Two years after plunging oil prices and western economic sanctions fuelled an investor exodus, the Micex stock index on August 23 hit an all-time high. It is up 25% this year in dollar terms, making Russia the sixth-best performer among 23 emerging countries tracked by MSCI Inc.
The ruble has gained 13% against the dollar this year, ranking third among all emerging currencies. Russia’s local-currency bonds rank third this year in performance out of 15 countries tracked by JP Morgan.
Many investors credit central bank chief Elvira Nabiullina for Russia’s resurgence. They cite her surprise decision to end the ruble’s peg to the dollar in November 2014 and then sharply raise interest rates to combat capital flight and knock down inflation.
The moves were painful for Russia’s economy, which went into a sharp recession as the value of the ruble slumped, reducing consumer and business purchasing power. But over time they have helped to restore some international investor faith in a country still shadowed by its 1998 default.
“The correct steps taken by the Russian central bank have restored confidence in the ruble and its macroeconomic policy,” said Andrey Kutuzov, an associate portfolio manager of the Wasatch Emerging Markets Small Cap fund.
Global investors this year have added $ 1.3 billion to funds that invest in Russian bonds and stocks, according to EPFR Global. The share of foreigners among government bondholders rose to 24.5% as of June 1, its highest level since late 2012, according to the Russian central bank.
The $ 700 million Wasatch fund has recently re-entered Russia with large investments in Lenta, a Russian retailer, after exiting all of its Russian positions in late 2014.
Russia is the latest beneficiary of a sharp rebound this year in emerging markets assets that has been driven in part by reduced expectations of Federal Reserve interest-rate increases. Rising US rates can hit emerging markets by pushing up the value of the dollar, weighing on the purchasing power of local currencies and making the dollar-denominated debt owed by many developing countries costlier to repay.
Despite investors’ enthusiasm, many analysts warn that the emerging market boom may be on borrowed time. Skeptics contend that market gains have outpaced real economic and political improvement, and that many governments including Russia’s have yet to fully embrace structural reforms such as opening labour markets and revamping government-related enterprises.
“Without working on these reforms, you’re not going to see growth in the longer run,” said Zachary Witlin, an analyst with Eurasia Group. “Monetary policy in itself can’t really do that.”
Despite this year’s market gains, Russia remains in recession. The International Monetary Fund said the country’s medium-term potential growth will be just around 1.5% annually, “barring significant structural reforms.”
Some developing nations are making headway, analysts said, pointing to Mexico, India, Indonesia and Argentina as among those that have embarked on structural reforms. But Russia, China and South Africa have yet to meaningfully address key issues, they said.
Russia has made little progress in diversifying its economy beyond oil sales or making its markets more transparent and credible, analysts said. Last week, the government delayed its planned sale of a stake in oil producer PAO Bashneft, a setback to Russia’s privatization process.
Should oil prices fall or expectations rise for another Fed rate increase, markets in Russia and other nations perceived to be lagging behind on structural reform likely will again face selling pressure due to their heavy dependence on commodities or hefty debt burdens, analysts and investors say. The ruble lost 1.4% against the dollar on Monday when crude oil fell 3%.
Investors also are mindful of the risks that Russian President Vladimir Putin’s unpredictable geopolitical ambitions could pose. In recent days, Moscow has been bolstering its military presence on its border with Ukraine, escalating tensions in the area.
But many investors believe Russian investments will bear fruit. Robert Neithart, a fixed-income portfolio manager at Capital Group, which manages about $ 9 billion in emerging market debt, said the firm is sticking with its holdings of ruble-denominated bonds, citing decent economic fundamentals.
At a recent yield of 9.1%, Russia’s ruble-denominated government bonds are particularly attractive to investors who are searching for higher returns at a time when rich-country bond yields are near zero. Ms. Nabiullina’s central bank is determined to bring inflation down to 4% in 2017 from around 7% now. Lower inflation tends to mean higher bond prices.
At Capital Group, Neithart has a risk-control framework in place to limit the size of his Russian position to reflect the potential for a shock that could come from some of the “hard-to-measure risks that are unique to Russia,” he said.
This article was published by The Wall Street Journal