Russian economy set to suffer more pain

A week ago, 298 people lost their lives when Malaysia Airlines MH17 came down in Eastern Ukraine. Western officials and the Ukrainian government have said that the flight was shot down by separatist fighters and fingers are being pointed at Russia for giving direct and indirect military support to the separatists. The downing of MH17, in our view, represents a renewed escalation in the conflict and the likely outcome is a further downturn in the Russian economy and downward pressure on Russian markets.

New sanctions set to hit Russia

In our view, the likely next step is to expand sanctions to the financial sector, which could seriously limit Russian financial institutions’ access to the international capital markets and thereby further increase funding costs for Russian companies. The EU will announce new sanctions today but, more importantly, we are still awaiting the next move on sanctions from the US government.

Furthermore, we would stress that the mere possibility of such sanctions will have an effect as they have already been implemented – international financial players are likely to reduce their exposure to certain Russian financial institutions, which have not yet officially been put on a sanctions list, but might be in the future.

Russian recession deepens but potential growth also falls

The Russian economy is effectively already in recession. The likelihood of renewed sanctions and the continued capital outflow from Russia is likely to continue to put downward pressure on Russian economic growth. In our view, it is fairly clear that the slowdown in the Russian economy is likely to continue in the coming quarters and also spread to private consumption. Therefore, we do not see any near-term turnaround or any pick-up in Russian growth this year.

Even more importantly, the overall Russian-Ukrainian crisis has been a serious blow to investor confidence in Russia. In our view, this is likely to have permanent long-term negative ramifications for foreign direct investments into Russia and the general increase in regime uncertainty is likely to put continued downward pressure on investments in Russia (both by domestic and foreign investors). This will seriously hamper potential long-term growth in the Russian economy, which is of course likely to have negative consequences on the valuation of Russian assets.

Rouble se to stay soft going forward, but a lot already priced in

Since the Russian-Ukrainian crisis started, we have been bearish on the outlook for the rouble and we remain fairly so. Given the outlook for more sanctions – and particularly given the risk of financial sector sanctions – it is hard to see a near-term turnaround in capital flows. Hence, we continue to expect continued outflows from Russia going forward. We do not necessarily see this as a (new) ‘sudden stop’ to flows into Russia (we have to a large extent already seen this), but rather a gradual ‘drying up’ of capital flows. Furthermore, we continue to see global oil prices trending lower, which is also likely to continue to weigh on the rouble even if the geopolitical situation does not worsen. We therefore also continue to recommend being positioned for further rouble weakness going forward – also relative to market pricing.