Russia: the real effects of sanctions

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Currently in Russia severe capital outflows seem to have stabilized. Economic downswing recently found a halt. Scenario of stagnation gained probability.

Effects on Russian economy from latest round of sanctions: Restrictions to external bond financing of selected Russian corporates, cutting them off from global financial markets

  • High external financing need of the Russian corporate sector. Rising borrowing costs.
  •  Changes in Bond Indices: since April 2014, Russian Ruble bonds are included in the Barclays Global Aggregate Index. Besides rating, a necessary precondition for being

    included in the index is free market access and market liquidity. If further sanctions are imposed, these preconditions might not be fulfilled which could lead to Russian local government bonds and investment grade corporates being taken out of the index again.

  • Hard currency government bonds should not be affected.

Effects of a more likely scenario of further sanctions:

  • Russia potentially drifting into outright recession. Capital outflows creating a major problem for economic policy.
  • The Institute of International Finance (IIF) estimates capital outflows would jump up 50% relative to the baseline. Expect fiscal deficit to jump to 6.5% of GDP by 2015, external financing need could rise to 120bn USD a year (a magnitude the IIF considers problematic)

    With the BRICS development bank being established, Russia might possibly be able to obtain temporary help there.

As for a general impact on markets, Wöhrmann points out the following:
  • Core market rates: We expect the situation to take a long time to abate in rates markets, but do not expect safe-haven flows to increase, as a lot is priced in already
  • Emerging Markets (EM) sovereign external debt: Russian sovereign debt is not directly affected by the sanctions and is e.g. not on the new U.S. sanctions list. The debt profile remains one of the strongest in EM. Biggest impact at the moment is deterioration of sentiment.
  • Credit: We stay positive on developed market credit, but watch developments around potential new sanctions very closely with regards to Emerging Markets Credit (EMC). Russian corporate bonds will trade, over the medium, primarily based upon the perceived probability of harsher sanctions being implemented (especially valid for CEMBI index members). As such, over the medium term, earnings from Russian corporates will be somewhat less relevant than normal. Both for the Ukraine-Russia conflict as well as events in the Middle East, we do not see significant spillover effects into the broader EM corporate universe so far.
  • Equities: Until now, the Dow Jones just looked through Russia sanctions. We expect Equity markets to react to a series of events rather than to single events, but it’s clearly getting worse and volumes are low in the summer. One of the biggest concerns is the impact on European earnings as a lot of companies are exposed to Russia. With regards to the situation in the Middle East, higher volatility across the Middle East is to be seen, but so far without an impact on global markets.

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