Russian authorities will succeed in creating stability says Barings AM

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Michael Levy, investment manager for the Baring Russia Fund at Baring Asset Management, comments on the economic situation in Russia following the decision by the country’s Central Bank to raise its main interest rate to 17%.

KEY INSIGHTS

  • We are encouraged by the orthodox response from the Russian authorities to the ongoing weakness in the rouble and their determination to stabilise the situation;
  • In the short term, we are likely to see further volatility, and there may be a trade-off between higher interest rates and economic activity next year;
  • Medium to longer term, we expect fundamentals to reassert themselves. These include the likelihood of a balanced budget, helped by a weaker rouble. The banking sector remains well supported by internal capital and central bank assistance.

WHAT HAS HAPPENED?

The Russian Central Bank raised its main interest rate from 10.5% to 17% at midnight on 15th December, citing concerns about the recent devaluation of the rouble and rising domestic inflation.

Over the past two months, the rouble has declined sharply in response to the falling oil price and sanctions, and it declined further today. This was accompanied by a decline in the Russian equity market in US dollar terms and a steep rise in Russian bond yields.

OUR ASSESSMENT

In our assessment, the Russian Central Bank has taken the correct steps to respond to the situation. We are particularly encouraged that they continue to follow orthodox policy and have not resorted to capital controls.

One could argue that they were slow off the mark but while the rouble has continued to weaken in the short term, along with equities and bonds, it is our assessment that the authorities should succeed in introducing greater stability to the market if they continue along this path.

There is likely, however, to be a trade-off between higher short-term interest rates now and a decline in economic activity next year. Taken together with the lower oil price, we are likely to see Russia enter recession in 2015.

The situation remains dynamic, and subject to geopolitical factors related to the sanctions imposed on Russia in relation to activities in the Ukraine, as well as the future level of the oil price.

Risks include the possibility that the authorities abandon orthodox economic policy and reach towards a form of strict capital controls, as well as the possibility that sanctions are extended or that the oil price remains low for an extended period.

Over the medium to longer term, however, we continue to expect fundamentals to reassert themselves to drive the equity market higher. A weaker exchange rate should help to offset the effect of a lower oil price for Russia, potentially heading towards a balanced budget. The banking sector remains well supported by capital and central bank assistance. Russia continues to hold very large reserves of oil and gas, as well as many other resources, representing a store of value which is, in our assessment, currently undervalued.

We scaled back our exposure to Russia as the situation in the Crimea escalated and are monitoring the latest developments closely with a view to taking action as required.

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