After the collapse of the former Soviet Union, Russia found itself searching for the right political and economic roadmap to carry it forward in a
Not long after the USSR’s collapse, Russia re-emerged as a major geopolitical player as Putin used Russia’s resentment toward the West to his advantage
post-Soviet world. After only a short time feeling lost in the political wilderness, Russia has once again emerged as a major player on the geopolitical stage. During this transition, it again rekindled its antagonistic Cold War-era relationship with the West. Yet despite this adversarial position, Russian debt has become increasingly attractive to foreign investors looking to diversify away from a troubled European Union and other low-return regions.
These seemingly contradictory developments may be a head-scratcher for some, particularly those in Europe who previously held front-row seats to the USSR's demise. However, they are more easily understood when one realizes how Russia fundamentally defines its identity in opposing terms to that of the West. Capitalizing on Russia's aggrieved sense of self, President Vladimir Putin been able to seize on the Russian people's nostalgia for a grand imperial past, in turn redirecting its old communist faith toward a new quest for global relevance.
Wielding energy as a weapon in Europe
For his part, President Putin has used the strategic principle of "divide and rule" to great effect by using energy as a weapon to drive a wedge between European countries that supported Russia and those who opposed it. Resurgent energy prices during the last decade provided the funding for this strategy, which largely focused on gaining influence through diplomatic and economic means.
Russia has wielded energy as a weapon in Europe to influence European politics, buy assets and gain disproportionate economic leverage
During Russia's economic rebound, the role of its gas in the European energy mix – through state-owned vehicles such as Gazprom – became so critical that Russia found itself capable of influencing European politics. Russia's big wallet also allowed its state-owned companies to buy energy assets in Europe, further cementing that dependency. Moreover, Europe failed to further integrate its own energy markets to diminish this Russian gas dependency, leading to "every man for himself" energy policies that, in turn, gave Russia disproportionate economic leverage in the region.
By the time oil prices collapsed in 2014 and the West slapped sanctions on Russia in the wake of the conflict in Ukraine, Russia was confronted by its own structural weaknesses: It was ruled by an autocratic and inefficient regime that relied upon a top-down economic model highly dependent on the energy sector. Only 14% of Russian exports in 2014 could be classified
Western sanctions and 2014’s collapse in oil prices revealed structural weaknesses, but higher oil prices should help the country rebound
as high-value-added exports, as Russia had a high dependency on commodities, in general, and oil, in particular. Commodities accounted for approximately 86% of total exports in 2015, down from 90.3% in 2011, with this decline largely due to lower prices. According to Russian Finance Ministry officials, if prices for Urals crude blend oil remain near $50-55 per barrel, Russia's budget could collect an additional $16-24 billion in additional taxes. Higher oil prices invariably improve Russia's balance of payments, fiscal deficit and growth dynamics.
A land of ambiguity for investors
Yet for investors today, Russia is both a fixed-income safe haven and a region rife with highly understated volatility. From a market perspective, this doesn't make much sense, so how could it be happening?
Part of the explanation is that Russia's willingness and ability to service and pay its debt goes hand in hand with its global superpower narrative. Despite the cathartic episode of Russia's 1998 debt restructuring – which involved disproportionate losses for holders of domestic Russian treasury bonds, known as OFZs – Russia has always strived to keep a clean record when it comes to debt service. This is reflected in its conservative macro policy framework and treasury management since the 1998 default.
Today, Russia is a land of ambiguity for investors – a fixed-income safe haven and a region rife with highly understated volatility
From an equity perspective, however, the picture is less encouraging, as Russia's top-down model does not bode well for transparency or for checks and balances. As a result, property rights in Russia – whether justified or not – are not very sticky. In such an environment, equity prices will always carry a premium.
So long as these conditions persist, Russia will remain an ambiguous destination for the investment community. This situation is likely to last for years to come, for the simple reason that nations rarely lose the idiosyncratic traits that gave rise to their nationhood in the first place. As Mr. Putin heads toward his fourth term in power, the question in many people's minds is not only what he will do next, but what comes after him. Will more Putin lead to more of the same – or to a more open, transparent Russia that is ripe for more interesting investment opportunities? One thing seems clear: Russia will not lose its deep sense of history, nor will it stop yearning for a stable and secure society.
Higher Oil Price Improves Russia's Growth Dynamics
Urals oil vs Russian GDP Sept 2012 - Sept 2016
Source: Bloomberg as at 30 Sept. 2016. Russian GDP represented by the RUDPRYOY Index, Urals oil by the FURAM1 Index. Note that Urals oil stopped pricing with Bloomberg for a period between 2013-2014; as such, prices during this period were calculated using Brent prices (CO1 Comdty) adjusted for the Ural-Brent differential.