Ukraine Prime Minister Volodymyr Zelensky’s remark February 14 that Russia would attack his country on the 16th of February sent stock markets tumbling before a senior aide qualified the statement as a joke. Zelensky was a professional comedian before he became Ukraine’s leader.
The US stock market recouped some of its earlier losses, and the NASDAQ index closed unchanged.
A key political risk gauge, the cost of US-dollar-denominnated insurance against default on Russia’s sovereign bonds spiked to 2.75 percentage points above the interbank rate early February 14 before settling back to 2.5 percentage points. That’s close to the high point during the peak of the Covid-19 market panic in March 2020, with the difference that the credit default swap market reflected fear of sanctions against the Russian Federation rather than economic distress.
The oil price fell to the low $20’s in early 2020, but today traded around $95 a barrel. Russia’s external finances are robust. Its current account surplus stands at 5% of GDP, close to the highest among the world’s big economies, and its foreign exchange reserves have nearly doubled during the past five years to over $630 billion.
Even under a worst-case scenario – a Russian incursion into Ukraine followed by punitive sanctions – it is hard to envision a scenario in which Russia would default on its foreign debt. With $455 billion of foreign debt outstanding and an average interest rate of about 5%, Russia’s sovereign debt service obligations are slightly over $20 billion a year. It has thirty times that amount in reserves.
Oil analysts are trying to work out the impact of Russian sanctions on the oil market. This is unclear; China almost certainly would continue to buy oil from Russia under any circumstances. Brent crude rose today to $96 a barrel, but the oil price has risen steadily due to constrained supply conditions for the past several months irrespective of events in Ukraine.
Rising oil prices are a major worry for Washington as well as Europe and Japan, and any attempt to boycott Russian oil – which comprises about a tenth of world supply – would lead to nasty economic consequences for the world economy.
It is hard to work out a scenario in which the Russian sovereign would run short of money, which makes the rush to buy insurance against Russian default seem overdone.
Russian equities are a different story. In US dollar terms, the Russian market has fallen nearly 30% since late October. Even if the Russian sovereign sails through a new round of sanctions, the Russian energy majors like Gazprom, Lukoil and Rosneft may run into trouble.
Russian banks, which comprise a large part of the Russian index, could be shut out of the dollar payments system. Even if they find workarounds through China’s RMB payments mechanism, their profitability will suffer severely.
Russian stocks look cheap; ERUS, one of the Russia country ETFs, trades at five times forward earnings and offers a dividend yield of 7%. But Russian stocks always are cheap given the layers of political risk associated with them, and it would take a great deal of courage to dip into this market at the moment.