Will the Rus­sian Bear live up to its name with the rou­ble?

Financial Mirror (Cyprus) - - FRONT PAGE -

Pres­i­dent Vladimir Putin is at it again, this time in Syria. The Rus­sian mil­i­tary has filled the vac­uum left by the U.S. and is ex­pand­ing its oper­a­tions against op­po­nents of Syria’s ruler, Bashar al-As­sad. The Rus­sians have pur­port­edly ini­ti­ated oper­a­tions against ISIS, but there is ev­i­dence to the con­trary, with rebels be­ing tar­geted. This begs the ques­tion: What is Vladimir Putin do­ing in Syria?

Rus­sia’s in­tran­si­gence in the Ukraine and now in Syria is as much about drum­ming up na­tion­al­is­tic fer­vour as it is an op­por­tu­nity to de­tract from the eco­nomic and so­cial up­heaval at home. The Rus­sian rou­ble has been rated as the sec­ond worst per­form­ing cur­rency among 24 emerg­ing mar­ket cur­ren­cies over the past 12 months ac­cord­ing to Bloomberg. In the same time­frame, the rou­ble has de­pre­ci­ated by 36% against the USD. These are in­deed wor­ry­ing sta­tis­tics for an econ­omy that is chiefly based on the ex­port of energy com­modi­ties (gas and oil).

Rus­sian ag­gres­sion in the Ukraine sounded the death knell for the Rus­sian econ­omy, with puni­tive sanc­tions be­ing im­posed by the U.S. and its Euro­pean al­lies. How­ever the rou­ble has sharply ap­pre­ci­ated since Jan­uary 2015. It opened the year at 58.1157 to the green­back and by Oc­to­ber 8, the rou­ble was trad­ing at 62.9421 to the dol­lar. This does not tell an ac­cu­rate pic­ture of how far the rou­ble has fallen, be­cause if we go back to Fe­bru­ary 2014 the cur­rency has de­pre­ci­ated by as much as 45% against the USD.

Af­ter Rus­sia for­mally an­nexed the Crimean Penin­sula (claim­ing that the ma­jor­ity of its res­i­dents wanted uni­fi­ca­tion with Rus­sia), the West de­cried Rus­sia’s ac­tions and slapped all sorts of sanc­tions on the coun­try. Rus­sia re­sponded in kind, and re­la­tions grew tense be­tween the su­per­pow­ers. Pres­i­dent Obama has been un­will­ing to en­gage with Rus­sia mil­i­tar­ily, and prefers in­stead to use mul­ti­lat­eral mea­sures such as sanc­tions and diplo­matic con­dem­na­tion to chas­tise his ad­ver­sary.

The Rus­sian econ­omy is largely de­pen­dent on strong com­modi­ties prices, since most of Rus­sia’s per­for­mance is based on energy com­modi­ties like crude oil. The price of crude oil has plunged be­tween 40% and 50% in the last year, and since it is de­nom­i­nated in US dol­lars, valu­able for­eign ex­change rev­enues are be­ing lost by oil-pro­duc­ing coun­tries. Rus­sia has seen a sharp de­cline in its avail­able forex re­serves. The Rus­sian cen­tral bank has been selling dol­lars to prop up the rou­ble, and even ad­vanced di­a­logue with China to cre­ate another re­serve cur­rency for the world, other than the USD.

Cap­i­tal flight from Rus­sia con­tin­ues un­abated, and the Rus­sian author­i­ties are re­spond­ing by slash­ing in­ter­est rates to stim­u­late eco­nomic ac­tiv­ity at home. Var­i­ous an­a­lysts are bear­ish on prospects for the rou­ble be­fore the end of the year, with a con­sen­sus es­ti­mate de­cline of a fur­ther 4% ex­pected. As one of the BRICS na­tions, Rus­sia also faces the same anx­i­eties as Brazil, In­dia, China and South Africa – no­tably the prospect of an in­ter­est rate hike in the U.S.

Should the Fed de­cide to hike in­ter­est rates at its next meet­ing in Oc­to­ber, per­haps in De­cem­ber, the Rus­sian rou­ble will plunge fur­ther. The fact of the mat­ter is that higher in­ter­est rates in the U.S. make the dol­lar in­her­ently more at­trac­tive. This means that cur­ren­cies like the rou­ble, the real, the rupee, the yuan and the Rand will be ex­changed for dol­lars. With a higher yield in a more sta­ble econ­omy, cap­i­tal flight from emerg­ing mar­ket economies will ac­cel­er­ate. How­ever an­a­lysts are gen­er­ally united in their con­sen­sus that a Fed rate hike will not take place in 2015, and will pos­si­bly only come to pass by March 2016. This gives emerg­ing mar­ket economies and their cur­ren­cies a breather in the form of sev­eral months within which to gen­er­ate sub­stan­tial prof­its while di­rec­tion of the Fed.

As long as US in­ter­est rates re­main in the 0-0.25% range, com­modi­ties traders and in­vestors will be more likely to take on riskier as­sets in emerg­ing mar­ket economies. We have seen a sharp de­cline in the share price of ma­jor min­ing com­pa­nies such as Glen­core PLC (GLEN), Rio Tinto (RIO) and BHP Bil­li­ton (BLT). These min­ing com­pa­nies face heavy debts and de­clin­ing ROE as a re­sult of multi-year low com­modi­ties prices. Cop­per is at a sixyear low, and crude oil is also lan­guish­ing. Rus­sia shares the same fate as its fel­low EM economies as it is heav­ily re­liant on min­ing and energy pro­duc­tion. But the Fed’s de­ci­sion not to raise in­ter­est rates is an im­por­tant one for Rus­sia and it will pre­vent a steep slide in the rou­ble’s cross­cur­rency ex­change rate.

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The Rus­sian econ­omy is fac­ing in­creas­ing pres­sures at home in the form of de­clin­ing new-car sales. The sharp de­pre­ci­a­tion of the rou­ble since 2014 has made cars markedly more ex­pen­sive. To try and al­le­vi­ate the pres­sures on con­sumers, the author­i­ties have opted for a 50 ba­sis point rate cut. No­body is quite sure how far the rou­ble will fall, but some are sug­gest­ing a de­cline to 70 or 75 against the US dol­lar.

Year-on-year, new-car sales plunged by 29% in Septem­ber. This fol­lows a lack­lus­tre month in Au­gust 2015. With more ex­pen­sive im­ports, the price of man­u­fac­tur­ing and assem­bly of ve­hi­cles in Rus­sia has also in­creased. But the gov­ern­ment does not want to rush into prop­ping up the rou­ble since this will hurt Rus­sia’s ex­port po­ten­tial.

At $50 per bar­rel for Brent crude, Rus­sia will cer­tainly start ben­e­fit­ing from the in­creas­ing rev­enue stream. For the cur­rent year, the mo­tor in­dus­try in Rus­sia is an­tic­i­pat­ing a 37% re­duc­tion in new-car sales. Rus­sia has al­ready been down­graded by credit rat­ings agen­cies, and its econ­omy is set to con­tract even fur­ther by the year’s end.

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