By Martin Perry, Investment Director at Heartwood Investment Management
Confidence remains fragile in Russia and, we believe, efforts on the part of the central bank and the Ministry of Finance to stem currency volatility are likely to be a sticking plaster over what is likely to be an extended and protracted political and economic problem.
Limited access to the US dollar funding market, resulting from the West's sanctions policy, and the decline in the oil price has driven local foreign exchange agents, corporates and households to hoard US dollars – the "dollarisation" effect. The Ministry of Finance intervened in the foreign exchange markets to sell nearly $7 billion of surplus US dollar reserves and stated that it would closely monitor exporters' foreign exchange operations. In addition, the Bank of Russia announced that it would recapitalise the banks in 2015 (details yet to be announced) and ease capital requirements, following its unsuccessful attempt to stem currency volatility when it raised interest rates by 6.5%.
In the near term, the Russian sovereign and the corporate sector should remain resilient. Cash (the majority held in foreign exchange) to short-term debt ratios are generally high in Russia's corporate sector, banks have a reasonable amount of net foreign assets, and the Russian sovereign's foreign reserves are just over $400 billion. Furthermore, the contraction in imports expected next year should maintain a current account surplus, assuming that the oil price stays around current levels.
However, under the current sanctions regime, falling growth, high inflation and high interest rates will lead to longer-term economic underperformance, which will not entice inward foreign investment and result in a further contraction in market liquidity. The political stakes are high. Putin has described the West's actions as attempting to "chain the Russian bear" and make it moribund, and he shows no signs of wavering from the current policy on Ukraine. The West will need to tread carefully to restore long-term economic stability not only to this region, but the broader global economy.
As well as rising political and economic risks in Eastern Europe, last week the Greek parliament voted in a first ballot to elect a new president. The government candidate, former European Union Commissioner Stavros Dimas, did not secure the required number of votes, increasing the risk of an early general election. There are another two rounds of ballots (23rd December and 29th December). The Greek government is looking for an early exit from its debt relief Troika (IMF, ECB and European Commission) programme, but the rise in the cost of financing (Greek ten-year bonds are yielding nearly 9%) makes an early exit unlikely. Developments in Greece serve as a reminder that euro sovereign debt sustainability issues have not gone away.