwhelming support in the Senate amid a probe into the Kremlin’s meddling in last year’s presidential election.

The developments “played a role in the Russian central bank’s decision, changing its mind on a more front-loaded easing, but not changing the scale of easing planned,” Morgan Stanley economist Alina Slyusarchuk said in a report.

Investors are pulling money from the biggest exchange-traded fund tracking Russian equities at the fastest pace since March. Traders withdrew $21.3 million from the VanEck Vectors Russia ETF on Thursday, taking six-day withdrawals to $149 million. Russia’s Micex stock index tumbled into a bear market last week.

After three straight rate cuts, the Bank of Russia may take pauses for longer than one meeting, depending on the way risks play out, according to Nabiullina. Even if sanctions target Russia’s bond market, the governor said the debt will remain attractive. A possible ban on owning government ruble securities known as OFZs only risks bringing losses for foreign holders and creating a buying opportunity for local investors, she said.

“A reduction in rates may slow down due to any external risks caused by sanctions if they will affect inflation and financial stability, which are the priorities for the Bank of Russia,” said Dmitry Polevoy, chief economist for Russia at ING Groep NV in Moscow.

Russia has been able to sidestep the tensions so far, completing a $3 billion foreign-debt sale on Tuesday, with the bulk of overseas bids coming from U.S. investors. Some European investors, however, were unable to participate the Eurobond sale because the state bank that arranged the deal is subject to sanctions.

“Despite the increased volatility on the market, driven both by the news of the U.S. authorities expanding sanctions against Russia as well as the noticeable decline in oil prices and the ruble’s exchange rate, demand for the new Russian bonds by investors from different parts of the world was stable and substantial,” the Finance Ministry said in a statement Friday. A total of over 200 investors submitted bids of more than $6.6 billion, it said.

Non-residents owned 1.83 trillion ($30.6 billion) of sovereign ruble bonds as of May 1, accounting for almost a third of the OFZ market, according to central bank data. Russian local-currency bonds have returned 8.25 percent this year in dollar terms.

The probability of the U.S. penalizing the sovereign “is rather low,” according to ING’s Polevoy, who expects more certainty if Russian leader Vladimir Putin and U.S. President Donald Trump meet at a Group of 20 summit in Germany in early July.

“The discussion of tighter sanctions is just one of factors the Bank of Russia takes into consideration,” said Stanislav Murashov, an economist at Raiffeisenbank in Moscow. “The Bank of Russia will nevertheless continue monetary easing. The question is: at what pace?”

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