Russia: Other Points of View

Russian Politics: A Different Kind of War

Friends,

 

Chris Weafer, an esteemed, long-term financial analyst in Moscow gives his summary of Russia's economic situation at this stage of the standoff between the U.S., its European allies and Russia.  Chris has remained totally neutral in his analysis over the years, is not involved with the Kremlin and  has been a boon to American and European investors over the years.

 

Chris Weafer

Senior Partner

Macro-Advisory Ltd

Moscow

 

December 4, 2014

 

We have today issued a special report looking at the political aspects – both geo-political and domestic – of the crisis. We address such questions such as “what are the political drivers of the crisis?”, “will Russia back down or continue to live with sanctions indefinitely?”  “Does the crisis risk altering the domestic political balance?”, “what are President Putin’s key geo-political and domestic priorities?”, “how does Russian legislation work?”

Today starts a sequence of important events – five important Thursdays in a row – which will serve to clarify the Kremlin's list of priorities and also what we may expect in terms of investment reforms and risks in 2015. Today President Putin delivered his annual address to the Federal Assembly (State of the Nation address).Nothing new or exceptional (see December macro Monthly to be issued in the coming days). Next Thursday (11 December) the Central Bank holds its last policy meeting of the year and is expected to clarify its ruble policy – if not forced to do so before then. On Thursday 18 December Putin holds his annual televised press conference and will answer questions from the audience and the public. Here also we usually get greater clarity on priorities and policy. That is the same day as the next EU Leaders Summit in Brussels, at which we should hear more comments about sanctions, etc. The followingThursday is 25 December and the fifth Thursday is New Year's Day. Rumors of Cabinet changes are already emerging in Moscow as the period between the Western Christmas and New Year is when such events tend to happen most often.

CEASE-FIRE PROCESS BRINGS SANCTIONS RISK RELIEF

FINANCIAL ANALYSIS

by Chris Weafer

Today we issue our September Macro Monthly for Russia. The breaking news from Kiev (Wednesday morning) is that Russia and Ukraine have agreed to a permanent cease-fire in eastern Ukraine. That was later amended by President Poroshenko's office to state both sides had agreed to a cease-fire process. We have reflected that news in this report but clearly there is a great deal more clarification to come in the days ahead – especially at the NATO summit in Wales (Thursday and Friday). If required we will issue a supplementary note in a few days.

Summary

• The escalation of fighting in eastern Ukraine immediately after the Minsk summit had raised the sanctions threat against Russia. The threats were expected to become even more pronounced in the days leading up to the NATO summit on 4-5 September.
• The breaking news from Kiev (Wednesday morning) is that Russia and Ukraine have agreed to a permanent cease-fire in eastern Ukraine, later amended by President Poroshenko's office to state both sides had agreed to a cease-fire process. Despite Moscow sticking with its long held position that it is not party to the conflict and therefore is not formally part of the peace deal, the news will greatly add to the optimism that the worst of the crisis has now passed. If the agreement is seen to be put into effect then optimism that the existing sanctions against Russia, and the retaliatory actions taken by Moscow, may be removed at the first review date on November 1st.

UKRAINE: ITS ONLY THE END OF THE FIRST PERIOD

FINANCIAL ANALYSIS

by Chris Weafer

A good hockey player plays where the puck is. A great hockey player plays where the puck will be” 

Wayne Gretzky

Petro Poroshenko’s first priority will be to suppress the para-military groups in East Ukraine. His second priority is to establish economic pragmatism with Moscow. The Kremlin is open to such an approach but has stipulated that it is closely monitoring the actions against the pro-Russia separatists in the East. This may yet be a deal breaker which would keep investment risk high in both countries. The worse the TV pictures from the East and the longer they last, the greater the pressure on markets in both countries. 

There are conflicting messages about a possible EU brokered gas deal. It is still very possible that a deal will be struck by the weekend (very positive for all sides and for Gazprom’s cash flows) but threats are still being exchanged against a tense political backdrop. As we have noted previously, a gas deal (or not) will provide the clearest signal of the hoped for pragmatic relationship between Russia and Ukraine and the start of an improvement in Moscow’s relations with the EU. 

We expect Ukraine to pay down $2 bln of the debt up-front and another $500 mln in June and Gazprom to revise its price to the European average (or close to it) which is currently $380 p/1’000 cm. Naftogaz is reported to be still unhappy with the terms (probably on the volume off-take) but the EU is pushing Kiev to reach a deal. That may be ahead of this weekend’s deadline or in the coming weeks. Kiev has received $3.2 bln from the IMF, plus has raised $1 bln via the US loan guarantee and is expecting at least $1 bln from the EU shortly. It has enough to cover Gazprom plus other scheduled debt obligations.

The full note is available  Download Ukraine_Its_only_the_end_of_the_first_period_28.05.14

CIS/UKRAINE: THE ONLY CERTAINTY IS CONTINUED UNCERTAINTY

FINANCIAL ANALYSIS

By Chris Weafer

“When politicians start talking about large groups of their fellow (citizens) as 'enemies,' it's time for a quiet stir of alertness. Polarizing people is a good way to win an election, and also a good way to wreck a country.” 

Molly Ivins, Author and political commentator

• The peace proposals offered by the president – an early election and a power sharing government – is a positive step forward in terms of politics but does little to resolve some of the key questions for investors and concerning the economy in 2014. The “deal” leaves open the question of who will provide the rescue deal that Ukraine critically needs and on what terms. Until resolved this will continue to hang over the debt, equity and currency markets. Clarity is not expected until after the elections. 

• Critical for bond holders and the currency is whether the Russia rescue deal remains in place or whether it will be suspended until the outcome of the elections is known. The next comments from Moscow will be key for the short-term performance of debt issues. In the event the deal is suspended or delayed, default risk will rise. If a pro-western government eventually takes power then default risk will be very high as an EU/IMF substitute deal will not protect all bond holders and will insist on the currency peg being eliminated. 

• In any event, given the continuing negative impact on the performance of the economy, including tax revenue generation/collection, the government will need more than the $15 bln agreed with Moscow last December. The total cost of a default-avoiding bailout for 2014 is likely to have risen to $20 bln at this stage.

Note; I do not propose to rehash the pros and cons of the politics. There is plenty of coverage of the issues in the media. This note is confined to the “what if” scenarios which may impact on the economy, on asset valuations and the possible contagion to Russia. 

To access the full report, click Download CIS_Ukraine_Briefing_Feb_21_14 

RUSSIA MACRO-POLITICS: TERMS OF ENDEARMENT

FINANCIAL ANALYSIS

by Chris Weafer

“I have grown to love secrecy. It seems to be the one thing

that can make modern life mysterious or marvellous to us.

The commonest thing is delightful if only one hides it.” 

Oscar Wilde. The Picture of Dorian Gray

Two main talking points. Okay, it’s a cheesy title but nevertheless appropriate. The two big talking points concerning Russia right now are the Ukraine deal and the presidential pardon for Mikhail Khodorkovsky. We know the basic facts about both but not the terms, the small print. Specifically what has, if anything, President Yanakovich agreed to in exchange for the Russian money and what are the terms of Khodorkovsky’s pardon? At yesterday’s press conference Khodorkovsky spoke of an “unspoken understanding” about what he is going to do in the future, which includes staying away from politics. Speculation about the specifics of both deals will continue to preoccupy Russia watchers for many months of 2014.  The fact that President Putin was negotiating with German officials and Khodorkovsky even as law enforcement agencies were preparing a third case is also intriguing. But that’s for another day. 

No immediate impact. Neither event has any short or medium term implication for the stock market, currency or the domestic economy.

May Gazprom get equity in the Ukraine pipe? Without wishing to add further to the plethora of speculation, one issue to watch for concerns Gazprom’s long standing ambition to own an equity stake in the Ukraine transit pipe. Recall that this was eventually part of the deal for cheap gas to Belarus. The point about this is that it would be much easier and cheaper to upgrade that pipe and plug it into the Balkan’s South Stream network than to build the Black Sea transit pipe. It would also satisfy President Putin’s demand that state companies cut spending and, perhaps, allow Gazprom to boost the dividend. 

To access the full report, click Download Russia_Briefing_Dec_23_'13 

Russia Macro-Politics: Friends Reunited

FINANCIAL ANALYSIS

by Chris Weafer

“History is that certainty produced at a point where the imperfections of memory meet the inadequacies of documentation”

Patrick Lagrange (French historian)

Economic weakness is the dominant concern for Russia. The headlines from Russia are dominated by two issues currently; the rapprochement between Russia and Ukraine and the still weakening domestic economy. In terms of possible market impact the former is potentially very significant for the longer term, especially if Ukraine were to move further and start talks to join the customs union. The latter is of much more immediate concern and unless reversed the weak macro data will soon lead to a scaling back of domestic earnings growth assumptions. That would hurt sentiment towards many of the domestic economy equity market themes and add more pressure on the ruble.

The Iranian deal may impact oil later next year. The international headlines are today dominated with the deal between Iran and the UN to curtail the country’s nuclear programme. That news knocked almost $2.5 p/bbl off the price of Brent in early Monday trading and adds to concern that further, more significant, price weakness may deteriorate Russia’s budget execution in 2014 and add further downward pressure on the ruble.

Friends reunited. It is case of “friends reunited” for Kiev and Moscow, for former Finance Minister Alexey Kudrin (he has been brought back into a formal Kremlin advisory role – see below) and now for Tehran and the UN. The investment implications for all three have been factored into our 2014 macro forecast assumptions and are reviewed in more detail below.

To access the full report, click here  Download Russia_Briefing_Nov_25_'13

RUSSIA MACRO-POLITICS: ONE STEP AT A TIME

FINANCIAL ANALYSIS

by Chris Weafer

“Although it is said that faith can move mountains,

experience shows that dynamite works better” 

Anon

Moving up the rankings. The main news last week was the gain in Russia’s ranking in the World Bank’s 2014 Ease of Doing Business survey. Russia is now ranked 92^nd (out of 189 countries) having moved up from 111^th last year (details below). This does not have any immediate impact on the perception of equity risk, on valuations, on earnings growth, nor on the medium-term macroeconomic indicators. It is important because it shows that the government’s commitment to business reforms is starting to yield some results. 

Russia now ranks 10^th best in the world for contract enforcement.  That disposes of a popular mis-conception about the risk of doing business in the country. 

Reform progress since the last elections. Over the past eighteen months we have seen more progress in advancing reforms that ever before. The list includes WTO entry, capital market reforms, anti-corruption legislation and better budget discipline. It can be argued that these changes are still not much more than a drop in the ocean relative to the size of the problem still to be addressed. But at least we now have reform momentum and that’s not something we could have said before the summer of 2012. 

To access the full report, click Download Russia_Briefing_Nov_5_'13 

RUSSIA MACRO-POLITICS: CHANGING POLITICAL AND ECONOMIC PARADIGMS

FINANCIAL ANALYSIS

by Chris Weafer

“It was impossible to get a conversation going; everybody was talking too much” 

Yogi Berra 

Ruble. The ruble looks set to trade in a relatively narrow band of approximately Rub/$\31.5 to $32.5/33.0 between now and year end. Rate cuts and stimulus spending are on hold this year. Next year will be very different with a very high risk of ruble weakness in the spring if the government’s forecast of economic recovery fails to show.

Equities YTD. The equity market continues to trade on (relatively) low volume but with positive momentum. My published view for this year (in a previous employment) was that the 2013 would be a game of two halves with the 1st half extending last year’s weakness while the 2^nd half would bring a rally. That has played out well. The RTS and MICEX lost 16.5% and 9.8% respectively in the 1st half. Since July 1st the RTS has recovered 18.9% while MICEX has rallied 15.2%. The RTS is now (Friday’s close) off only 0.7% year to date and MICEX is up 4%.

More to come. I see both indices ending the year higher than Friday’s close but with even more volatility and with Russian indices tracking the global EM trend, albeit with high beta. Investors are likely to focus more on US macro data as an indicator of when the Fed may start to taper. Tomorrow’s (Tuesday) delayed October payroll report is one of those reports expected to have a direct market impact.

To access the full report, click here  Download Russia_Briefing_October_21_13

RUSSIA MACRO-POLITICS: GAMBLING ON STABILITY

FINANCIAL ANALYSIS

by Chris Weafer

“Eskimo:  “If I did not know about God and sin, would I go to hell?” 

Priest:     “No, not if you did not know”

Eskimo:  “Then why did you tell me?” 

Annie Dillard (Pilgrim at Tinker Creek)

Battening down the hatches. Having spent all summer talking about the need to lower debt service costs and stimulate growth in the flat-lining economy, the recent policy decision by the Central Bank, and the government’s proposal to cut budget spending to avoid expanding the deficit, points to a near 180 degree turn in strategy.

The key assumption. Instead of trying to boost growth with spending and policy initiatives the government seems intent on maintaining stability while trying to pull inflation towards 5.5%. The thinking appears to be that A) the economy will show some recovery over the next four months because of the base-effect from a weak 2^nd half in 2012, B) the global recovery will pick up pace and help Russia’s export industries, and C) lower inflation and stability will create the right backdrop for organic recovery in 2014.

That’s a heck of an assumption to make. Inflation will surely fall to less than 6% by the end of this year and the Central Bank should be able to maintain the ruble within a defined range of (probably) R/$31.5–R/$34.0. Global recovery, especially in emerging markets, still has a flashing question mark as regards timing because of the uncertainty of the Fed’s actions, the return of Washington bickering over budgets and deficits and a probable period of fresh concerns in the eurozone (see later).

The consumer sectors are more at risk. The bigger question mark is over the impact on domestic growth from the decision to cut budget spending in 2014–2016. The breakdown of cuts is still to be finalized but it seems that the bulk of the cuts will be borne by the “soft-targets” rather than by sectors represented by powerful lobby groups, e.g. defense. A scale back, or freeze, in public sector salary increases and in the pensions system may be replicated by other industries keen to use the excuse to improve profitability. That may directly hurt the consumer sectors which have been the engine of growth in the economy for many years. The revised budget plan for the next three years is expected on October 1^st.

To access the full report, click here  Download Russia_Briefing_September_24_13 

Russia Macro-Politics: New Investment Season…Getting Better or Worse?

FINANCIAL ANALYSIS

by Chris Weafer

“Act, and you shall have dinner; wait and you shall be dinner” 

Klingon Proverb (Star Trek)

This Briefing note will no longer include specific stock, currency and debt strategies. Specific trading strategies will henceforth only be included in separate and bespoke client briefings. But I will retain this background briefing format for the time being.

The most important determinant of how emerging market assets, including in Russia, will perform over the medium term will be the actions agreed at the Sept 18^th FOMC meeting and what Fed Chairman Bernanke says at the post meeting press conference. 

Ahead of that this week’s US payroll report will affect short-term trading as this is the most important political-economic indicator as far as Washington is concerned and the number will likely determine whether the QE tapering actually starts now or later.

In Russia the Central Bank’s policy meeting will take place on Friday week. The ruble weakened further in August despite the 6% rise in the oil price. Investors have been waiting for several months for the start of rate cuts and even though economists are split as to when this may happen, the Central Bank should cut this month. Policy makers are probably worried that a) inflation is still above 6% and b) a rate cut may send the ruble lower against an already very nervous backdrop in emerging market currencies. But there is clear need for growth stimulus and the very high cost of debt servicing is a big drag on the economy. The current high oil price will provide some downside protection making this a good month to start rate cuts.

To access the full report, click here  Download Russia_Briefing_September_4_'13