While the current episode of Russian geopolitical and economic turmoil may seem significant, the following chart from Goldman Sachs shows the tempestuous time the nation has had over the past 150 years...
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And here are Goldman's thoughts on Russia and The West now and into 2015...
Where we stand now:
Currency distress has taken center stage in Russia, with the ruble down 40%+ against the US dollar since early August. Already under fundamental pressure from sanctions and lower oil prices, the currency experienced a sharp sell-off this week in what we would characterize as a crisis of confidence. After the USD/RUB exchange rate depreciated by 10%+ on December 15 alone, the Central Bank of Russia (CBR) responded with a 650bp midnight rate hike. Despite the unexpected move, the ruble has remained weak. The currency's high volatility – part of which was likely driven by retail deposit outflows – and the sharply higher interest rate environment introduce risks to the health of Russia’s banks.
The sharp currency movements come on the back of shocks to the Russian economy from geopolitics (Russian capital outflows and sanctions that limit foreign inflows), falling oil prices, and sharp tightening of domestic financial conditions. Russian economic growth in the first three quarters of the year nevertheless stood at 0.8%yoy, indicating the economy’s resilience. The weakening of the ruble served as an important channel for the macroeconomic adjustment, keeping ruble-denominated oil prices relatively stable and shielding local balance sheets from more intense stress. However, the CBR’s large rate hike now makes it likely that FX distress migrates to domestic balance sheets.
The conflict in Ukraine remains far from resolved. The eastern Donetsk and Luhansk regions are still under rebel control, having declared independence on the back of controversial referendums held in May. Presidential elections later brought pro-Western Petro Poroshenko to power, though voting did not take place in parts of the east. Large-scale violence subsided after a ceasefire in September, but sporadic clashes have continued.
Diplomatic relations between Russia and the West remain strained, and economic sanctions against Russia appear likely to remain in place in 2015. President Obama is due to sign into law new sanctions legislation, although this is unlikely to result in any meaningful escalation of sanctions, in our view. In fact, there have been growing signs in the past several weeks of a renewed push toward diplomatic negotiations over the conflict in Ukraine. Meanwhile, deals between Moscow and Beijing on natural gas and currency-swap lines have reinforced expectations for the Kremlin to pivot eastward.
In response to Western sanctions, Russia introduced bans on food imports from the United States, Europe, Canada, Australia, and Norway for one year. This ban has had greatest effect on fresh product exports from Europe but little impact on the more tradable and storable agriculture products, such as wheat (of which Russia is a large exporter). As expected, the ban triggered a sharp rise in Russian food inflation. Of course, the worst-case scenario of Russia halting energy exports to Europe has not come to fruition, and exports of base metals and palladium have also been maintained. Following an agreement over gas debt payments, Russia also reportedly restarted gas flows to Ukraine on December 8.
Despite limited direct exposures to Russia, increased uncertainty resulting from the conflict weighed on investor sentiment in Europe and was one of several factors behind a deterioration of European economic indicators in 2Q14.
What to look for in 2015:
A highly uncertain Russian economic picture. Since the CBR’s decisive rate hike, we have placed our forecasts for rates, FX, growth and inflation on hold. There is a high likelihood of further measures to arrest the ruble’s fall – including a tightening of liquidity that leads to higher front-end rates, FX interventions and, in more extreme scenarios, there could be a risk of capital controls and bank holidays. Meanwhile, sustaining the CBR’s current policy stance for some months is likely to come at the cost of a sharper economic contraction, forcing pain onto local corporate and household balance sheets. The domestic banking system is now the most important place to watch for signs of broadening stress. And in the event that contingent liabilities in the banking sector are taken onto the sovereign balance sheet, pressure could migrate to sovereign credit.
Persistent tensions between Moscow and the West, with a highly uncertain path to resolution of the conflict over Ukraine.
Subsiding negative influences on the European economy, contingent on the conflict being contained.
Still little impact on Russian commodity production and exports. Russia may be able to keep oil production flat during 2015: lifting costs for conventional projects are low, and the cost structure is more resilient than that of other producers as Russia has a local service industry that generates ruble-denominated operating costs. Further out, Western sanctions combined with weaker market conditions may pose a downside risk to oil production. In terms of natural gas, a 2009-style disruption to European gas flows appears unlikely this winter, but in the current tense geopolitical climate there is still a risk that the deal breaks down. And as far as agricultural commodities, we continue to believe that sanctions impacting Russian agricultural exports are unlikely given their large size and the potential humanitarian aspect of such a move.
