2017: Focus on Russia
2016 was a good year for Russia. Following two years of challenging economic and geopolitical conditions, the country’s investment outlook now appears to be slowly improving. Q4 saw investors piling in from the cold into Russian equity funds, with mutual funds and ETFs invested in Russian bonds also being seen as increasingly attractive investments. Meanwhile, long-time Ruble bulls have seen their patience rewarded, with the Russian currency appreciating sharply against the US dollar in 2016. We take a look at some of the driving forces behind these favourable economic indicators for Russia and whether they can be sustained:
OPEC’s deal to curb oil production is the single biggest factor behind Russia’s more auspicious economic outlook. Russia’s exports are significantly weighted towards energy, and the oil price drop from over $110 a barrel in mid-2014 to $30 in early 2015 sent the Ruble into freefall, pushing up prices and costs for consumers and businesses. 50 per cent of Russia’s tax revenues also come from oil and gas, and the tax system is heavily geared towards the oil price, which has meant that low oil prices have placed significant strain on the country’s tax revenues in the past two years.
The deal reached between OPEC and other oil-producing nations like Russia to cut production has thus provided a welcome boon to the Russian equity market and the economy as a whole. The Ruble, for example, appreciated by more than 20 per cent against the dollar in 2016. However, further oil price movements are likely to be linked to compliance levels on agreed output curbs and the economic health of large oil consumers such as China. Higher oil prices will doubtless bring short-term economic reprieve for Russia, but they will not alter the fundamentals of the country’s medium to long-term economic outlook.
Shifting political winds in the West are a further source of investor optimism towards Russia. The imposition of sanctions on Russia by the US and EU following its annexation of Crimea left energy companies and state banks unable to raise debt of more than 30 days maturity on Western markets, creating significant (though not insuperable) obstacles to international business in key Russian sectors. In recent weeks, however, US President-elect Donald Trump’s overtures to President Putin have raised hopes of a more constructive relationship between Washington and Moscow, possibly even leading to the easing or repeal of sanctions. Francois Fillon and Marine Le Pen, the current French presidential front-runners, are both long-time advocates of easing sanctions on Russia, while other EU countries such as Italy and Hungary have historically favoured a more indulgent relationship with Moscow. With the EU set to lose one of its most vocal Russian opponents in the wake of the Brexit referendum, the EU may come under increasing pressure from member states to abandon sanctions on Russia.
Domestic political and economic factors
Internal political factors, however, continue to blight the country’s economic outlook. Domestic and foreign investors remain wary of investing capital in Russia because of concerns over corruption, bureaucracy and the protection of property rights. State monopolies also continue to hamper the prospect of genuine competition in key sectors such as energy. While structural reforms of the country’s political and legal systems would go a long way to allaying investor concerns on these matters, it is unclear whether the Government has an appetite for introducing such measures.
Furthermore, while inflation is down from a giddying high of nearly 13 per cent in 2015, it remains above 5 per cent, a figure which is high by Western standards and unlikely to bring an immediate end to current belt-tightening by consumers. The Ruble’s appreciation on the back of rising oil prices will also hurt exporters, who had benefitted from a boost in competitiveness after the currency’s fall in 2014.
Looking ahead to 2017, it is clear that Russia’s economic outlook is rosier than it has been over the past couple of years, with higher oil prices and the possibility of a thaw in Western relations spurring renewed investor interest in the country. However, the fundamentals of Russia’s economy remain unchanged, and question marks remain over how much investment and growth can return to the country without deeper structural reforms.
By Geoff Upton