The new U.S. sanctions against Russia are mostly unpopular with financial markets around the world, but these moves to pinch Russia’s main financing pipeline – the ruble bond market – are already somewhat of a point of no return, with potentially far-reaching consequences.
In view of the 2014 Ukraine crisis, and the former special counsel Mueller (Robert Mueller) report accusing Russia of meddling in the U.S. election and other previous sanctions experience, fund managers are not eager to large-scale get out of Russian assets.
The Russian ruble plunged as much as 2% against the dollar on Thursday, before clawing back its losses and is expected to post its best weekly performance so far this year. Yields on Russian bonds issued in local and international markets have also fallen.
Such a market reaction shows that the U.S. ban on U.S. investors buying new Russian ruble bonds (OFZ) is just another annoyance for a market that has been dealing with the risk of sanctions for years.
Investors originally feared “nuclear” options, such as a complete ban on U.S. companies buying ruble-denominated Russian sovereign debt, or isolating Russia from the international funds transfer system. That may be the case in the future. But for now, U.S. funds can buy such bonds in the secondary market, and most companies already do so.
But many warn that the U.S. action is an escalation of previous sanctions targeting individuals and Russian dollar debt.
“This is not a new round of political sanctions against a few officials or obscure blacklisted companies,” said Christopher Granville, managing director of consulting firm TS Lombard and veteran Russia watcher.
“This time they are essentially imposing financial sanctions meant to hit Russia by hiking borrowing costs and weakening the ruble.”
Granville believes this will result in Russian interest rates being 50 basis points higher than they would have been without the sanctions.
Indeed, banks such as Morgan Stanley and JPMorgan Chase now see a higher-than-expected 50 basis point rate hike at the Russian central bank’s April 23 meeting, which could hurt the strength of Russia’s economy’s projected 4% rebound in 2021.
Foreign investors have reduced their positions in Russian public debt to a six-year low, with U.S. investors holding nearly 7% of the total. Extrapolating from the expected $37 billion (2.8 trillion rubles) in Russian bond offerings this year, the withdrawal of U.S. buyers would reduce demand by $2.6 billion.
This is an extreme figure, however, and does not take into account secondary market purchases.
Russian banks could also absorb the excess bonds. But this could reduce market liquidity – Russian investors are buying bonds primarily to hold – and yields should rise at least modestly.
Slow destruction
Russia is in a stronger position to withstand these blows than most developing countries. Since the double whammy of plummeting oil prices and the first wave of sanctions over the annexation of Crimea in 2014, Russia has built up fortress-like defenses.
Russia’s debt-to-GDP ratio is about 20 percent, less than one-fifth that of the United States.
The risk from the sanctions is that the economy could be eroded over the long term, as well as a weakened Russian presence in international markets, and these scenarios are about to become apparent.
“Sanctions cause slow damage,” said Pavel Mamai, co-founder of hedge fund Promeritum Asset Management, “and each individual sanction will not cause significant harm, but this trend will. Russia is becoming increasingly marginalized.”
The 2019 sanctions make future Russian dollar-denominated debt no longer eligible for inclusion in major bond indices, such as JPMorgan Chase’s Global Emerging Markets Bond Index. JPMorgan will likely also exclude new Russian public debt issues; the firm has a number of popular emerging bond indexes under its belt.
That means investors who track the relevant indexes, or use them to gauge asset performance, will have little incentive to buy Russian bonds.
Russian bonds make up 4.2% of the JPMorgan Corporate Bond Index, down from 5.6% in 2013. This share will shrink further as many large Russian companies and banks are barred from the dollar bond market.
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