“Buy when there is 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 is blood on the streets of Kyiv. Share prices tumbled on the first news of war, but investor appetite has not followed suit. The knock-on effects of the war threaten to destabilise the global economy, which remains on thin ice.
Russia on the brink of default
Putin had planned for the prospect of international isolation. Since the annexation of Crimea in 2014, in anticipation of further international isolation, Moscow has taken 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 couldn’t have been better prepared for the international isolation. In practice, all this turned out to be worth very little, as the past couple of days have shown.
While Russia holds significant currency reserves, these are largely held by international institutions such as the IMF or the Bank for International Settlements (BIS) and other central banks.
A spokesperson for BIS stressed in a media briefing on Monday that while it could not disclose its banking relationships, it intended to adhere to the sanction: “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 indicated that they have frozen its accounts. This leaves another 14% of Russian central bank reserves in China and other assets held by private banks, as the Financial Times reports, but much of its foreign currency reserve is now effectively not accessible.
This meant that even a central bank interest rate hike of 20% hat little effect in restoring faith in the Ruble, which fell by 30% and is now worth less than $1 (£0.75). Ordinary people on the streets of Moscow or Saint Petersburg, dashed to their nearest ATMs in an attempt to convert their savings to dollars.
Investors followed suit. The crisis swiftly spread to bond markets as rating agencies downgraded Russian debt to junk status, despite its overall low debt volumes. Yields on dollar denominated 10-year Russian bonds surged above 12% while it’s largest bond, set to mature in 2047 lost about half of its value and Ruble denominated bonds ceased trading. US authorities have now banned the purchase of any new Russian bonds for US investors.
Forced sellers
Russian stock markets remain closed and equity investors are keen to exit the market, but in the absence of anyone willing to buy Russian assets, doing so is far from straightforward.
Norway’s $1.3trn (£0.97bn) sovereign wealth fund was among the first institutional investors to pull the plug on its holdings of $25bn (£18.6bn) in Russian assets, swiftly followed by other big institutional investors, from Norwegian Pension Fund KLP to USS closer to home. Simon Pilcher, CIO of USS, told the BBC that the DB fund had sold off some £450m in 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 already confirmed that selling its stake in Rosneft is likely to result in a $25bn (£18.6bn) hit. Pressure is now mounting on other energy giants, from Total to ExxonMobil and Glencore to follow suit.
Uninvestable
The next big turning point will now be the exclusion of Russian assets from indices, a move which is currently being consulted by MSCI. Russia currently accounts for 4% of the index provider’s emerging market
The index provider warned last night that it is consulting to remove Russian-linked assets from the MSCI Standard, Small Cap, Microcap, Value and Growth, US Equity, US REIT, Islamic, Domestic Standard, Domestic SMall Cap, Overseas China Standard and Overseas China Small Cap indices before the end of this week.
This would turn investors who, either knowingly or unknowingly had a passive exposure to Russia in to forced sellers at the worst possible time, as everyone is rushing towards the exit gates.
Those wishing to sell Russian assets this late in the day will struggle to find an underwriter, as Russian banks are now banned from acting as an underwriter for the sale of Russian assets, the Russian central bank has banned overseas investors from selling on the Moscow Exchange, and most non-Russian banks do not underwrite Russian assets. This leaves about $86bn (£64bn) in equities and $60bn (£44bn) in Russian 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 more broadly. MSCI revealed in its Liquidity Risk Monitor Report for the week to 24th of February that bid ask spreads for US and non-US bank loans and corporate bonds had shot up and that quoted price standard deviations had increased swiftly.
Inflation impact
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 further accelerate inflationary trends, as Claudio Borio, head of the Monetary and Economic Department at BIS, acknowledged: “The context the environment has indeed become more complex for central banks. We’re 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 supply side shocks but stressed that central banks would have to respond depending on their country-specific circumstances.
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