The Russian central bank increased interest rates from 10.5% to 17% last night, in a dramatic move intended to stabilise the plummeting currency, which hit a fresh low of 64 roubles to the dollar yesterday.
The central bank’s decision to significantly increase interest rates is designed to make holding roubles more attractive, and stop Russian individuals and companies taking money out of the country and seeking safe havens such as the US dollar. The currency bounced upwards sharply this morning as a result, to 59 roubles to the dollar, but has slid back and is trading at 67 RUB/$ at the time of writing (11am). The rouble is the worst performing major currency so far this year having lost half its value against the US dollar. This has been prompted by sanctions, and the falling oil price; the Russian government receives half its total revenues from petroleum, according to the IMF.
Meanwhile the MICEX stock market index is down around 5% in local currency terms, but converted into Sterling this equates to a 50% loss for UK-based investors. Laith Khalaf, Senior Analyst, Hargreaves Lansdown: ‘The Russian central bank has moved to battle stations to defend its currency. So far the move has not stopped the slide, and it may yet have negative effects on the Russian economy. International investors will remember how the currency crisis of 1998 and subsequent default on sovereign bonds brought Wall Street to its knees, via the exposure of the giant hedge fund, Long Term Capital Management. While the currency has significantly weakened this year, default by the government looks unlikely this time around because Russia has relatively low levels of government debt compared to GDP.
Despite this, the Russian economy and companies do face serious problems. Rising interest rates will take a toll on a country which is already on the brink of recession. If the price of oil remains around $60 in 2015, Russia could see economic growth contract by 4.5%, according to the Bank of Russia. Meanwhile some Russian companies will have debts denominated in foreign currencies, which will put them under further financial pressure. Longer term Russia’s vast natural resources are likely to prove positive. Like other emerging markets Russia also has a population which is expected to become wealthier over the long term. For investors wanting exposure to Russia, a long-term horizon and a strong stomach are both an absolute must. It has been a painful year, but like all emerging markets volatility is to be expected .The stock market falls seen this year mean Russia has continued to be among the cheapest markets in the world, according to our analysis, though clearly there are reasons for this, and cheap markets can remain out of favour for a long time.’
Debt and dollars
The level of Russian sovereign debt denominated in dollars is significant because it becomes much more expensive for the Russian government to pay off as the rouble falls. However, according to Wells Fargo, dollar-denominated debt of the Russian central government remains manageable, currently totalling around $38 billion, which requires around $6 billion capital and interest payments in 2015. Meanwhile Russia has around $400 billion in foreign exchange reserves, and a relatively low debt-to-GDP ratio of around 10%, which is why Russian government bonds carry a BBB- rating from Standard and Poor’s (just inside the investment grade universe).
How to invest
For adventurous investors there are a number of funds which offer exposure to Russia. The Neptune Russia and Greater Russia fund features on the Wealth 150 list of our favourite funds across the major sectors. There is also an investment trust, JPMorgan Russian Securities, which invests in the shares of Russian companies, but be aware that investment trusts may use borrowing to enhance their returns, which adds additional risk. There are also around a dozen Russian ETFs listed on the London Stock Exchange, but they don’t all aim to track the same index, or share the same goals, so investors should take care to ensure an ETF meets their objectives before investing.