Russian bond yield to drop to Greek levels
There are three big factors that are shaping the Russian recovery at the moment. Two are well-known (sanctions and muted crude oil prices), but the third is usually overlooked – the ongoing corporate sector restructuring as the debt excesses of the past need to be addressed. In our experience, when a country enters a period of balance sheet restructuring for the private sector, this phase lasts three-to-five years, which means that Russia is likely to be in the middle of it. We believe that this force is bringing inflation below the CBR’s target and may well take Russian borrowing costs down to today’s Greek sovereign yields levels in the next two years – this means a further 300bps drop at best, and probably more by late-2019.#ChangingEurope
Since the 1998 ruble financial crisis, Russia has gone through two episodes of credit bonanza, affecting primarily the corporate sector, particularly the non-financial segment. Total debt, measured by the financial accounts dataset, which includes liabilities against banks, trade credits, bonds, and so on, and non-financial corporates are indebted to the tune of 175% of GDP (as of Q216, the latest data available): more than twice the equivalent measure seen in Turkey or Germany (78% of GDP and 72% of GDP respectively using Eurostat data); and well north of Spain’s 93% of GDP (which has dropped from the peak of 128% of GDP in 2010).
In our view, the combination of a relatively modest level of crude oil prices, the international sanctions against some Russian entities, and the high indebtedness accumulated in the past are all constraining the speed of the recovery and forcing a cleaning-up phase in the business sector. Some of these effects are visible in the balance between the birth of new companies and bankruptcies – which showed a heavily negative level in 2015 and 2016, and is still suggesting further weakness ahead. It is also visible in modest wage pressures (compared with Russian’s recent history) and a rapid drop in inflation.
The preliminary estimate of 3Q real GDP showed an expansion of 1.8% yoy, missing the Bloomberg consensus expectations of 2% slightly and down from the 2.5% yoy seen in 2Q. That said, in our view, it was not a bad performance at all, given the backdrop – in fact, we see real GDP growth stuck between 1.5% and 2% for the foreseeable future, at least until one or more of these key constraints loosen. In our experience, once a country embarks on a corporate restructuring phase, it easily lasts three-to-five years, implying that Russia is about half-way through it probably. On sanctions, there is a material risk of a further increase early next year coming from the US and, in our view, European governments are too busy dealing with Brexit and the reshaping of the EU to genuinely consider lifting the sanctions next year.
As far as crude oil prices are concerned – we simply observe that it appears stuck around USD 50-55/bbl more often than not, and the central bank of Russia (CBR) remains very concerned about oil prices dropping to USD 40/bbl in future. Conscious of the muted oil price outlook, the Ministry of Finance estimates an ongoing budget deficit consolidation to 1.4% for 2018E and to a roughly balanced budget in 2019E and 2020E, down from a peak shortfall of 6% of GDP in 2009.
Inflation has halved in the past year, falling to 2.7% yoy in October, and, on the basis of the weekly data, it has even dropped below 2% since, well below the CBR’s 4% target. Our models suggest that inflation is likely to continue to undershoot the target in the next two years on average, even with rouble weakness – in large part, as a result of the corporate restructuring phase that is taking place.
Significant structural changes are taking place in Russia: investors and entrepreneurs alike should take notice. #ChangingRussia
We believe that the inflation outlook should allow the CBR to bring down the policy rate slowly, from 8.25% to 6.25% by the end of 2018E, and may well reduce it by a further 200bps by the end of 2019E. This implies that local OFZ bond yields are likely to trade close to current Greek bond yields and should carry on catching up with Greece eventually trading below 5% for the first time in over 10yrs.
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