News & analysis UKRAINE: INVESTORS DASH FOR CASH
With investors scrambling to sell Russian assets, what will the impact be on the global economy? Mona Dohle reports.
“Buy when there’s blood on the streets,” is an old adage from the Napoleonic wars when opportunistic traders cashed in on discounted shares in the midst of bloodshed. Fast forward 200 years and there’s blood on the streets of Kyiv. Share prices tum- bled on the first reports of war, but investor appetite has not followed suit. The knock-on effects of the war threaten to desta- bilise the global economy, which remains on thin ice. Putin had planned for the prospect of international isolation. Since the annexation of Crimea in 2014, Moscow took steps to “sanction-proof” the Russian economy. Russia had shored up international currency reserves to the tune of $630bn (£469bn), cut back sovereign debt to 20% of GDP and reported a chunky current account surplus, thanks to lucrative gas revenues. In theory, the Russian economy could not have been better prepared for the sanctions that followed its invasion of Ukraine.
In practice, this turned out to be worth very little, as the first few weeks of the war have shown. While Russia holds significant currency reserves, they are largely held by international institutions, such as the IMF or the Bank for International Settlements (BIS). A spokesperson for BIS stressed during a media briefing in February that while it could not disclose its banking relation- ships, it intended to adhere to the sanctions: “The BIS will not be an avenue for sanctions to be circumvented,” she said. Similarly, European central banks, which hold much of the remainder of Russia’s central bank’s assets, have already indi- cated that they have frozen its accounts. This leaves another 14% of reserves in China with the rest held by private banks, as the Financial Times reported, but much of its foreign currency reserves are now effectively inaccessible.
This meant that even a central bank interest rate hike of 20% had little effect in restoring faith in the rouble, which as of mid-March is still worth less than $1. As a result, people on the streets of Moscow and Saint Petersburg dashed to their nearest bank in an attempt to convert their savings to dollars. Investors followed suit. The crisis swiftly spread to bond mar- kets as rating agencies downgraded Russian debt to junk, despite its overall low debt volumes. Yields on dollar denomi- nated 10-year Russian bonds surged above 12% while it’s larg- est bond, set to mature in 2047, lost about half of its value. US authorities have now banned US investors from buying any new Russian bonds. Russia’s debt markets re-opened on March 21, and, at the time of writing, it narrowly avoided a default by meeting an initial $120bn (£90.3bn) re-payment due
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in March. But with most of its reserves frozen, the possibility of default is still on the table.
Forced sellers
Investors are keen to exit the market, a trend which picked up speed as many index providers, including MSCI, expelled Rus- sian stocks from their main indices. Prior to the war, Russia accounted for 4% of the index provider’s EM index. This turned investors who, either knowingly or unknowingly had passive exposure to Russia, into forced sellers at the worst possible time, as everyone rushed towards the exit gates. Norway’s sovereign wealth fund was one of the first to pull the plug on its $25bn (£18.6bn) of Russian assets at the beginning of March, swiftly followed by other institutional investors, from USS to Norwegian pension fund KLP. Simon Pilcher, USS’ chief investment officer, told the BBC that the defined benefit scheme had sold some £450m of Russian assets. UK investors have also been hit indirectly, with BP and Shell intending to sell their stakes in Russian energy firms Rosneft and Gasprom at a loss. The energy giants are yet to find a buyer, but BP has confirmed that selling its stake in Rosneft is likely to result in a $25bn (£18.6bn) hit. Pressure is mounting on other energy giants, from Total to ExxonMobil, to follow suit. Those wishing to sell assets this late in the day will struggle to find an underwriter, as Russian banks are now banned from acting in such a capacity for the sale of Russian assets, the cen- tral bank has banned overseas investors from selling on the Moscow Exchange and most foreign banks do not underwrite Russian assets. This leaves about $86bn (£64bn) in equities and $60bn (£44bn) in sovereign debt held by international investors unable to find a buyer or underwriter. There are early indications that the scramble to exit Russian assets is affecting market liquidity. MSCI revealed in February that bid/ask spreads for US and non-US bank loans and corpo- rate bonds had shot up and that quoted price standard devia- tions had increased swiftly.
Beyond the short-term scramble to sell anything with links to Russia, a longer-term consequence for UK investors could be the impact of the Ukraine war on inflation. Oil prices have risen above $100 (£74.5) a barrel for the first time in eight years, while gas and other commodity prices have also surged. This is likely to accelerate inflationary trends further, as Clau- dio Borio, head of the monetary and economic department at BIS, acknowledged: “The environment has indeed become more complex for central banks. We are already seeing the strong increases in commodity prices which are going to put upward pressure on [price levels] in the longer term. Borio warned that rising price levels could lead to negative sup- ply side shocks but stressed that central banks would have to respond depending on their country-specific circumstances.
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