Politics trumps & thumps economics

March 11, 2014 JRL Russia List Economy, Business, Investment, Trade, Ukraine, Russo-Ukrainian War

(Business New Europe – bne.eu – Chris Weafer, Macro-Advisory – March 11, 2014)

“Sanctions and boycotts would be tied to serious political dialogue”
Daw Aung San Suu Kyi

We have cut our growth forecast to 1% for 2014, and revised some other macro forecasts partly because of the uncertainty and disruption caused by the Ukraine crisis but also reflecting the continuing slowdown in the economy coming into 2014.
We highlight the risk of earnings revisions across the domestic sectors in the equity market which detracts from otherwise attractive PE valuations. LUKoil (LKOD LI) is added to our Top Ten Russia Our end year ruble forecast rate of R/$36.0 remains unchanged.
Any dip in the price of Sovereign Eurobond issues is a buying opportunity.

Economy at risk from political crisis.

The headlines concerning Russia are dominated by the events in Ukraine and the threat of sanctions. Despite the soft sanctions approach so far, the situation remains dangerous, particularly since Crimea’s parliament voted to join the Russian Federation and to hold a referendum on 16 March. This represents a clear danger to sentiment towards Russia as it is difficult to see Moscow doing anything other than accepting Crimea. The US and EU are very likely to threaten further sanctions then.

We cut our GDP forecast.

Because of the weaker ruble, down more than 10% against both the dollar and the euro as we go to print, and the clear damage to confidence amongst consumers and businesses, we have cut our economic forecasts for this year. Forecast GDP growth is reduced to 1.0%, down from 1.9% previously and lower than last year’s 1.3% growth. The main damage is likely to come from higher inflation, tighter money markets, slowing consumer activity and a second year of declining investment spending.

Earnings at risk.

Slower activity in the economy will inevitably lead to a cut in earnings expectations for domestic-focused stocks. Although the market is cheap in PE terms, as long as there is a major question mark over earnings coupled with elevated Russia risk foreign investors will continue to shy away. Investors will not return until they are sure the crisis is over. That may not be until after the Ukrainian presidential election at the end of May and the (presumed) resumption of political relations between Moscow and Kiev. But, market weakness in Russia also needs to be placed in the context of global EM weakness. Year-to-date investors have pulled almost $30 bln (just under 4% of AUM) from EM fund.

Ruble and confidence take a hit.

The main short-term concerns are focused on the ruble, inflation and the impact on both consumer and business confidence. The CBR was forced to abandon its previous “light-touch” interventionist policy to rescue the ruble on 3 March. Prior to that the ruble had fallen almost 10% against both the US dollar and the euro from the start of the year. The rapid decline contributed to deteriorating confidence and raises fears that activity will slow even further until the risk perceptions moderate. Inflation is a major concern and the weakening currency was one factor pushing the rate to almost 6.3% at the end of February.

Federal budget is a beneficiary of weaker ruble.

The flip-side to the weak currency is the boost for the federal budget, as dollar-based taxes translate into higher ruble revenues. So, unlike 2008 when oil was collapsing and the CBR ran through one-third of its foreign currency reserves, the country’s balance sheet is now in good shape. This does not, however, guarantee against further declines in activity across the economy, nor will it prevent a further sentiment driven slide in the ruble. But, it suggests the government will have options available to try and stimulate growth and stabilize the fiscal & monetary position after the crisis passes. Longer term, the weaker ruble may encourage greater import substitution. For now, we retain our year-end ruble-dollar forecast at RUB/US$36.0

Retailer Lenta managed to avoid the crisis, raising just under US$1 bln via a London IPO. Plans by other issuers, such as Detsky Mir and Metro, will now remain on hold until Russia risk subsides. The government had also announced, prior to last weekend, that it hoped to raise approximately US$5.5 bln via privatizations this year. That plan is also shelved for now.

Also, in this month’s Macro Report;

We explain the changes to our Russia macro forecasts and include the full table of revisions in Appendix 1.

We compare Russia’s fiscal strength and budget execution today to that of August 2008 and conclude that Russia is in a much stronger position to withstand the fallout from the Ukraine dispute than was the case six years ago.
But, it is clear that Russia now needs a big boost to inward investment if a new growth model is to be created. We examine the challenges ahead and consider how they have been made more complicated as a result of the Ukraine crisis.

In the Macro Month section we review the latest data releases in Russia and conclude that the weakness reported through the 3rd and 4th quarters of last year is continuing.

In the Currency section we look at what is driving the ruble lower and separate the issues which may prove temporary from the structural problems which will need an effective policy response. We look at the positives and negatives from the weaker ruble.

In the Politics section we review the latest opinion polls, which show steady support for the president, and what we may now expect post Sochi i.e. the Ukraine crisis notwithstanding. We also include a short bio of Deputy PM Dmitry Kozak. He was responsible for delivering a successful Olympics (cost notwithstanding) and is now possible in line for another high profile role in government.

In the CIS Spotlight section we look at the trend in the Ukraine economy and what can be expected from the IMF/EU bailout.

In the Capital Markets section we look at the performance of equities, debt and commodities through February and year to date; what have been the key drivers; what assets fared relatively well or badly; what are the issues facing investors today.

And finally, we have our Last Word section which has a Russia relevant book review, the reason why Moscow City center traffic flow has suddenly improved and a mention of the recent regional economic forum which we attended in Krasnoyarsk.