5/10/2014: US Removes Russia from GSP Access as Biden Admits US 'Leadership' over Europe

This week, amidst generally holding ceasefire in Ukraine and with Russia continuing to constructively engage in the multilateral process of normalisation of Eastern Ukrainian crisis, the US leadership once again shown its hand on the issue of Russian relations with the West. Instead of pausing pressure or starting to return trade and diplomatic relations toward some sort of normalisation, the US actually continued to raise pressure on Russia.

First, earlier in the week, the US issued a decision to terminate Russia's designation as a beneficiary developing country in its Globalised System of Preferences (GSP) - a system that allows developing economies' exporters somewhat 'preferential' access to the US markets at reduced tariffs. This decision was notified on May 7th and officially published by the White House on Friday when it came into force.

The US GSP is a program designed to aid economic growth in developing economies (more than 100 countries and territories) by allowing duty-free entry for up to 5,000 products.

According to the White House statement, President Obama "…determined that Russia is sufficiently advanced in economic development and improved in trade competitiveness that it is appropriate to terminate the designation of Russia as a beneficiary developing country effective October 3, 2014."

The likely outcome of this is, however, uncertain. Russian exports to the US in the categories covered by the GSP programme are primarily in the areas of strategically important materials, including rare-earth metals and other key inputs into production for US MNCs. The same MNCs can purchase these inputs indirectly from outside the US. So, if anything, the White House decision is harming its own companies more than the Russia producers by de facto raising the cost of goods with low degree of substitution.

While, personally, I do not think Russia is a developing country - it is a middle income economy - in my opinion, the best course of diplomacy (in relation to trade) is opening up trade markets and reducing (not raising) trade barriers. This is best targeted by lowering tariffs first and foremost in the areas where private (not state) companies supply exports. GSP is a scheme that should be expanded to include all economies, not just developing ones and the US and Europe should pursue more open trade with Russia and the rest of the CIS. Sadly, the Obama Administration is using trade as a weapon to achieve geopolitical objectives (notably of questionable value, but that is secondary to the fact that trade should not be used as a weapon in the first place, but as a tool for helping achieve longer term objectives closer economic and social cooperation).


In a related matter, the US VP, Joe Biden, openly confirmed this week that the US has directly pressured its European allies to impose sanctions against Russia. On October 3rd, speaking at Harvard University, Joe Biden said that: “It is true - they [European countries] did not want to do that [impose sanctions against Russia] but again it was America’s leadership and the President of the United States insisting, oftentimes almost having to embarrass Europe to stand up and take economic hits to impose cost,” the vice president said.

So, apparently, there was quite a bit of discord in the Western 'unity' camp over the actions against Russia. Which makes you wonder: was that resistance based solely on the European countries concern for the economic impact of sanctions on their own economies, or was it a function of their scepticism over the actual events in Ukraine (the nature of the latest Ukrainian 'revolution'? the role of the Western powers in stirring the conflict? the role of Russian in the conflict? etc)? Or may be all of the above?..


One way or the other, the US is driving a dangerous game. It is pursuing extremely aggressive course of actions against Russia with no concrete road map for de-escalation, no specific targets for policy and no back up strategy for addressing the adverse effects of isolating Russia in other geopolitical issues, such as ISIS, Middle East, Iran, North Korea and so on.

11/9/2014: Russian Equities and the Crisis: Update

An update of the event study on the impact of the Ukrainian crisis on Russian equities - through yesterday's close.

A chart for two main indices: MICEX (Ruble denominated) and RTS (USD denominated):

And a summary table of % changes in the indices (reed cells mark cumulative declines, green mark increases). Two indices impacts and changes are diverging due to Ruble devaluations vis-a-vis USD:

You can see very clearly that MH17 and subsequent third round of sanctions had the most dramatic impact effect (short-term shock), with most of the impact and longer-term effect accruing to the MH17 event, rather than sanctions. However, in terms of the long-term impact, Yanukovich's flight and replacement by interim Government in Kiev had the most dramatic effect on Russian markets.

Overall crisis impact is fully captured by two factors:

1. Russian markets effectively saw downgrading of the pre-crisis (pre-January 1, 2014) trends (so there is a loss of potential growth that would have happened if there was no crisis, assuming pre-crisis trend would have been sustained - a tall assumption, given the economy slowdown was well underway before the crisis hit); and
2. Devaluations of the Ruble since January 1 (not all of these devaluations were driven by the crisis, as I explained in numerous notes before, as the Central Bank was already moving toward a free float for the Ruble for some years now and set a target for the free flow back in the mid-2013).

24/7/2014: DB's Worst Case Scenario for Ukrainian Crisis

Earlier this week, Deutsche Bank Research published its 'worst case' scenario for acceleration in the Ukrainian conflict. Here's the slide:

Some of the points are in overlap with concerns I expressed here. Investment interlinks between Europe and Russia covered here. My roadmap for solutions is here. And you can read my note on changes in Russian geopolitical strategy here.

17/7/2014: More Russia Sanctions, Same Pains, Same Strategies

Another set of sanctions and another tumble in Russian shares. This time around, sanctions have impacted major Russian companies with significant ties to the global economy. However, no broad sectoral sanctions were introduced.

The following companies are hit:

• Rosneft - largest oil producer in Russia
• Gazprombank - largest bank in Russia outside retail sector
• VEB - Vnesheconombank 
• Novatek - largest independent natural gas producer
• Federal State Unitary Enterprise State Research And Production Enterprise Bazalt, 
• Feodosia Oil Products Supply Company (in Crimea)
• Radio-Electronic Technologies Concern KRET 
• Concern Sozvezdie
• Military-Industrial Corporation NPO Mashinostroyenia  
• Defense Consortium Almaz-Antey
• Kalashnikov Concern
• KBP Instrument Design Bureau
• Research and Production Corporation Uralvagonzavod 

Full list here: http://www.treasury.gov/ofac/downloads/ssinew14.pdf

The U.S. Treasury Department said that under new sanctions, the U.S. companies are only prohibited from dealing in "new debt of longer than 90 days maturity or new equity" with the listed non-defence firms. There are no asset freezes, no prohibitions or restrictions on export/import transactions. The sanctions do not impact U.S. and other multinationals' work in Russia, unless Moscow retaliates with such measures (which is unlikely).

This contrasts with previous sanctions under which sanctioned companies were prevented from conducting any transactions, including export/import and clearing with the U.S. firms.

So we are having a clear attempt to undercut some Russian companies' access to the U.S. debt and equity markets, while preserving their ability to trade.

VEB will unlikely feel the pinch. The bank converted the National Wealth Fund deposits into capital recently, so it can offset the shortfall on foreign funding.

Gazprombank is a different issue. Last month, Gazprombank raised EUR1 billion at 4% pa in the foreign markets via a bond sale on the Irish Stock Exchange. Gazprombank has one of the largest exposures to international funding markets of all other Russian financial institutions - it has 78 outstanding eurobond issues demented in a number of currencies. So the real problem with the sanctions is that they may open the way for EU to follow, which can shut Gazprombank from the Euro-denominated debt markets too.

When it comes to Rosneft, sanctions are weak. The U.S. simply cannot afford shutting flows of Russian gas and oil to global markets. Reason? Imagine what oil price will be at, if Rosneft was restricted from trading. The company is responsible for roughly 40% of the total Russian oil production which runs at around 10.5-10.9 million barrels per day. Get Rosneft supply access cut and you have an equivalent of entire Iraq's 2013 output (that's right - total output of Iraq is lower than that of Rosneft alone) drained from the global production. Rosneft pumps more oil than Canada and more than double the output of Norway.

You can read on geopolitics of Russian oil & gas here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html

The real target of the sanctions are pre-paid contracts that Rosneft and Novatek have on future supplies of oil and gas. These are de facto forward loans, repayable with future oil and gas supplies. Rosneft exposure to these currently sits at around USD15 billion. Another target: long term funding for energy companies. Rosneft raised USD30 billion in two loans in 2012 and 2013, in part to co-fund buyout of TNK-BP which cost Rosneft USD55 billion in 2013.

In reality, while short- and medium-term borrowing costs for two Russian energy companies is likely to rise, the effect in the longer term will be to push more and more trade and finance away from the U.S. dollar and U.S. markets. Plenty of potential substitutes are open: Hong Kong and Singapore being the most obvious ones. London is a less likely target. For example, in June partially state-owned UK Lloyds Bank cancelled a USD2 billion prepayment facility with Rosneft. The loser is, of course, Lloyds as it foregoes substantial revenues, while Rosneft can secure (albeit also at a price) similar funding from any number of larger trading companies it deals with, e.g. Glencore, Vitol or Trafigura.

Bloomberg covers some of the immediate reactions in corporate debt markets here: http://www.bloomberg.com/news/2014-07-17/rosneft-bonds-sink-most-on-record-as-sanctions-shut-debt-markets.html

All in, there is still ca USD60 billion worth of maturing corporate debt that Russian companies need to roll over before the end of 2014. This is a bit of a tight spot for Russian economy going forward, but it can be offset by releasing some of the liquidity accumulated on Russian banks balance sheets in 2013.


There is a bit of a silver lining for Russia from the U.S. sanctions too. To-date, higher oil prices worldwide (primarily driven by the Middle East mess, but now also with a support from the latest Russia sanctions) pushed up Federal Budget surplus to 1.4% of GDP (see latest arithmetic here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html) over January-May 2014. This means Moscow can afford a bit more of a stimulus this year, offsetting any sanctions-related adverse effects on its economy in the short run.

On another positive side, sanctions have triggered renewed interest in Moscow in developing domestic enterprises with a view of creating a buffer for imports risks (http://en.itar-tass.com/world/741073). Imports substitution is a norm for Russian economy during strong devaluations of the ruble. This time around, we can expect a push toward more domestic investment and enterprise development to drive imports substitution growth to compensate not for Forex changes, but for the risks of deeper and broader sanctions in the future.


So I would re-iterate my previously made call: 

1. Russian economy is in a short- medium-term decline in terms of growth
2. Growth slowdown is compounded by rising borrowing costs and adverse news flow
3. With correct course of actions (monetary & fiscal policies and potentially some regulatory changes), Moscow can steer the economy into recovery in 2015
4. Ukraine crisis abating during the rest of 2014 is likely to support (3) above

All of the above suggest the markets will be oversold by the time Russian equities corrections hit 8-10% mark, assuming, of course, no further escalation in Ukraine (both with and without Russian influence, Ukraine's internal problems have now been firmly pushed by the EU into Russian domain).

There has been no cardinal change in the Western strategy with respect to Ukraine (support at any cost of Poroshenko push East) and with respect to Russia (blame at any opportunity for anything happening in Ukraine). The latest sanctions are simply a replay of the previous ones, which means that the U.S. is relatively satisfied with the progress in Ukraine, while the EU has moved to the back seat, having finalised the association agreement and unwilling to expand on this.


As a side note: there are implications building up for Western companies, relating to the U.S. and EU sanctions:

• Bloomberg reports (http://www.bloomberg.com/news/2014-07-16/as-ukraine-heats-up-exxon-to-airbus-eye-growing-risks.html) on Exxon Mobil Corp, Airbus Group NV and Daimler AG risks;
• ITAR-Tass covers the cases of Caterpillar and Bombardier: http://en.itar-tass.com/world/741083

On political front, here is an interesting report on President Putin approval ratings: http://en.itar-tass.com/russia/740817. I have not seen the original study cited in the report, yet.

17/5/2014: Are Markets Punishing Russia?.. or the Emerging Markets?

An interesting analysis from the BBVA Research on capital flows to EMs… while much can be discussed, one thing is of interest from my point of view (not covered by the BBVA): Russian inflows.

We've heard about alleged markets punishment and investors flight from Russia. And there has been some for sure. Except, the theory that this flight is tied to naughty kremlin behaviour in Ukraine is a little… how shall we put it… a stretch may be?

Ok, let's look at how net capital flows look in the EMs: 

Emerging markets are some 14% below trend - big outflows starting with non-Ukraine Fed tapering:

So Asia is even worse off than the general EMs... And Asia is Ukraine-free and Fed-tied.

Yes, Russia is down… 24% below trend by estimates of the BBVA

And guess what: decline started in the same 'tapering-on' period and well before Ukraine and accelerated similarly to the rest of EMs. 

And worse… look at what happened in Brazil:

Brazil's 'troubles with Ukraine' started earlier on than rest of EMs, but accelerate with Fed tapering.

Heard of Indonesia? It seems also to be in a conflict with Ukraine:

So how about that thesis alleging that Russia is being punished for Ukraine crisis by those investors?