What will it take to end Russia’s currency crisis?
Alexander Moseley, Senior Portfolio Manager, Emerging Markets Debt Relative
16 December 2014
Russia is in a full-blown currency crisis, and currency crises end when either the central
bank overreacts with overwhelming policy steps to support the currency or the underlying
source of stress ends.
Russia’s surprise 650 bps hike yesterday after a one-day, 10% rouble depreciation is positive, but it
is not enough. Our strategy has been to be underweight the rouble for most of this year, and we will
continue with that strategy until one of three things happen: the central bank overwhelmingly moves
to support the currency, oil stabilises, or sanctions are lifted.
Alexander
Moseley
Senior Portfolio
Manager
It is difficult to see the underlying source of stress ending. An end of the war in Ukraine and the
lifting of sanctions would be unambiguously positive. But a deal over Ukraine is unlikely to happen
any time soon. The war in Ukraine is a unique feature of this crisis. Stabilisation of oil prices would
also be unambiguously positive. But this is difficult to predict and in any event there are better
risk/reward ways of positioning for a rebound in oil.
Therefore, the market is left with central bank policy as the main driver to restore confidence in the currency. We
believe the central bank has the tools to support the currency and maintain domestic depositor confidence, but it needs
to demonstrate that it is willing to use them before confidence is restored. If it does, extremely negative sentiment and
positioning would all be supportive of rouble stabilisation.
We believe the central bank has the tools to support the currency and
maintain domestic depositor confidence, but it needs to demonstrate
that it is willing to use them before confidence is restored.”
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Rate hikes—The market needs to see substantial further rate hikes near double digits.
Domestic capital controls—The market would benefit from the adoption of domestic capital controls, which,
when combined with overwhelming rate hikes, can be very effective. Policy measures could include: (i) the
restoration of export surrender requirements, (ii) administrative limits on deposit withdrawals or FX purchases,
or (iii) rouble tightening on banks such as required reserve requirements. These could also be combined with
emergency rouble liquidity lines to strategic companies to avert domestic defaults.
FX intervention—This tool is off the table because a lack of market access and the decision to repay external
debts mean the government wants to conserve official currency reserves. We believe this is the correct policy.
IMF programme —This option is off the table because of geopolitics.
Even though the currency and economy are undergoing extreme stress, the likelihood of a default on Russian dollar
sovereign debt is extremely low. Under sanctions and oil prices in the $40-50 range, we see Russia's sovereign
creditworthiness in the BB range from BBB currently. At current spread levels, Russia sovereign 5yr Credit Default
Swap is now trading as a B rated credit, which seems excessively pessimistic to us. A low probability of default on
sovereign dollar debt is supported by three reasons below.
Talking Point What will it take to end Russia’s currency crisis?
For professional investors and advisers only
First, Russia has the liquidity to repay all of its external debts, both public and private. If Russia were to repay its
maturing public and private external debt using its official currency reserves of $419 billion and financial system FX
assets of $256 billion (excluding any corporate FX assets, which are anecdotally substantial but have unavailable
data), Russia covers 100% of its $678 billion in external public and private sector debts and would repay the entire
amount in about three years. This is a more comfortable liquidity starting point than most countries would find
themselves in in Russia's position.
Second, Russia has one of the strongest sovereign debt profiles of any country globally. Russia's public sector debt is
15% of GDP, with a healthy maturity structure and with about 50% of the total denominated in FX.
Finally, the $91 billion decline in official FX reserves year-to-date to $419 billion from $510 billion has been matched
almost exactly by repayment of public and private external debts. Thus, contrary to many press reports, Russia's policy
has been to use official reserves to delever and not to support the currency outright or fund capital flight. Forced
deleveraging is clearly a sign of stress, but it is a creditor-friendly policy. As reserves fall further, there will probably be
limits to the government's willingness to fund private sector debt repayments. This decision will benefit repayment of
sovereign and strategic quasi-sovereign corporate debts. It also means that the distribution of FX assets will become
increasingly important in assessing creditworthiness.
The outlook for corporate US dollar-denominated debt is more nuanced. Any non-sovereign asset tied to economic
growth will remain under pressure as the economy enters recession and market access to external debt markets
remains blocked. Individual companies also face the risk of being singled out by EU and US sanctions. And the
repayment picture for individual Russian corporates is issuer-specific based on its balance sheet, operating model and
likelihood of sovereign support. Because sovereign risk is the main risk in Russia right now, the best risk/reward and
liquidity remains in Russian sovereign dollar debt rather than corporate debt or local currency.
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views expressed or reflected in other Schroders communications, strategies or funds.
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