There is no imminent prospect of improvement for Russia as an investor location, despite more favourable economic trends.
Of all the prominent emerging markets, Russia is perhaps one of the most perplexing. It is a huge and enticing country, with a wealth of resources, but is at the mercy of sanctions with acute political and institutional weaknesses, and endemic corruption, deterring foreign investors.
As one contributor noted, quoting Winston Churchill’s description of Russia, it is “a riddle, wrapped in a mystery, inside an enigma”.
Largely, this reflects its rich-resource endowment, its state-supported banks and strong net-asset position.
And yet Russia has also failed to make any headway in the global risk rankings and is languishing towards the lower end of the third of the five categories of risk into which Euromoney’s divides its 174 countries.
In 77th place, Russia is still considered a medium risk and is barely more than a point from falling into tier four, a high-risk category. That may occur in 2022 if Russia’s risk profile continues to develop unfavourably, after it slipped a little in the latest survey undertaken in Q3 2021.
Russia has experienced periodic economic crises before, and it has always bounced back, benefiting from its importance as a notable cereals, steel and hydrocarbons producer, while it was less affected by the pandemic due to accepting a high mortality rate and minimizing lockdowns in conjunction with an economy that was less vulnerable due to its structure.
The latest forecasts published by the IMF see real-terms GDP growth of 4.7% in 2021 followed by 2.9% growth in 2022, as the economy settles down after the pandemic-related disruptions that led to a contraction of 3% in 2020.
The unemployment rate will fall and a balance-of-payments current-account surplus is expected, with fiscal balance restored by an expanding economy and higher oil prices.
The Russian economy is certainly heading into the new year in relatively favourable financial shape, according to Dmitry Dolgin, survey contributor and ING global research chief economist for Russia and the CIS, who nevertheless attaches a note of caution.
“This is due to strong commodity markets and prudent macro policies, but the growth impulse seems to be waning as the post-Covid recovery is over, new drivers outside the commodity extraction sector are yet to be seen, and significant uncertainties are present with global and local inflation and interest rate trends, as well as with foreign policy risks,” he says.
“All of this limits Russia’s ability to convert its large current-account surplus into local fixed investments.”
The government is targeting 2.5% real disposable income growth next year, which will be hard to achieve when the mood in the private sector is downbeat- Dmitry Dolgin, ING
The economic growth outlook is facing higher risk, says Dolgin, because of a high Covid infection and mortality rate since October.
“In Q4 2021, the government managed to make progress with the vaccination rate, which increased from 33% as of September to almost 50% currently, but this is still in the mid-range of its peers,” he says.
Dolgin warns the main channel of Covid’s effect on GDP is not through lockdowns, but through a direct negative impact on population size that currently cannot be offset by net immigration.
Another contributor responding anonymously mentioned an excess mortality rate of one million in 2021 alone.
Dolgin echoes the views of other experts when mentioning inflation as another risk factor. This is putting pressure on the central bank, Bank of Russia, to tighten monetary policy and impose direct macro-prudential restrictions on retail lending.
Accelerating inflation is the main economic challenge for 2022, he says before adding: “The government is targeting 2.5% real disposable income growth next year, which will be hard to achieve when the mood in the private sector is downbeat.
“Through direct-budget spending on pensions and state-sector salaries the government fully funds 42% of the Russian population and 34% of the total household income. Russia’s fiscal position is good enough to provide some extra support, but that would lead to further shift in the state spending structure away from investments.”
Dolgin continues: “In 2021, direct support to household income accounts for as much as 56% of enlarged budget spending versus 45% 10 years ago. Structural and institutional measures to increase the efficiency of the economy are needed to address the current challenges.”
Quite apart from these fundamental economic challenges, investors must also take a view on the political situation and its likely effect on investor returns, noting as one other local expert has that the Russian regime has been transitioning from an autocracy based on populism to a dictatorship based on repression and fear. This is leading to a rise in criminal cases in the media and in “objectionable” public organizations with a rise in paranoia and “spy-mania”.
In that context, Russia remains perplexing with Vladimir Putin at the helm and bemoaning the encroachment of Nato to its border, bearing in mind the Russian military build-up on the border with Ukraine, the past absorption of Crimea, the president’s recent soundings on the strong historical ties between Russia and Ukraine and the apparent unclear loyalty of much of the Donbas region to the Kiev government.
As one Russia-based expert noted, there are just under 100,000 Russian soldiers amassed close to the border, with a plan to increase it to 175,000. That can only mean it is being used as a form of blackmail for talks, although it may of course develop unpredictably as both US and UK military figures have warned about recently.
“Europe’s energy dependence on Russia is a complicating factor making for difficult negotiations,” says Johan Krijgsman of Krijgsman & Associates.
“Pressure for a settlement seems to be growing and, given Russia’s diplomatic achievements in establishing working relationships with China, India and Turkey, a resolution to the Ukraine impasse may not be impossible. However, the implementation of the Minsk agreements will not be an easy solution for Ukraine to accept.”
A cut-off from Swift or limitations on rouble convertibility appear to be far too exotic to be seriously considered- Dmitry Dolgin
Dolgin says that an open military conflict on the Russia-Ukraine border is not part of ING’s base-case scenario, and neither is it for other contributors based in Russia who requested not to be mentioned.
“However, a concentration of deadly force on both sides of the border and involvement of other parties definitely creates risks of provocations or unintentional mishaps, which can have severe repercussions, including material tightening in the sanction pressure towards Russia,” he says.
“A cut-off from Swift or limitations on rouble convertibility appear to be far too exotic to be seriously considered, Nord Stream2 sanctions are unlikely to be supported by the EU, while a ban on foreign participation in the new state debt on the secondary market is not out of the question [although it is also not a base case for ING that would require a strong trigger].”
The potential new US sanctions on Russia’s OFZ treasury bond market would not create financial stability risks, according to Dolgin, but will cause additional nervousness in financial markets. Others have noted that it would create exchange-rate instability.
Dolgin and others note, however, that the risks of war and of further sanctions alone will have a negative effect on the perception of Russia as an investment location and prevent Russian assets from outperforming their peers in the long run. They also constrain economic growth potential.
Otherwise, Russia would be a more attractive proposition at current oil-price levels and its Euromoney risk ranking would be higher.