The crisis in Ukraine has dealt Russian assets a sharp blow. The stock market fell by a fifth in the first four months of 2014 as over $60bn fled the country; the rouble is down by almost 10% this year. Yet Russia “appears to hold strong economic as well as military cards”, says The Economist.
Because it supplies 24% of the EU’s gas and 30% of its oil, it’s “hard for the West to design sanctions that do not backfire”. Russia’s relatively healthy balance sheet suggests it can ride out a period of capital outflows. It has a current account surplus of around 2.1% of GDP.
A long history of such surpluses – thanks to oil and gas exports – has allowed Russia to amass almost $500bn of foreign exchange reserves. Government debt is just 13% of GDP and it has a budget surplus, so there is scope for fiscal stimulus to counteract a downturn.
Still, the crisis is gradually undermining an already structurally weak economy. The immediate problem is that the central bank is worried about the sliding currency fuelling inflation, already high at 7%.
It has raised interest rates to forestall price rises and bolster the rouble’s appeal, but this has squeezed growth. GDP growth has slipped to below 1% year-on-year, reckons Capital Economics.
The underlying problem is that Russia needs to boost investment to improve its production capacity and innovation. But weak property rights, bloated bureaucracies and endemic corruption have deterred the foreign money required – which is even less likely to head to Russia now.
The country desperately needs foreign ideas to find “new ways of doing things and [to] put pressure on dozy domestic companies”, says The Economist. “Instead, the economy is turning in on itself as a result of the crisis in Ukraine.”
Both the near- and long-term outlook are uninspiring, and could deteriorate even faster if the crisis escalates. Yet there comes a point when all the potential bad news is in the price, and we think Russia has reached it. Stocks are trading on a cyclically adjusted price/earnings ratio of 6.1, the second-lowest in the world except for Greece.
That implies considerable upside for the market if the crisis thaws and Russia shows signs of moving towards reforms, as it occasionally has in the past. The JPMorgan Russia Securities Trust (LSE: JRS) and the iShares MSCI Russia Capped ETF (NYSE: ERUS) are two ways in.