A Dangerous Game: Russian Debt Roulette
Russia’s economy is dependent on oil and gas. Hydrocarbons are responsible for roughly 70 percent of Russian exports and, directly and indirectly, for almost 80 percent of the Russian federal budget. The recent downfall of oil prices, along with the isolation from Western capital markets following the Russian annexation of Crimea and support for separatists in eastern Ukraine, has severely damaged Russia’s economic situation. Stagnation turned into recession, the ruble devalued and inflation became double-digit. It all made the situation inflammable, and an unexpected and unexplained decision of the Central Bank to raise the prime rate from 10.5 percent to 17 percent overnight immediately caused brief but powerful panic among consumers and in securities markets. It allowed many analysts to derive apocalyptic predictions, including the forecasting of problems with sovereign and corporate currency-denominated debt repayments.
Rating agencies have been much more cautious. While recently reassessing their forecasts for Russian ratings, they argued that “the probability of default is still very low.” In the latest move, S&P downgraded Russia’s sovereign rating to below investment-grade level (BB+); however, this rating level corresponds to circa 1.5 percent default probability. For comparison, Turkey and Indonesia also have BB+ S&P ratings; both are considered to be healthy economies with high potential.
Russian securities markets reacted more nervously, and yields of Russian short-term sovereign bonds rose twofold, while credit default swaps reached 500 bps, while CDS for Turkey is almost one third of Russian level. Still, such levels look much more like the ones in the summer of 2011 (when the price of oil was rising and Mr. Putin had neither cracked down on the opposition, nor invaded Ukraine, and when the idea of Russia defaulting would have seemed utterly implausible) than like the pre-default ones.
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A quantitative exercise is a helpful, if perhaps slightly boring, way to understand the exact picture. Out of the $525 bln of Russia’s total exports in 2013, over $300 bln were oil- and gas-related. The price of oil fell from the average for 1H 2014 of $109 per barrel to $60, and, provided it remains at that level, Russian exports in 2015 will fall some $180 bln down to $340 bln, or, as the gas volumes are set to fall as well, even lower.
We are already seeing an 80 percent devaluation of the ruble due to the changes in the inflow of petrodollars. As of today, there is no intention on the part of the government or private employers to increase wages and/or pay substantial bonuses in early 2015. Capital shortage will cause Russian banks to put major lending programs on hold and stop issuing consumer finance loans, resulting in around 5 percent of household income being used for existing debt repayment. Given all of this, we can expect disposable income to drop over 50 percent in dollar terms and household consumption to fall about 30 percent, leading to an at least 50 percent drop in consumer goods imports. Industrial imports will also fall dramatically due to greatly reduced access to capital and anticipated recession of consumer spendings. Thus, imports will certainly not exceed $250 bln, with some economists even believing that it will not reach $200 bln. (It is worth noting that in 2007, Russian imports did not exceed $200 bln.) Russians will not suffer severely, but rather will have a more balanced consumption following an unjustified demand increase in recent years.
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The surplus (exports minus imports) will in any case be near or higher than $100 bln. Provided the oil prices do not fall much further, such balance can be maintained for at least three to four years. And even if oil drops to $40 and stays there, the balance will still be positive.
The rest is quite simple. As of December 2014, Russia’s hard currency reserves exceed $360 bln, and in 2015, the currency-denominated debt due, including interest, nominally does not exceed $150 bln, out of which almost $60 bln represent the financing from offshore holding companies to subsidiaries in Russia. At least 50 percent of the rest are maturing bilateral loans, more than half of which will be prolonged by lenders, as the borrowers’ situation will remain satisfactory. Thus, we should not expect the net repayment to exceed $60 bln; in 2013, capital flight did not exceed $50 bln, and it will be a surprise if it exceeds $70 bln in 2015.
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These numbers suggest that in order to balance its balance of payments, Russia will need to find just about $30 bln, either through borrowing, or by using its hard currency reserves. Given Chinese leaders’ recent friendly declarations and provided the RUR-CNY swap agreement stays in place, Russia will likely be able to borrow over $60 bln of new funds in 2015, with its total currency debt remaining roughly unchanged and its reserves (currently constituting over 30 percent of the country GDP and approximately 1.5 percent of annual imports) at the same level or higher.