Weekly 27 November 2021

Market woes

Hello! This week our top story is about why November is the worst month this year for Russian markets. We also look at the dismissal of the head of Russia’s penitentiary service following revelations about prison torture, and the possibility of a default for state-owned Rusnano — a company supposed to nurture high-tech innovation.  

November to be worst month of 2021 for Russian markets

November isn’t over yet, but it’s already clear that it will be the worst month of the year on the Russian markets. With the emergence of the Omicron coronavirus strain last week causing global markets to nosedive, some fear these losses are only the start.

  • In many ways, the current situation on world stock markets recalls the events of spring 2020 when the coronavirus first emerged — and a sharp drop in the price of oil Friday made it the biggest daily fall since March 2020. However, other analysts believe the oil market reacted too quickly, and will soon correct itself.
  • The Russian market faces this new, worldwide sell-off in far from peak condition. The ruble has weakened almost 9 percent against the U.S. dollar over the last month, and Russia’s stock indexes have dropped into correctional territory (defined as a fall of at least 10 percent): between Oct. 20 and Nov. 26, the Moscow Exchange sank 11 percent and the dollar-denominated RTS declined 16.4 percent. At the same time, foreign investors have been exiting the Russian bond market (OFZs): a five-month increase in non-resident investments last month became an outflow. And quotes for credit-default swaps are at their highest levels since spring 2020.
  • Until the emergence of Omicron, much of the pressure on Russian markets has been down to rising geopolitical tensions, said Dmitry Polevoi, investments director at Loko Invest. “It’s a question of the so-called geopolitical trio – Ukraine, Belarus, and Armenia-Azerbaijan,” he said. “For investors, there are too many unknowns. The logical response is to secure profits as the year ends.”
  • The problems for the OFZ market, however, have deeper roots. Analysts, the markets and the Central Bank have all consistently underestimated the impact of spiraling inflation, according to Polevoi, and accelerating price rises are forcing the Central Bank to resort to tougher action.
  • The oil price and the price of the ruble are no longer as closely connected as they once were. “But the dynamics of commodity quotations influence the feelings of foreign investors, so some connections remain,” Polevoi said. On top of this, the Central Bank is buying a lot of foreign currency, putting pressure on the ruble.
  • The government’s fiscal rules will eventually help resolve the situation, according to Natalia Orlova, chief economist at Alfa Bank, “But this happens with a lag: for example, right now the state is buying [currency] as if oil prices were over $80, but prices have fallen much lower. This means that in the coming weeks the Finance Ministry will purchase a lot of [ruble] currency.”
  • The ruble is currently trading at 75.6 to the U.S. dollar and Orlova expects it to weaken to 76 rubles against the greenback by the end of the year. In the event of geopolitical stabilization, Bank of America anticipates a strengthening to as much as 72 rubles against the U.S. dollar.

Why the world should care

It’s hard to imagine geopolitical tensions will stop being the fundamental driver of the Russian markets any time soon — and these tensions show no sign of easing. Ukrainian President Volodymyr Zelensky said Friday that he had received information about a Russian-backed coup attempt. That evening, U.S. President Joe Biden announced his intention to talk to both Zelensky and Russian President Vladimir Putin.

 

Russian prisons boss fired amid evidence of torture

Russian President Vladimir Putin on Thursday fired Alexander Kalashnikov from his position as head of the Federal Penitentiary Service (FSIN). In the absence of any official explanation, experts linked the dismissal to recent, high-profile allegations of torture in Russian prisons, and infighting within the security services. Kalashnikov’s replacement was announced as Deputy Interior Minister Arkady Gostev.

  • The main reason for Kalashnikov’s ouster was widespread public criticism of torture in Russia’s prisons, according to a source quoted by news agency Interfax. “This is an early departure that must be linked to external issues,” human rights activist Pavel Chikov told the BBC Russian Service. He added that the reshuffle might be connected with a power struggle between the Interior Ministry and the Federal Security Service (FSB) for control over the prison service. Sources quoted by media outlet RBC mentioned the same conflict: they speculated Gostev’s appointment meant the effective transfer of control over Russia’s prisons from the FSB to the Interior Ministry.
  • Human rights organization Gulagu.net earlier this year published reports of shocking torture in Russian prisons — as a result of which the Investigative Committee opened seven criminal cases. Top FSIN officials in Saratov Region — where much of the abuse was said to have taken place — were fired.
  • Gulagu.net said at the time that it had received access to an archive of “more than 40Gb” of torture videos collected by former prisoner Sergei Saveliev, who was a computer operator in a hospital and archived the recordings. Gulagu.net provided the names and ranks of FSIN and FSB staff who, they claimed, were in charge of the torture. The torture included beatings, rape, and prisoners being handcuffed and forced to say they were “nobody”. The violence was carried out under orders from high-ranking officials in FSIN, according to Gulagu.net.
  • In the wake of the revelations, Saveliev was accused of illegally accessing computerized information and fled Russia (although the case was thrown out earlier this month). Saveliev is now seeking political asylum in France.
  • Kalashnikov, under whose watch this torture allegedly took place, has worked for various Soviet and Russian security agencies since 1987. He took charge of FSIN in 2019. His immediate predecessor, Gennady Korniyenko, was in post for seven years before retiring. Prior to that, FSIN boss Alexander Reimer, who was in charge between 2009 and 2012, was jailed for eight years after embezzling almost 3 billion rubles ($40 million) earmarked for the purchase of electronic tags.
  • Kalashnikov’s replacement is Arkady Gostev, 60, who began his career in 1981 as a Moscow cop. He has been a deputy interior minister since 2012.

Why the world should care

It’s unclear whether Gostev’s promotion will lead to an overhaul of the penitentiary service. Either way, evidence gathered by human rights groups like Gulagu.net suggests that torture and other abuses are endemic to Russia’s prison system.

State-owned tech firm Rusnano faces possible default

Set-up to nurture innovation and help diversify the Russian economy, state-owned Rusnano was this week facing the possibility of a default. Rusnano managers were reportedly locked in debt restructure negotiations with investors after trading of the company’s bonds was suspended. The saga has led to questions about whether state-driven innovation in Russia can ever be successful.

  • The Central Bank ordered the Moscow Stock Exchange to suspend trading in Rusnano bonds last Friday. The corporation later explained that it was in discussions with creditors about restructuring, admitting that it had accumulated a “disproportionate debt”.
  • Rusnano has completed nine bond issues worth a total of over 70 billion rubles ($938 million). It owes a coupon on five of these next month.
  • Trading of Rusnano bonds resumed Monday, and — to no-one’s surprise — quotes for the corporation’s bonds fell sharply. The situation will test the state’s willingness to incur financial losses on high-risk investments, according to Konstantin Anglichanov, senior director at ratings agency Fitch (the only Western agency with a rating for Rusnano). “It’s almost impossible to discern what Rusnano is doing with the mandate it received from the state,” he said.
  • The Finance Ministry said Tuesday that Rusnano would continue to fulfil its debt obligations, but only on securities with a state guarantee (at the start of 2021, just 75 percent of Rusnano’s total debt was backed by state guarantees). Notably, media outlet RBC reported that a quarter of the non-guaranteed bonds, worth about 10 billion rubles, are held by Promsvyazbank, the primary bank for Russia’s defense sector. The Finance Ministry also said Rusnano’s board of directors would be replaced to improve efficiency.
  • Fitch placed Rusnano’s credit rating under review Wednesday. Rusnano currently has a BBB rating — if the company is downgraded one notch it would mean joining the lowest investment category, BBB-. Anything lower falls into the category of speculative or non-investment: companies with these ratings are typically characterized by an increased risk of default and greater vulnerability to changes in the business environment.
  • While the situation is unprecedented, a default is far less likely than a restructuring, according to Konstantin Svyatny, CEO of Aton Management, who dismissed the idea that Rusnano’s problems cause wider economic problems. “The problems of one issuer will not have a significant impact on the yield of government securities,” he said.
  • However, even if the situation is quickly resolved, some believe Rusnano’s problems are a blow to all state-owned companies. Events raise questions about the investment axiom that quasi-sovereign companies always enjoy higher credit ratings (as they are backed by the state).
  • Fitch wrote just a year ago that a Rusnano default would “adversely affect the Russian capital market, and also harm investor confidence in the reliability of government support, especially in the light of the increasing issuance of debt without government guarantees”.
  • Rusnano was set-up in 2007 and was led for thirteen years by Anatoly Chubais, the architect of Russia’s post-Soviet privatization drive and one of the last of the reformers of the 1990s left in a top government post. Chubais took on a new role last year as presidential envoy for climate change.
  • There have long been concerns about the management of Rusnano. The Audit Chamber highlighted ineffective management and expenditure in 2013, while opposition leader and anti-corruption campaigner Alexei Navalny regularly accused the company of misusing state funds. Chubais has even been blamed for the recent debt problems. But others believe Rusnano’s fate was sealed from the start. Economist Maxim Averbukh argued in a column for newspaper Novaya Gazeta that there is a chronic lack of interest in innovation in Russia while the economy revolves around raw material exports and state spending.

Why the world should care

The story of Rusnano is a reminder that a company’s ‘state connections’ should not be a substitute for a proper analysis of its financial health. From now on, investors are unlikely to take state support for such companies as a given.