Toast of Emerging Markets in 2021, Russia Gives Pause

(Bloomberg) -- Russia's performance this past year has made it the toast of emerging markets.

But as 2022 approaches, the tens of thousands of Russian soldiers gathered near the Ukrainian border are giving its backers pause for thought.

For all the gains the country's assets have made in the past 12 months, a military incursion into Ukraine would transform the narrative instantly, analysts say. Unprecedented U.S. and European sanctions would leave Russia off-limits to many investors, rendering the benefits of rising commodity prices, record international reserves and the central bank's hawkish turn all but irrelevant.

“If it invades Ukraine, Russia would disappear as an asset class,” said Elena Loven, a fund manager at Swedbank Robur Fonder AB in Stockholm, which oversees more than 1 billion euros ($1.13 billion) of assets, with the bulk invested in Russia. “Sanctions will be imposed and it will be impossible to know what you can and can't do. At some point, Russia would become uninvestable.”

While most emerging-market currencies have weakened against a resurgent dollar in 2021, the ruble has remained resilient, currently little changed from a year ago. It's a similar story for local-currency and dollar bonds, which have posted losses but still beaten the average performance among Russia's peers. Meantime, the benchmark MOEX Index of stocks has risen 14% in ruble terms.

While the Kremlin insists it has no intention of invading Ukraine, tensions with the U.S. and Europe haven't been this fraught since the Crimea standoff in 2014. Analysts say the sanctions imposed then would pale in comparison with those currently being mulled in Washington and Brussels, which include harsher limits on Russian banks and exclusion from key international transaction networks such as SWIFT.

Despite the saber-rattling, most investors don't think it will come to this, and any signs of lasting, meaningful detente would be grounds for a rally. U.S. President Joe Biden plans to talk by phone with Russian leader Vladimir Putin later on Thursday.

Ukraine Conflict

Investors can also take comfort from the buffers Russia has built for itself since 2014. President Vladimir Putin has ensured the central bank has bulked up its international reserves to a record $626 billion while keeping the reins on external debt. Added to which, there's not that much that the U.S. and Europe can do that won't inflict harm on the wider global financial system, especially in light of Russia's status as one of the world's largest energy exporters.

The Bank of Russia has been one of the most aggressive central banks in emerging markets this year. Policy makers led by Governor Elvira Nabiullina have lifted the country's key rate by 425 basis points to 8.5% and signaled further increases may follow to limit rising consumer prices. Inflation is running at about 8%, twice the bank's target. Authorities are expected to start to unwind the increases sometime in 2022.

The following are comments from investors and analysts on the outlook for Russia in 2022. They have been redacted for brevity.

Mark Mobius, a founding partner of Mobius Capital Partners LLP in London, which has $350 million invested in emerging markets:

“If there is an invasion, the impact will be very negative not only for the Russian market but for markets in Europe and perhaps even for the U.S., depending on how the U.S. government reacts.”
“Any of the commodities would be good to look at. There has been some weakness but it looks like the pricing of all commodities will be reasonably strong, although the big price boom we have seen is now correcting.”

Alexander Kudrin, the Moscow-based chief strategist at Aton, which manages the equivalent of about $4.6 billion in assets:

“It's hard to hedge against the geopolitical risks. Investors can bet on the widening of credit-default swaps, which are a hedge to a certain degree against any type of geopolitical” event.
“International investors have a clear case of carry trade” in Russia. “The premium is high now. Even if the Federal Reserve increases its key rate by 25 basis points, there is still enough. If 10-year U.S. Treasury yields rise to 2.5%, I would say Russia and the rest of the emerging-market sector would lose appeal.
“Russian ruble rates, which have risen substantially because of the central bank's hikes, have great potential to fall and that's what makes Russia a bullish case.”

Renat Nadyukov, a money manager at NN Investment Partners in London, which has $160 million invested in Russian equities:

“There is a high probability that the central bank will manage to bring down inflation in 2022, assuming lower geopolitical volatility, no severe impact from the Omicron variant on the global and domestic economy and no ad-hoc changes to domestic fiscal policy.”

Tatha Ghose, an analyst at Commerzbank AG in London:

“When all emerging-market currencies are weakening during the first half of next year, we expect only modest weakness in the ruble.”
“Our 2022 forecast of a weaker ruble is based on our global view that emerging-market currencies will weaken across the board because of a tighter stance at the Fed and ECB.”

Brendan McKenna, a currency strategist at Wells Fargo in New York:

“We are forecasting a weaker ruble, but the depreciation we are forecasting is actually pretty gradual.”
“Higher oil prices, a hawkish central bank, solid underlying fundamentals as well as sufficient asset buffers can support the ruble and defend it against a larger selloff.”
“We actually expect the U.S. dollar to strengthen against most emerging-market currencies next year as the Fed quickens its tapering pace and brings forward interest-rate hikes.”

Felipe De La Rosa, chief investment officer at General Invest in Moscow:

“It's good Russia gets new stories -- not linked to the old economy -- such as the tech sector. This is increasing Russia's market attractiveness for international investors in the light of ESG.”