Russian Ruble Expected to Bounce Back in Short Term

NEW YORK ( BBH FX Strategy) -- We do not expect today's outsized declines in Russian assets to be the start of a trend and would be inclined to take the recent moves as an opportunity to establish relative value trades within the emerging markets.

In the foreign currency space, we think the Russian Ruble (RUB) can outperform amongst high-beta currencies including the Indian rupee, Turkish lira and South African rand during this pullback in risk appetite. The key difference is the current account balance and oil prices, which are likely to remain supported by geopolitical tensions.

Moreover, the RUB should benefit in the short term from the gradual pricing out of the political risk premium and maybe even a reversal of some outflows as the country gets back to business as usual.

For the USD/RUB, the near-term target is the 200-day moving average of around 30 currently. After that are the retracement targets from the December-February drop around 30.1785, 30.5907, and 31.0028. Much will depend on euro-zone developments.

In the medium to longer term, however, Russia should continue to trade at a significant discount to its EM peers as fiscal spending catches up with Putin and the political transition approaches. Unlike a usual electoral cycle in EM, Putin will have to continue fiscal outlays to prevent the erosion of his fragile support base even after the electoral victory. This time around, he relied on spending promises for doctors, teachers, police and the military, amongst others.

In an interview with Reuters, Finance Minister Anton Siluanov calculated the new fiscal costs to be as much as 2% of GDP each year, though other sources put it at as much as 3%. Russia's budget arithmetic is essentially conducted on the simple balance between spending and oil prices.

For example, the oil price required to balance the budget increased from $34 a barrel in 2007 to $117 this year given the increased size of fiscal spending. Benchmark Russian Urals crude is currently trading around $122. If Iran-Israel tensions ease, one would expect Urals to move below the breakeven $117, which would clearly be negative for Russia.

Siluanov appears to be a voice of reason in the Kremlin, but it's too bad he has little political power. As for his predecessor and stanch fiscal hawk Alexei Kudrin, we very much doubt he will play any significant role in the "new" administration, despite Putin's encouraging words recently. Our best guess is that he will wait in the sidelines until something resembling a consolidated opposition is able to form.

We therefore agree with the assessment by Fitch ratings as it has threatened to cut Russia's long-term ratings on the basis of the deteriorating fiscal accounts and growing dependency on oil. Russia is a classic case of high tides hiding the rocks (and those who are swimming naked). Still, our own sovereign ratings model shows Russia as a solid BBB+ credit, and so downgrade risk to Fitch's BBB rating does not appear elevated right now. If we experience a sharp decline in oil prices, however, Russia will be materially affected.

The Elections

Aside from the usual evidence of carousel voting and ballot stuffing, it appears as if this time observers and the opposition members may be able to statistically prove that fraud occurred beyond a reasonable doubt. This may be possible because observers gotten hold of the protocols containing the results from individual voting stations.

They are now busy matching these protocols with the results provided by the central election officials. Nevertheless, some early estimates by locals also suggest that, corruption aside, Putin would still win the election -- albeit by a much narrower margin than the 64% of votes he received.

As his victory speech made clear, Putin's conciliatory gestures towards the disgruntled segments of Russia will be economic, not political. The escalation in the crackdown towards protestors over the last few days resulted in hundreds of arrests. We assume the domestic upheaval will quiet down soon, but there is no doubt that the process of regime change is in motion, though it will take years still before we see the political results -- but the economic results may become visible far sooner. While Putin has already signalled willingness to stand again for a fourth term, there are many that doubt he can last his next 6-year term. Much will depend on the economy and the oil tides.
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