10/4/16: Russian Bonds Issuance: Some Recent Points of Pressure

Catching up with some data from past few weeks over a number of post and starting with some Russian data.

First, March issue of Russian bonds. The interesting bit relating RUB22.8 billion issuance was less the numbers, but the trend on issuance and issuance underwriting.

First, bid cover was more than four times the amount of August 2021 bonds on offer, raising RUB22.8 billion ($337 million) across

• fixed-rate notes (bids amounted to RUB47 billion on RUB11.5 billion of August 2021 bonds on offer)
• floating-rate notes (bids amounted to RUB25 billion on issuance of RUB9.33 billion of December 2017 floating coupon paper) and 
• inflation-linked securities (amounting to RUB2.01 billion)

This meant that Russia covered in one go 90 percent of its planned issuance for 1Q 2016, as noted by Bloomberg at the time - the highest coverage since 2011. With this, the Finance Ministry will aim to sell RUB270 billion in the 2Q 2016.

Bloomberg provided a handy chart showing as much:

Now, in 2011, Russian economy was still at the very beginning of a structural slowdown period and well ahead of any visibility of sanctions.

Sanctions are not directly impacting sales of Russian Government bonds, but the U.S. has consistently applied pressure on American and European banks attempting to prevent them from underwriting Moscow's Government issues (http://www.wsj.com/articles/u-s-warns-banks-off-russian-bonds-1456362124). Prior to the auction, Moscow invited 25 Western banks and 3 domestic banks to bid for USD3 billion worth of Eurobonds (the first issuance of Eurobonds by Russia since 2013). Despite the EU official statement that current sanctions regime does not prohibit purchases or sales of Government bonds, Western banks took to the hills (at least officially).

The point of the U.S. pressure on the European banks is a simple threat: in recent years, the U.S. regulators have aggressively pursued European banks for infringements on sanctions against Iran and other activities. In effect, U.S. regulatory enforcement has been used to establish Washington's power point over European banking institutions. And the end game was that, despite being legal, sale of Eurobonds was off limits for BNP Paribas, Credit Suisse, Deutsche Bank, HSBC, and UBS, not to mention U.S.-based Bank of America, Citi, Goldman Sachs, JP Morgan Chase, Morgan Stanley and Wells Fargo.

Another dimension of pressure is the denomination of the Eurobond. Moscow wanted Eurobond issued in dollars. However, dollar-issuance requires settlement via the U.S., enhancing U.S. authorities power to exercise arbitrary restriction on a deal that is legal under the U.S. laws (as not being officially covered by sanctions).

Beyond underwriters, even buy-side for Russian Government bonds is being pressured, primarily by the U.S., with a range of European and American investment funds getting hammered: http://www.bloomberg.com/news/articles/2016-03-24/russia-loses-buyside-support-for-eurobond-after-banks-balk.

Russian Government bonds (10 year benchmark) are trading at around 9.26-9.3 percent yield range, well down on December 2014 peak of over 14.09 percent, but still massively above bonds for countries with comparable macroeconomic performance statistics.

Interestingly, there is a huge demand in the market for Russian Eurobonds, as witnessed by mid-March issuance by Gazprom of bonds denominated in CHF (see: http://www.bloomberg.com/news/articles/2016-03-16/gazprom-taps-switzerland-with-russia-s-first-eurobond-this-year).

It is worth noting again that Russian Government bonds are not covered by any sanctions and are completely legal to underwrite and transact in.

Beyond this, the Western sanctions were explicitly designed to avoid placing financial pressures on ordinary Russians. Government bonds are used to fund general Government deficits arising from all lines of Government expenditure, including healthcare, social welfare, education etc, but also including military spending, while excluding supports for sanctioned enterprises and banks (the latter line of expenditure is linked to funds being sourced from the SWF reserves). Given this, the U.S. position on bonds issuance represents a potential departure from the U.S.-stated objective of sanctions and can be interpreted as an attempt to directly induce pain on ordinary Russians (the more vulnerable segments of the population, such as the elderly, children and those in need of healthcare, or as they are termed in Russian - budgetniki - those whose incomes depend on the Budgetary allocations).

This is a sad turn of events from markets and U.S. policy perspectives - placing arbitrary and extra-legal restrictions on transactions that are perfectly legal is not a good policy basis, unless the U.S. objective is to fully politicise financial markets in general. Neither is the U.S. position consistent with the ethical stance de jure adopted under the sanctions regime.

21/5/15: IMF to Russia: Do What You've Been Doing, Because We Say So

So the IMF released the summary statement on its Article IV 'consultations' for Russia. The stuff reads like something generated by a pre-historic algo with insight of a first order non-stochastic linear equation.

"The Russian economy is in a recession due to lower oil prices and sanctions. In addition, long-term growth remains low given structural bottlenecks." You have to laugh. IMF knows that sanctions are tertiary to Russian recession. Oil prices are primary and structural slowdown that started in late 2012 is secondary.

"The authorities’ macroeconomic policies have helped stabilize the situation, but there remain significant uncertainties regarding oil prices and geopolitical risks. Given these risks, the macroeconomic policy stance must be prudent." In IMF-speak this means that the Russian authorities did an excellent job so far managing the crisis, but they have done it without using IMF 'advice' or 'tool kit'. Which means that, to IMF, they haven't done it as well as the IMF could have done it. Obviously. Really.

So the bad Russkies better deploy the fabled IMF's 'structural reforms' pack:

• Stay low budget deficits (on which they really have no choice and are so far planning to do the same without the IMF 'advice'); 
• Lower central bank rates (which they are already doing without the IMF 'advice'), 
• Provide "limited stimulus" from the fiscal policy side (which, again, they are doing as much as they can). On Central Bank rates: to remind you, on 30 April, the CBR cut its key rate by 150bp to 12.5%. Without IMF's 'help'. I suspect the CBR will move rates below 10% by the end of 2015, unless there is a major reversal in ruble position, or if inflation reverses its (for now very fragile) moderating dynamics (inflation declined from16.9% y/y in March to 16.4% in April)... and… hold it… 
• "Finally, re-invigorating the structural reform agenda and avoiding de-integration from the world economy remain crucial to lift potential growth." Ah, there, IMF said it… 'structural reforms'. 

In other words, IMF is clamouring for some credit in the above. Ex-post the start of Russian adjustments, IMF recommends exactly the same adjustments, so when anyone asks what did IMF do when Russia was clawing its way out of the crisis, the IMF can say: we recommended them.

Of course, another bit that fills one with wonder in the IMF statement is how can Russia 'avoid de-integration from the world economy' any differently than it has been doing to-date?

To recap last 12 months or even last 12 years: Russia initiated a huge whirlwind of 'global integration' projects and activities in Asia Pacific, the Central Asia, India and Latin America. May be these are not quite 'global' enough for the IMF? Or should Russia somehow magic up 're-integration' with the EU? Actually it is trying to do so on a bilateral basis (proposing trade sanctions relaxation with a handful of countries) and tried - unsuccessfully so far - with the EU itself. Did Russia 'de-integrate' itself out of South Stream? Did Russia de-integrate itself from joint energy projects in the Arctic? Did Russia 'de-integrate' itself from the debt and investment markets in Europe? Nope, not them - that was the EU de-integrating Russia. But Russia did continue to de-de-integrate itself in nuclear energy sector, for example, in Hungary and Finland and Turkey and elsewhere...

IMF's generalities aside, the Fund updates some of its point estimates for the Russian economy.

A month ago in its April World Economic Outlook update, IMF forecast Russian economy to shrink 3.83% y/y in 2015 and 1.096% in 2016. Now, one month later, the forecast is for the economy to shrink 3.4% in 2015 (a 0.4 percentage points improvement in one month) and post a "mild recovery" (as in positive growth) in 2016. The Fund 2015-2020 projection in April was for an average rate of growth of 0.096% and 2016-2020 average of 0.9%. This time around, the Fund is expecting a medium-term growth to be 1.5% per annum. Seems like at least someone in the Fund is starting to look at the real dynamics in the economy.

Here's more of what the Fund does get right: "Persistently low oil prices or an increase in geopolitical tensions could further weaken the economic outlook... However, in the near-term, sizeable buffers, including high international reserves, low public debt, and a positive net international investment position should help safeguard external sustainability." Yes, the risks are there. But, the idea that Russia is just going to run out of reserves by the end of this year - often repeated by numerous analysts, including some who should know better - is bonkers, unless something really massively negative happens. Which may happen. Or may not. IMF is of little help on this point estimate.

One interesting bit: "The re-pricing of the FX liquidity facilities was adequate. The central bank could consider limiting further the FX allotments to ensure that the facilities remain sufficient for emergency purposes. The announced program of FX purchases to build precautionary buffers is welcome."

Did you hear that? Yes, Russia is again building up its forex reserves. Not the stuff you normally read in the Western press. Things are short-term, for now, but Russian FX reserves bottomed out in the week of April 17th at USD350.5 billion. Last week, they were at USD362.3 billion. Again, things might change and these increases can be reversed, but when was the last time that you read in the mainstream media that the CBR is now buying dollars and euros rather than selling them?

Russia will need higher reserves. Its economy is being held back by the severe impairment to its companies access to capital markets - reaching well beyond the intended targets of the sanctions. The West, which imposed these sanctions under the explicit stipulation that they were not supposed to hurt ordinary businesses and households, is doing absolutely nothing to rectify the problem.

Meanwhile, gross fixed investment continues contracting: in March down for the 15th consecutive month at -5.3% y/y. Net capital inflows in the non-banking sector totalled USD18 billion in 1Q 2015, second weakest in 12 months period, while total net capital inflows were USD32.6 billion - second highest year-to-date. The IMF is forecasting Russian aggregate investment to drop from 21.6% of GDP in 2013 and 19.9% of GDP in 2014 to 17.6% in 2015, before recovering slightly to 17.9% in 2016. This clearly puts strong emphasis on the need to support investment activity in the economy.

The IMF does note the serious drag on medium term growth exerted by the structural weaknesses in the economy. In line with what many, including myself, have argued before, the IMF puts forward a set of very general 'directional' reforms needed:

• "Less regulation and a reduction of the government’s role in the economy remain crucial to foster efficiency, confidence and investment". It worth noting that the Fund does suggest more and better regulation in the banking sector.
• "…improving protection of property rights" - a perennial problem that can only be resolved over the long run
• "…enhancing customs administration and reducing trade barriers" - a problem that is unlikely to be sorted because the Russian Government is pursuing medium-term growth strategy based on imports substitution - a strategy that, if executed correctly (a big 'if') can be quite productive
• "…empowering the Federal Antimonopoly Service (FAS) to eliminate entry barriers to several sectors/markets" - really a pipe dream at this stage, unfortunately.
• "…to improve labor force dynamics in the face of negative demographic trends, pension reform should be a priority" - which is something that was well underway prior to 2014 crisis, but got derailed by the extreme demand for dollar liquidity in the system triggered by the 2014 crisis.

Can't wait to see the 70-pages-plus full report. At least it promises colourful charts, if not an incisive insight... 

5/3/15: Russian Oil & Gas: production and exports

Russian energy exports in the year of economic sanctions -  a nice survey Oil Price (h/t to @RussiaInsider) via http://oilprice.com/Energy/Energy-General/Impotent-Western-Sanctions-Fail-To-Disrupt-Russian-Energy-Exports.html.

Basic summary: volumes are up (coal), holding (uranium). But, tellingly, no discussion of oil and gas exports. Reason: both are under twin pressures of price and sanctions. So a quick add-on:

• Oil revenues: switching wells off in Siberia in the winter is tricky, risky and hard to do, so the black gold continues to flow even at current prices. But 2014 oil exports revenues were down 11.4% to USD153.8 billion and volume of exports was down 5.6% y/y to 223.4 million tons. 
• Oil production: OPEC estimates Russian oil production to decline by 70,000 bpd in 2015 with exports declining by 60,000 bpd y/y. Meanwhile some industry players have much more gloomy outlook: Lukoil sees a possible drop in Russian production of 800,000 bpd by the end of 2016: http://www.reuters.com/article/2015/03/03/russia-crisis-lukoil-idUSL5N0W537K20150303. Meanwhile, December 2014 saw a sharp rise in Russian oil exports to 4.4 million bpd as the Government cut export duty from 59% to 42%. New duty covers also 2015, so we can expect some support for production levels. OPEC estimated Russian production volumes to average 10.58 million bpd, with Q1 2015 forecast of 10.6 million bpd and Q2 forecast of 10.54 millions bpd.
• Gas: full year estimates for Gazprom exports are down 18.6% y/y to USD54.73 billion, volume of exports down 12.1% to 172.6 billion cubic meters. Average contracted price in 2014: USD317 per 1,000 cubic meters, down 7.5% y/y.
• Gas plans: Russia has been aggressively shifting new contracts for supplies to Asia Pacific and Turkey. By Energy Ministry estimates, Russian gas exports to Asia will rise from 14 bcm in 2014 to 130 bcm in 2035 and oil and coal exports will more than double.
• Worth noting the increasing switch in favour of refined petroleum products exports, discussed here: http://www.reuters.com/article/2014/12/09/russia-oil-exports-idUSL6N0TS1XV20141209
• Overall trade impact of the above was to drive down exports revenues to USD782.9 billion or down 7% y/y. Trade surplus was USD210.9 billion in 2014.
• If imports remain where they were in 2014, and oil price averages of 2015 at USD45 pb, Central Bank of Russia estimates a decline in exports revenues (and trade balance) os around USD 160 billion - painful, but still leaving the country in a trade surplus.

13/2/15: Data: Don't Bank on Sanctions Triggering Political Change in Russia

A very interesting insight into the interaction of politics and economics in public perception of political power distribution and public satisfaction with political life from the Pew Research: http://www.pewglobal.org/2015/02/12/discontent-with-politics-common-in-many-emerging-and-developing-nations/

Here are some numbers:

Political satisfaction in Russia in the above chart is quite telling and coincident with public approval ratings for the Government (though these are always lower than the approval ratings of President Putin). In fact, Russian public satisfaction with political situation is the highest in the entire sample of countries. The data covers Spring 2014, so it is somewhat dated and does not reflect subsequent economic and geopolitical developments.

In the context of Russia and Ukraine, the above chart maps public perception of the power of oligarchs. Not surprisingly, Russia comes out much more favourably than Ukraine. Notice that Russian perception of power concentration in the hands of the wealthy is on par with Asian median. As chart below shows, Russian perceptions of power concentration in the hands of the wealthy is actually consistent with Higher Income countries median at both ends of the opinion spectrum.

And for the last, a fascinating plot of relationship between economic environment and satisfaction with political system:

Again, note Russia's position in the above, which appears to be statistically below the correlation line, implying significantly higher satisfaction with political system component to be unrelated to economic environment/conditions than sample average.

All of the above reinforces the argument that in Russia's case, economic environment is much less important in driving public attitudes toward political system than in other countries, which, of course, reinforces the argument that economic sanctions and economic warfare against Russia are unlikely to deliver the results expected under the traditional assumptions of the close links between economic performance and political satisfaction. In other words, don't bank on sanctions and/or economic hardship triggering regime change in Moscow. At least not in the short- to medium-term.

9/2/15: Sanctions: "poisoning the public water supply in the hope of killing some enemies"

An excellent article on the effectiveness of economic sanctions as a tool in geopolitical conflicts: http://www.capx.co/sanctions-against-russia-are-dangerously-defeating-in-a-globalised-economy/

Quick quotes:

"Research by the Peterson Institute for International Economics in 1997 showed that, in instances where the United States imposed economic sanctions in partnership with other nations, between 1945 and 1970 they were successful in 16 cases and failed in 14 – a success rate of 53 per cent. Between 1970 and 1990, when sanctions were applied more prolifically, they succeeded in 10 instances and failed in 38, reducing the success rate to 21 per cent. ...Unilateral US sanctions had a high success rate of 69 per cent between 1945 and 1970, tumbling to 13 per cent in the period 1970-90."

Meanwhile, "in economic terms they carry a cost. …the reality is that Russia is the European Union’s third largest commercial partner and the EU, reciprocally, is Russia’s chief trade partner. Who thought it was a good idea to subvert this arrangement?"

"Economic sanctions have the same credibility as poisoning the public water supply in the hope of killing some enemies. Sanctions are not a weapon that can responsibly be used in a globalised economy."

Yep. On the money. Though I am not so sure that "killing some enemies" is even an attainable goal here: so far, sanctions have been hitting predominantly smaller enterprises (via cut off of credit supply) and ordinary people (via supporting currency devaluations). As per oligarchs and Government-connected elites, for every instance where their property abroad has suffered, there are tens of thousands of instances where devalued ruble has made their forex holdings and forex-denominated portfolios of investments increase in purchasing power. So be prepared to see more concentration of economic power in Russia in their hands over the next 12 months.

17/12/2014: Russian Industrial Production & Investment

Russia's industrial output fell 0.4% in November after two months of relatively strong growth, expanding 2.9% and 2.8% in October and September. Core drivers were:

• Manufacturing sector contracted at 3% in November, having expanded 3.6% in October. The latest change, if confirmed over the next few months, might signal wearing off of the imports substitution effects from Russian counter-sanctions.
• Natural resources exploration sector expanded output by 2.5% in November
• Production of heat and electricity rose 7% in November
• Pipeline production grew by 30% in October, gas turbines manufacturing rose 91%. The $400 billion gas contract with China, signed in May was the reason, as Russia started construction of the 4,000 km Power of Siberia pipeline in September.

Note: November Manufacturing PMIs were up http://trueeconomics.blogspot.ie/2014/12/1122014-russia-manufacturing-pmi.html signalling that things might improve in December data.

On a no-surprise side, fixed capital investment was down in the first nine months of 2014 and in Q3 2014 - declining by around 2% or well below expectations. SMEs investments declined, while investment by larger companies rose. Oil refining investments remain the largest contributor to manufacturing sector investments, per BOFIT. Food sector investments also were robust. Q3 also saw reversal of negative growth in total investments in machinery & equipment by large and medium-sized firms.

BOFIT: "Growth in investments of large firms reflects the government’s goal, reinforced at the start of this year, of getting large state-owned enterprises to increase investments
despite the hard times. The economy ministry indicated in November that investments of so-called natural monopolies, which represent some of the biggest state-owned enterprises, will grow even more notably next year."

Another handy chart via BOFIT:

19/11/2014: Two articles on Russian economy and reforms

Two important articles on Russian economy and policy via Bloomberg:

• Putin Said to Stun Advisers by Backing Corruption Crackdown: http://www.bloomberg.com/news/2014-11-18/putin-said-to-back-crackdown-on-corruption-as-sanctions-bite.html and
• Russia Braces for 'Catastrophic' Drop in Oil Prices: http://www.bloomberg.com/news/2014-11-14/putin-says-russia-preparing-for-catastrophic-oil-slump.html

11/11/2014: Another Wild Ride for Rollercoaster Ruble

On the first day of its quasi-somewhat-sort-of-free float, Ruble is, as predicted (http://trueeconomics.blogspot.ie/2014/11/7112014-russian-ruble-rough-days-ahead.html) is showing no trend other than the one in rising volatility.

Two charts: one day and five days:

Both: MarketWatch 

It has been a wild ride. The shorts are having their lunch:

 Source: @Schuldensuehner 

Remember, CBR abandoned regular interventions strategy and opted for free float of the Ruble. But the float is not quite free, as CBR said it will instead intervene in limiting supply of foreign currency to trading and debt cover only, removing the so-called speculative positions of Russian banks and corporates.

This will be tough to strategise, since much of the so-called 'capital outflow' (Western terminology) or 'speculative demand' (Russian terminology) is related to debt maturity redemptions. These are hitting Russian economy hard in the wake of virtual shut-down of Western debt markets for all Russian companies and banks (including those not covered by sanctions):

Source: Reuters

Still, something will have to be done. Russia is losing foreign exchange reserves fast:

The latest statistics from the CBR covering October show that, inclusive of gold holdings, the value of Russian foreign exchange reserves fell to USD416.23 billion at the end of October, down USD94.76 billion year on year (-18.5%) and down USD63.93 billion (-13.3%) since the first round of sanctions was introduced. Actual foreign exchange reserves (currency holdings) are down USD96.02 billion year on year to USD370.92 billion.

The only surprising bit - given the rate of reserves depletion - is that Russia still did not introduce direct capital controls, although CBR decision this week is looking increasingly like a veiled control regime.

Note: more detailed comments on the Ruble are forthcoming in Euromoney report and Expresso, so stay tuned for links.

24/10/2014: Weekly Russian Economy Update

Bofit released some latest data on Russian economy, so here is the summary, with some of additional points by myself.

September economic activity acceleration came as a bit of a surprise.

• Manufacturing output was up 4% y/y, driven in part by devaluation of the ruble and in part by increased oil refining activity.
• Defense spending is up 33% y/y in January-September, which also is helping manufacturing orders.
• Agricultural output is sharply up as harvest hits near-record levels.
• Consumption is up as retail sales rose 1.7% y/y with non-food sales up 3.5%. Some observers suggest that households are taking out savings to prepare for higher inflation (inflation hit 8.3% in September, sharply up on 8% in August). Since incomes declined in real terms (down to devaluation and inflation), we can assume that this is to some extent true, although banks are not reporting declines in deposits.
• New car sales shrank 20% y/y in September from 0% y/y in Q1 2014. 
• But consumption is most likely showing lags relative to the rest of the economy, so we can expect continued deterioration in retail sales into Q1 2015.
• Decline in fixed capital investment shallowed out by about 2 percentage points, as Bofit notes "thanks to distinctly better development in investment of large energy and transport enterprises than other investment".
• Meanwhile, construction activity is slowing down from the H1 2014 boom.

Net outcome: the Economy Ministry estimates GDP growth at +0.7 % y-o-y in January–September 2014, with only slight deceleration in the July-September.

This is strong reading, considering some forecasts (e.g. World Bank at 0.5% for 2014). That said, as I noted earlier today, with Central Bank heading into October 31 decision on rates with expected 50-100 bps hike, we might see a sharp decline in the economy in Q4 2014. It would take 0.2% drop in Q4 to get us to WB outlook.

On the other front, everyone who grew tired of focusing on ruble collapse have switched into prognosticating federal budget meltdown on foot of falling oil prices. Yes, Brent fell by a quarter compared to 2014 highs. And Urals followed the trend with prices around USD85/barrel. The chart below (via Bofit) illustrates.

But no, this is not a letdown yet on fiscal side. Here's Bofit analysis: "If the price of crude oil holds at the $85–95 level for a longer time, Russian growth will be much slower than current consensus forecasts predict… Russia’s 2015 federal budget also assumes an average oil price of $100 next year, producing a budget deficit of 0.5 % of GDP. The impact of a lower oil price on Russia’s fiscal balance will still be manageable; the nominal increase in budget revenues from ruble depreciation will in part off-set losses. Prof. Sergei Guriyev estimates public sector finances could withstand an oil price of $80–90 for a couple of years thanks to reserve funds and the weak ruble. Sberbank’s research department has calculated that the current account will remain in surplus next year even if the oil price holds at $85. Export revenues will fall, but also imports will decline substantially on e.g. the weak ruble and impacts from economic sanctions."

How fast Russian imports fall relative to exports? Tough guess, but here's IMF data showing 2009 crisis period:

One thing is clear: the above forecasts by the IMF for 2015 show pretty small reaction in imports. If Russian demand for imports goes negative, it will be down to a number of factors:

1. Lower ruble leading to imports substitution - which is GDP-enhancing;
2. Russian sanctions leading to imports substitution - which is GDP-enhancing;
3. Government contracts shifting to imports substitution (including those with Ukraine, relating to military equipment) - which is GDP-enhancing.

And as 2009 shows, the room for contracting imports is massive: 28.7% y/y in one shot. And IMF is forecasting 2015 decline to be just 0.3% y/y.

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.

14/9/2014: Update: Sanctions Round 4: Russian Banks, Stocks & RUB

Updating my chart on Russian stock market performance:

A very interesting set of statements from Sberbank Chairman, German Gref on the impact of sanctions on Russia's largest bank. Two source articles for this are: http://www.vedomosti.ru/finance/news/33360751/sberbank-ne-isklyuchil-rosta-stavok and http://www.vedomosti.ru/finance/news/33332871/sberbank-doveli-do-singapura?utm_source=vedomosti&utm_medium=widget&utm_campaign=vedomosti&utm_content=link

Some quotes from the above:

1. External funding markets are already de facto closed [for Sberbank] - including markets for debt under 90 days (recall, debt over 90 days is directly restricted under the sanctions). De facto, per Gref, sanctions are much tighter than de jure. Hard currency liquidity position of the banks is severely disrupted. 
2. Impact is significant: Sberbank has 28 outstanding euro debt issues in the markets: 22 of these are denominated in USD, 3 in CHF, 1 in Euro, 1 in Turkish lira and 1 in rubles. Prior to the EU sanctions (round 3), Sberbank placed USD1 billion in 10 year 5.5% coupon euro-debt in February 2014.
3. Russian banks are seeking new avenues for raising debt and equity. Per Gref, Sberbank is looking to re-list some of the existing equity, currently trading in US and European markets in other markets. Singapore is one potential platform, with Sberbank considering following in the footsteps of Gasprom which re-listed some shares in Singapore in June 2014. Sberbank is looking at Singapore as a new platform for both equity and debt. Currently, Sberbank shares are traded in London (LSE: September 10 daily volume traded is USD64.1 million), Frankfurt (Xetra: daily volume is insignificant at USD77,453 million), over the counter in the NY (volume is also small at USD0.95 million) and in Moscow (volume RUB6.8 billion or USD181.3 million). Moving into Singapore can provide significant access to new markets for Sberbank and open, simultaneously, access to new debt issuance.
4. Gref expects that the CBR will raise deposit rates on foreign currency deposits to increase funding pool.
5. There are no serious issues with ruble-denominated liquidity, although share of ruble funding coming via the Central Bank is relatively high and rising. State funding is now the main source for growth in credit supply since July as CBR funding rose by RUB223 billion to RUB5.6 trillion, Federal and regional budgets funding is up RUB87 billion to RUB624 billion, and funding via Finance Ministry is up RUB36 billion to RUB656 billion. Share of state funding in the banking system is now at a record of RUB7.1 trillion (13.7% of total banking sector liabilities).

In a related statement, another sanctioned bank, Rosselkhozbank also noted that new sanctions have zero material impact on its access to foreign liquidity, as debt markets de facto froze on foot of the third round of sanctions.

As a reminder, Sberbank, VTB, Gazprombank, VEB and Rosselkhozbank were hit by the fourth round of sanctions announced this Friday. The new round extends July 2014 3rd round of sanctions and prohibits EU investors from trading in new equity and debt instruments issued by these banks with maturity in excess of 30 days (previous round banned trading in instruments with maturity over 90 days).

Note: As covered on this blog, the CBR has de facto allowed free float of the RUB in advance of its pre-commitment to do so starting from January 2015. The CBR stopped interventions in the FX markets back in June 2014 and non-intervention continued through August and into the first two weeks of September. Prior to June, the CBR actively intervened in the FX market to support RUB. Over the last 6 years, the longest period of non-intervention in the FX markets was just 3 days.

12/9/2014: Bank of Russia Leaves Rates Unchanged

So Bank to Russia decided to maintain its benchmark rate at 8% today. The announcement is here http://www.cbr.ru/eng/press/pr.aspx?file=12092014_133319eng_dkp2014-09-12T13_29_04.htm. This was expected by majority of analysts: 17 expected no hike, 7 expected a 50bps hike and 1 expected a 25bps hike. My own view - tweeted out yesterday - that the decision could have gone in favour of a hike.

My rationale was (and remains the same for the next two-three months):

1. Russian sanctions against Western exports of food pushed up inflation and inflationary expectations. I wrote about this before on a number of occasions. As far as we know, early September CPI accelerated upward momentum. In July, when inflation shot up to 7.5% (well ahead of 5% annual target), the CBR responded with a hike and the Government revised its outlook for inflation (July decision raised rates from 7.5% to 8%). August figures (through September 8) suggest inflation has increased to around 7.7% and core inflation hit 8.0%.
2. Ruble weaknesses persist: the currency is now down roughly 5% on end-of-July figures. CBR's reluctance to intervene aggressively in the FX markets means the pressures are still building up.
3. Government policy favours higher inflation: the Government is pushing for a hike in VAT and for an introduction of a regional sales tax (ca 3%) on top of that. On the related, PM Dmitri Medveded held a meeting between cabinet ministers and a panel of Russian economists discussing various options for addressing fiscal risks. The group of economists invited was unanimously against the introduction of a regional sales tax, preferring to increase VAT instead.

Nonetheless, the CBR is clearly watching for any effects of July hike on inflation. As noted in the release, money supply growth fell off the cliff: down from 17.1% a year ago to 6.5% this year.

The CBR is also clearly concerned with the deposits situation in the banks, noting that higher rates create incentives for raising savings. This represents a policy of switching as much as possible of the lost funding from international markets (sanctions) into deposits funding.

The CBR has also revised its economic outlook which is now much gloomier than that of the Government. Utilisation capacity remains high, but labour productivity growth is sluggish, per CBR, which suggests that the CBR is more pre-occupied with structural weaknesses in the economy. The CBR now expects the economy to shrink by -0.2% y/y in Q3 2014 and expand by just 0.4% in 2014 overall. CBR outlook for 2015 is pretty dire too: GDP growth of just 0.9-1.1%.

With the above points in mind, it is pretty clear that CBR will have to continue raising rates in months ahead, so the current pause is just a temporary 'hold-back and watch' scenario. 

Meanwhile, the Economics Ministry stepped up its criticisms of the CBR - an open warfare that has been going on over the summer. CBR July hike was uncoordinated with the Government and was in a direct response to the CBR outlook forward, reflecting inflationary pressures on foot of trade sanctions and the risks arising from planned tax hikes. Worse, CBR deputy chairwoman Ksenia Yudayeva openly criticised the government for failing to take into the account the inflationary risks inherent in the proposed tax policies. The Government and the Economics Ministry are clearly unhappy with monetary tightening which comes amidst decelerating investment in the economy and at the time when Western sanctions have already severely restricted major banks' access to international funding markets. These restrictions are feeding through into retail rates and choking off already fragile credit growth.

Back in August, President Putin visibly backed the Economics Ministry in the fight with the CBR when he accepted the Economy Minister Alexei Ulyukayev's proposal that future inflation targets be set by jointly by CBR, his ministry and the Ministry of Finance. This comes on top of the already established consultative representation for the two ministries at the CBR board. So far, the CBR stuck to its medium term target structure based on inflation target of 4%+/-1.5%. And in today's note the CBR confirmed this target as still standing.

5/9/2014: Investment and Foreign Exchange Reserves: Latest Data from Russia

Some recent news from the Russian economy's front.

In recent months we have witnessed some significant slowdown in both investment in Russia and economic growth (see here for the latest signals http://trueeconomics.blogspot.ie/2014/09/392014-russian-services-composite-pmis.html and here for the longer range data: http://trueeconomics.blogspot.ie/2014/08/2882014-state-of-russian-economy.html). But we now have some interesting data on the compositional changes in investment and the numbers are puzzling. As reported by BOFIT, aggregate decline in domestic investment in H1 2014 in Russia was driven by the smaller firms and the 'grey' economy.

This was offset, to a large extent but not fully, by a rise in investment by large and mid-size firms, households and the government which (combined) increased investment by 3%. As BOFIT noted, "the situation differs from 2012 and 2013, when investments of large firms stumbled". On private sector side, large and mid-sized companies investments rose in energy sector, industry, manufacturing, transport and food processing.

Construction and real estate investments rose on foot of new building activity with new apartments completions in H1 2014 up over 30% y/y in terms of numbers and floor area. This is puzzling, as household credit (ex-housing) fell, while housing loans demand remained strong. This suggests a rush to completions associated with the bust dynamics and I would be surprised if this activity carries over into H2 2014-H1 2015 without a major slowdown.

On an outright negative side, investment in machinery and equipment continued to shrink, following the beginning of the strong downward trend that started back in 2013.

Meanwhile, also this week, Russia and China launched the construction of the first section of the Power of Siberia pipeline which is set to deliver 4 trillion cubic meters of gas from Russia to China over the 30 years period, starting in 2019. The pipe was launched from Yakutian Chayanda gas field (which will start production in 2015 and has estimated reserves of 1.2 trillion cubic meters of gas and 93 million tons of liquid hydrocarbons with planned daily production of 25 bcm of gas and 1.5 million tons of oil) and will run 3,968 km and is expected to cost, in the end, some USD20 billion (including USD7.5 billion of associated investments relating to the pipeline to be allocated across the Siberia). But the pipeline will also enable access to other Yakut and Krasnoyarks fields.

Comparative market figures are massive. Europe purchases from Russia some 160 billion cubic meters (bcm) of gas in 2013. China's annual consumption is 170 bcm and this is expected to rise to 420 bcm by 2020.

While China and Russia both build and co-finance the project, steel pipe for the project will be supplied by the Russian company TMK.

Here is map - via @RT - of the new pipelines systems in works for Russian South-East:

Note: I covered in depth the geopolitical changes in Russian oil and gas development in the earlier note here: http://trueeconomics.blogspot.ie/2014/07/1772014-geopolitics-of-russian-gas-oil.html

Finally, time to update the data for International Reserves position for Russia based on data through the end of August, published today.

Total Foreign Reserves of the Russian Federation at the end of August 2014 stood at USD465.228 billion, down EUR44.446 billion year on year (-8.7%). Relative to the pre-sanctions period (March 2014), reserves are down USD28.1 billion (-5.7%).

Excluding IMF SDRs and other IMF-held reserves, actual foreign exchange and gold reserves stood at USD452.24 billion, down USD44.28 billion on the same period 2013 (-8.9%). Virtually all of this reduction came since January 2014 (USD44.04 billion), but from March 1, 2014 levels, the reduction has been USD27.76 billion (-5.8%).

Gold holdings alone rose in value by USD518 million in 12 months through August 2014 (up 1.1%) and are now up USD1.4 billion since March 1, 2014 (+3.1%).

Two charts to illustrate:

The above is consistent with virtual non-engagement by the Bank of Russia in FOREX markets, as outlined in this note: http://trueeconomics.blogspot.ie/2014/08/2882014-state-of-russian-economy.html.

29/8/2014: While New Financial Sanctions Loom

When America sneezes, Europe catches a cold… These days, America is more pointing than sneezing, and Europe is heading for the bite rather than a cold. The bite of sanctions against Russia.

Yesterday, at an advisory call I highlighted the details of potential impact that deeper financial sector sanctions against Russia can have on Russian banks and investment. You can read more on the topic here: http://trueeconomics.blogspot.ie/2014/08/2882014-state-of-russian-economy.html

In my view, the damage can be heavy. And this was based on the US proposals being aired around to ban Russian banks' access to short-term funding and derivatives markets.


Today, the UK joined the chorus of 'throw Russian financial system into the dark ages'.

Let's start from the latter.

The UK is planning to push EU leaders to ban Russian access to the Society for Worldwide Interbank Financial Telecommunication system, commonly known as SWIFT. If SWIFT access for Russian banks is interrupted, the impact will be big. Cross-border banking will become excruciatingly expensive and limited for Russian companies and banks, including all companies and banks - whether sanctioned explicitly, or left off the list of sanctions to-date. Trade flows and payments will be disrupted too.

Russia has been preparing for this already, having announced back on August 7 that it is working on creation of the domestic system for banks transfers and data transmissions.

Swift is a 'worldwide' system because it is used worldwide, covering 215 countries, but the company is incorporated under the Belgian law and as such is a hostage to the EU, which did block Iranian banks' access to the system back in 2012. This raises a major point for the stability of the global financial system: a major technical part of it is a de facto subject to the political choices of the EU.

If Russia succeeds in developing its own system (and it is hardly nuclear science to put one together) and, as planned, if it were to wire China into it too to cover settlements in yuan and ruble, there will be two repercussions that the UK leadership is not considering:

1. Much of flows between Russian banks and flows with other partnering banks will fall outside the normal international system that offers some transparency; and
2. The system can create a new competitor to SWIFT - a competitor outside the regulatory net of the Western authorities. 

Meanwhile, the US is pouring over its own 'solutions'. As was reported earlier this week, the US is looking into limiting derivatives trading (including commodities options and futures, plus currency derivatives) and short-term loans for Russian corporates and banks.

So far, sanctions have impacted only longer-term debt issuance by the companies listed explicitly on the sanctions list, but also cooled off other Russian corporates' access to the US and European debt markets, despite them not being on the list. Bloomberg reported earlier this week that  Russian companies placed only USD4.1 billion of bonds abroad since mid-March 2014, which is less than a fifth of issuance in the same period last year.


Combined, the two approaches will impose a significant cost onto Russian economy. More importantly, the measures will disrupt legitimate, non-sanctioned (to-date) ordinary day-to-day business conducted by Russian companies. They will also put pressure on Russian funds outside the country, including ordinary savings, small business funds and investments. The sanctions, if passed, will have to be matched by Russia, and it is very hard to imagine what the co-measurable response can be.

Bigger issue, of course, is that sanctions are not only unproductive in achieving the Western goal of stopping Russian engagement in Ukraine, but are actually counter-productive. Ukraine is a geopolitical conflict theatre today, not an economic one. And the conflict goes across three core points:

1. Russia's security in the face of encroaching Nato - including the 2002 Nato-Ukraine Action Plan, the 2005 Intensified Dialogue, the 2008 Bucharest declaration that effectively invited Ukraine to join Nato "when it wants to join and meets the criteria for accession"and so on - all temporally pre-dating December 2013.
2. Russia's sense of humiliation suffered over the last 24 years, compounded by the endless nationalist and Russophobic rhetoric emanating from a number of Eastern European countries and promoted by the West in the 1990s and 2000s and 2010s, including tolerance of the EU over the third-rate citizenship status for Russian-speaking 'minorities' in some Accession States, and
3. The failed state of Ukraine.

I am not going to expand extensively on any of the above points, let the historians deal with them, but it is clear that none of them have anything to do with economic conditions in Russia. However, all of them are being only reinforced by the sense of political and popular consolidation that is sweeping across Russia today, triggered in part by the sanctions. The current leadership of Russia is actually being helped, not harmed by the sanctions precisely because their imposition and acceleration continue to remind ordinary Russian people that points (1) and (2) are valid. They need no reminder that point 3 is valid as millions of Ukrainians work in Russia, trying to make some sort of a future that is simply infeasible in Ukraine itself.

In a nutshell, anyone who knows Russian history also knows that Russian culture, history, social institutions - all rest on the foundations of securing unity in adversity. The more adversity you throw Russian way, the greater consolidation the Russian system will achieve.

Time to smell the roses, folks. The West will not [rightly] put its own boys-in-uniforms into Ukraine to protect the Maidan Government. The West [for want of funds and will] will hardly even pay the cost of rebuilding the Ukraine. The West [for lack of capability absent any serious Federalist reforms in the country] is not going to create a functional state out of the failed one. Ukraine is not Latvia or Estonia. Expecting a functional democracy to emerge in a large state fragmented by linguistic, ethnic, cultural, historical and social divisions of the magnitude that prevail across the Ukraine without some sort of a Federal state not anchored in chauvinistic nationalism exercised by either side is naive. Iraq is a model here, not Czechoslovakia.

Time to smell the roses, folks. Time to do something along these lines: http://trueeconomics.blogspot.ie/2014/08/2682014-ukraine-road-map-toward-de.html

2/8/2013: Sanctions v Russia: Some Fallout, Some Fizzle

One of possible fallouts from the latest round of sanctions against Russia is the effect of banking sector restrictions on funding of Russian banks.

I commented on this before, but left out some specifics. One area of concern is syndication markets - currently not covered by sanctions explicitly. Bloomberg reported yesterday that some banks might be scaling back their syndication operations with Russian banks. VTB is facing refinancing USD3.1 billion worth of syndicated loans - this has been put on ice since June. One factor is high risk of US fines should sanctions expand and the banks get caught in the middle of transacting with Russian counterparts.

In related news, UK RBS cut back funding for Russian clients. RBS has GBP2.1 billion exposure to Russia, with net exposure of GBP1.8 billion, down GBP100 million in the H1 2014. Some GBP900 million is exposure to Russian corporates and GBP600 mlm to Russian banks. Russia accounts for roughly 3% of RBS balance sheet and the bank is now aggressively cutting new operations in Russia, in line with sanctions.


Meanwhile, MSCI is now offering a new EM index excluding Russian equities and is planning a new MSCI Russia index excluding VTB shares. All in the name of giving investors comfort that they comply with the US sanctions. VTB is being excluded because it is the only listed Russian bank that faces restrictions on credit issuance and equity trading in the US (other banks - Bank Rossiyi and Rosselkhozbank are not listed), European sanctions cover same operations for the above three, plus Gazprombank and Sberbank. Sanctions are set with duration of 12 months from issuance and are subject review every 3 months. S&P and DJ are expected to follow MSCI indices revisions. More on this : http://www.bloomberg.com/news/2014-08-01/msci-creates-indexes-excluding-russia-reviews-vtb-on-sanctions.html?cmpid=yhoo

On liquidity effects of the sanctions, Moody's issued a note yesterday saying that Russian markets are facing no liquidity risk as corporate balance sheets are enjoying significant cash buffers, sufficient to cover bonds redemptions over 18 months period. More: http://www.vestifinance.ru/articles/45479

And Bloomberg View agrees, on the aggregate: http://www.bloombergview.com/articles/2014-07-30/mr-putin-can-ignore-mr-market "Russia owes its bond creditors about $153 billion, according to data compiled by Bloomberg. Some $126 billion of the nation's debt, though, is denominated in rubles. A further $26 billion is dollar debt, with just $1 billion owed in euros. That makes Russia relatively immune to the need to raise foreign capital to refinance its debts… Russia has raised about $3.5 billion through domestic bond sales this year, and has also tapped the state pension fund for a further $2.9 billion. Raising rubles won't be a problem; the finance ministry can always strong-arm domestic institutions into showing up at the auctions and accepting lower yields. So, just in case anyone was expecting Mr. Market to do any work for them in punishing Russia for its Ukrainian adventures, think again."

28/7/2014: Double Down or Stay Course in Ukraine: the Only Rational Alternatives for Moscow?

The latest reports from the U.S. strongly suggest that Russia is perceived as an un-yielding adversary in Ukraine and that Moscow is about to 'double-down' on its gambit in Ukraine (see here).

The point is that if so, then why and then what?

Why? Russia has currently no exit strategy from the conflict in Ukraine. Forcing complete and total closure of the separatists operations is

1. Infeasible for Moscow (the separatists are not directly controlled troops that can be withdrawn on orders and indications are, they are not all too well coordinated and organised to be following any orders);
2. Were it even theoretically feasible, will be immediately visible to the external observers. Note that, for Moscow, (1) means political benefits of such an action will not be immediately apparent, while (2) means political costs of such an action will materialise overnight.
3. As sanctions escalate, the marginal returns of domestic political support become more important, since external economic benefits from cooperation vanish, but marginal costs remain (see below).

On marginal external benefits: it is absolutely uncertain what exact conditions Russia must fulfil to completely reverse the sanctions: is it

• (a) compel the rebels to surrender unconditionally to Kiev troops? 
• (b) compel them to surrender to either official troops or pro-Kiev militias, unconditionally? 
• (c) compel them to surrender conditionally - without any conditions set and without any mechanism to enforce these in place? 
• (d) compel them to declare a ceasefire - without any conditions set and without any guarantees of enforcement by the opposite side? 
• (e) compel the separatists to engage in peace talks - not on offer by Kiev? 
• (f) compel the separatists to stand down - in some fashion - and enter into negotiations with Kiev on Crimea? 
• (g) Is Crimea at all on the table? and so on...

On marginal costs: the costs of sanctions are tied to Russia delivering some sort of compliance with Western demands. Can someone, please, point to me a website where these demands are listed in full and the states that imposed sanctions have signed off on a pledge that once these conditions are satisfied, sanctions will be lifted?

Thus, in simple terms, current Western position leaves little room for Moscow not to double down in Ukraine. The only other viable alternative for Moscow currently is not to escalate. De-escalation, as much as I would like to see it take place, is not within rational choice alternatives. The core reason for this is that when one constantly increasing pressure in forcing their opponent into the corner without providing a feasible exit route for de-escalation, the opponent's rationally preferred response, at certain point in time, becomes to strike back and double down.

Update: interestingly, Reuters editorial today (29/7/2014: http://www.reuters.com/article/2014/07/29/us-ukraine-crisis-putin-analysis-idUSKBN0FY1AC20140729?feedType=RSS&feedName=topNews&utm_source=twitter) provides very similar lines of argument on costs and incentives for Moscow to de-escalate the situation in Eastern Ukraine.

28/7/2014: Germany: Independent Views on Russian Sanctions

Two research institutes covering economic policy in Germany on Russia sanctions:

• Detailed analysis by DIW Berlin: https://www.diw.de/de/diw_01.c.469198.de/presse/diw_roundup/are_the_economic_sanctions_against_russia_effective.html
• Brief note from Ifo Institute on sanctions linked to longer term strategy: http://www.cesifo-group.de/ifoHome/presse/Pressemitteilungen/Pressemitteilungen-Archiv/2014/Q3/press_20140725_Russland-Konflikt.html

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.