Russia is now a must at the diplomatic level, but also economically, thanks to its energy sector and investors who flock to the Moscow Stock Exchange.
The strategy of the fortress
To overcome international sanctions — and not relive the financial and economic crises of the past — the Russian authorities isolated their economy from external shocks. Therefore, at the budgetary level, they have taken a very cautious approach. Since 2017, federal budget spending, excluding interest payments on the public debt, cannot exceed fiscal revenues, largely dependent on energy prices. And the price chosen is deliberately low, fixed for this year at $43.5 for the Russian reference barrel, whereas it exceeded $60 in the first half and is $70 today. When oil price exceeds the reference price, excess revenues are transferred to the National Wealth Fund and invested in foreign assets. Otherwise, the Government may draw on reserves to finance itself.
This fiscal rule mitigates the pro-cyclical effect of oil prices on the Russian economy. As a result, despite the covid crisis and the collapse of global energy demand, Russian GDP fell by only 3% in 2020 compared to a 6.3% drop in the Eurozone.
The other pillar of the fortress's strategy is the central bank, which carries out a credible and independent policy to achieve its 4% inflation target. In March, it raised its key interest rate to contain the surge in inflationary pressures. This policy reassures investors and avoids financial crises.
Russia is a central player in energy
In the energy sector, the revival of Russia is most spectacular, and long before the current energy tensions. The masterstroke of Moscow was to agree from 2016 with the members of the Organization of Petroleum Exporting Countries to regulate the market. The 14 OPEC countries, Russia and nine other producer countries also control 55% of world production and 90% of oil reserves. This gives this grouping where Russia plays a decisive role: influencing the oil market to levels never reached before. This « expanded cartel » has supported oil prices in recent years while preventing a surge that would cause a new destabilizing boom in shale oil production in the United States.
Russia's involvement in the « cartel » did not prevent Russian production from reaching its highest level since 1991 and the break-up of the Soviet Union in 2019, confirming the country's 2nd place in the world in the ranking of oil producers. The role of Russia in gas is even more significant with 20% of world production and above all a predominant share in exports. Moreover, more than 40% of the gas imported by the European Union comes from Russia, which benefits doubly from the current energy crisis.
The gas sent to the west pays more with the soaring prices. And Moscow has all the cards in hand to ensure the future of its gas sector by pushing the signing of a long-term contract with European countries concerned with ensuring their supply.
Denounced and long threatened by international sanctions, the Nord Stream 2 pipeline, which is supposed to double deliveries to Germany, is eagerly awaited.
Acclaimed by investors
It has grown in recent months, but the appetite of investors for Russian equities is not new. The Moscow Stock Exchange has been performing well for several years. However, implementing the fortress's strategy in 2017 sounded the alarm in the Moscow market. With a credible central bank and a prudent fiscal policy, the ruble collapse, as in 2014 when it lost half its value in a few months, is no longer relevant.
On the contrary, the Russian currency is today perceived as a stable currency. Moreover, with a public debt of only 20% of GDP and an external debt of 27% of GDP compared to 41% five years ago, Russia's financial situation has never been more solid. Especially since the Reserve Fund has accumulated $188 billion (12% of GDP) and the Central Bank has almost doubled its foreign exchange reserves since 2015, now more than $600 billion.
Reassured by the country's financial strength, investors rush into the Russian market to take advantage of the energy sector, which accounts for 50% of the market capitalization. As a result, Opep+ decided to increase daily production by 400,000 barrels each month, including a quarter from Russia with the global recovery.
Russian production will thus return to 2019 highs next year. The gas sector is also increasing its production to meet the foreign demand. As a result, rising prices and exports are boosting the profits of Russian companies and making them more attractive. The mining and processing sector (15% of the stock market) also benefits from the surge in prices.
It is not too late to take advantage of the boom in the Moscow stock market. The global recovery will continue to support demand and commodity prices.
Any relaxation of international sanctions could also reinvigorate other sectors of the Russian economy. Therefore, Russian equities are attractive as part of a neutral portfolio.