Shunned by the west and bruised by record-low oil prices, Russia is finding itself at a strategic crossroads. Melodie Michel investigates.


In the middle of difficulty lies opportunity.” Judging by the flurry of recent headlines about Russia, Albert Einstein’s most famous quote must be on everybody’s lips in the country. President Vladimir Putin makes new announcements of bilateral trade agreements with Asian and Middle Eastern countries every week, topped off by speeches displaying his intention to move away from US dollars and towards local currencies in trade settlements. In the middle of Ukraine-related trade sanctions from the US and the European Union, Putin sees an opportunity to find new allies – and he’s working hard at it.

But policy changes take time to be implemented, and for now Russia is on the verge of recession. The country’s GDP is expected to shrink by 3-4% in 2015, while inflation could soar by as much as 12%. The situation is caused less by the sanctions than by the record decline in oil prices observed since mid-2014. Considering that 58% of Russia’s exports are made up by oil and gas, Tatneft head of international legal Peter Gloushkov was not exaggerating when at the latest GTR Russia and CIS Trade and Export Finance Conference he said: “The rouble is oil.”

In fact, the rouble went from US$0.029 in August 2014 to US$0.016 in mid-February 2015, after hitting its lowest point (US$0.014) at the end of January. This drop of over 45% coincided almost exactly with the price of crude oil, which went from US$100 a barrel last August to just under US$45 at the end  of January, then back up to about US$52.

“The central bank is in a difficult position because it can’t control the oil price and the rouble shadows the oil price almost exactly,” says Jan Randolph, director of IHS sovereign risk rating service. In order to slow down the collapse of its currency, the Russian central bank hiked up interest rates by 6.5% to 17% in November last year, with the whole banking system suffering the collateral damage of that decision. It then surprisingly dropped the rate by 2% at the end of January, partly relieving the pressure on lenders, but sending the rouble back down.

Wait and see

It is important to note that unlike Iran, Russia is still allowed to receive ECA support under the sanctions – as long as deals don’t involve the biggest, state-owned banks including Sberbank and Gazprombank. However, international banks are wary of an expansion of sanctions that could make this type of financing illegal, and as a result, are on the back foot.

“A major fear at the moment is that the area of sanctions could be widened for the public banks. At the moment, ECA business from the EU is accepted, which means that if you want to tighten the sanction regime there is still an opportunity to cut access to ECAs.From our perspective this would have an additional major impact on the European economy,” says Ralph Lerch, global head of export finance at Commerzbank.

Similarly, banks are very cautious about the non-sanctioned entities they choose to do business with, as the list of sanctioned names is never definitive.

“It’s no secret that international banks have withdrawn from the market, and I think it’s a mixture between sanctions and a negative perception of Russia in general. Overall we see that international banks are now adopting more of a wait-and-see approach,” Alexey Tyupanov, the recently-appointed CEO of Russia’s ECA Exiar, tells GTR.

According to him, local banks, both sanctioned and not sanctioned, are also feeling the pinch, struggling in particular to get refinancing.

“The biggest Russian banks are state-owned banks and they’ve all been sanctioned so they don’t have access to long-term US dollar or euro funding, and because of the depreciation of the rouble the central bank has raised the base interest rate quite substantially. Of course it influences the interest rate on loans provided by state-owned banks,” he adds.

In reaction to this, Exiar has become the sole shareholder of the Export-Import Bank of Russia, giving it the ability to provide direct loans on top of insurance cover. This new initiative will ultimately provide direct loans to exporters, but also refinance banks’ export credit portfolios. However, it currently only has very limited funds to do so, and expects an equity injection from the government “in the next few months”.

Three years after its creation, Exiar is targeting US$5.5bn worth of support and US$1.5-2bn of direct loans in 2015.

But with Russia’s sovereign rating downgraded to BBB- by Standard & Poor for 2015, the agency is bound to face increased scepticism from banking partners.

“[Before the sanctions] we got several invitations from Russian banks asking us to join them in doing business with Exiar, and we were then approached by western, including German, companies who decided to expand their business in Russia using the ECA for supplies from Russia to other CIS countries.

“These companies incentivised us to go for it, we started studying Exiar’s statutes and requirements, and we thought we would be ready to go towards the end of 2014 or beginning of 2015, but now this has all been put on hold. With Russia at a minus sovereign rating, Exiar is less beneficial as a risk mitigant due to regulation and risk calibration,” explains Lerch at Commerzbank.

Silver lining

But it’s not all doom and gloom for Russian exporters. Corporate speakers at the February conference in Moscow, including Tatneft’s Gloushkov, explained that efficiency optimisation strategies started in 2013 have helped large companies (which form 80% of Russia’s GDP) to cope with the tightening of the economy. Despite the sanctions, they all seemed confident in their ability to keep securing dollar-denominated loans.

While the fall in the rouble is making life at home more difficult, it is also making Russian products extremely competitive on international markets, and since domestic demand has dropped, most companies plan to increase their exports in the coming year.

Growing commodities demand from emerging markets is prompting a shift in traditional trade flows, with Asia, Mena, Latin America and Sub-Saharan Africa all seen as hotbeds for opportunities.

Good deals have become great, and although Western investors may be sharing the banks’ wait-and-see attitude, the Asian approach is a lot more bullish. According to Yuri Botiuk, partner at Pinsent Masons, “every week there is a new joint venture from China to Russia”.

At Exiar, Tyupanov has also noticed tremendous interest from Asian counterparts. “Russia was always competitive in space, energy and railways: the capital consuming sectors. Russian producers managed to renovate their production facilities between 2001 and 2012, so now they don’t have to import spare parts. Production is almost 100% Russian, so they can compete and decrease their prices in US dollars on the international export market.

“Asia was the first region to comprehend that you can now purchase goods from Russia for even cheaper than it used to be,” he points out.

Pivot to the east

So Russia is now looking east. The country signed a US$24bn currency swap agreement with China last October, and Putin has intensified efforts to improve relationships with India, Pakistan, Indonesia and even Japan. But can the region absorb the western trade lost?

The general consensus is that it can’t.

First, there are logistical issues: Most of Russia’s economy and population is located west of the Urals. “Everything is invested towards Europe. All the pipelines go to Europe, all the trade is between Europe and Russia. There’s very little east of the Urals so the idea that you can somehow pivot to the east is going to be very difficult – it’s going to take decades to switch,” says Randolph at IHS.

Then, there are the cultural differences. Speaking at GTR’s Russia conference, Dina Merkulova, director of financial institutions and ECAs, international trade finance at Alfa Bank, explained that although Russian banks started building relationships with their Asian counterparts years ago, it is taking a long time to overcome cultural barriers around business transactions.

“Big Chinese players have subsidiaries in Russia, but unfortunately they are quite small with small volume limits. Building relationships is challenging. You can never understand the motivations of Asian banks, it’s hard to know who makes the final decisions and their pricing is not very transparent. What we need more is support in trade and export finance and the biggest part of that business is still covered by international, not Chinese banks,” she said.

Randolph goes as far as talking about a “deep latent political suspicion” between Russia and China: “From the point of view of Chinese traders and investors, Russia is a lot cheaper now, and there’s a sort of natural political inclination for Russia and China to co-operate in order to disengage from the dollar dependence.

“But my view is that it won’t be a real substitute from the current Russian/European trade. Russia’s very wary about all the land it has east of the Urals, where it only has a small percentage of the population, right next to billions of Asian people. They are very worried about developing trade and investment too far.”

New currencies

Demand is also strong from the Middle East, particularly for soft commodities and capital goods and services, but trade capacity with the region will remain limited due to the fact that for both parties the main export is oil.

No matter where demand comes from, Russian exporters and their banks will take time to familiarise themselves with previously untapped markets, but more importantly, they will face liquidity and sanctions obstacles when trying to secure financing for these contracts.

Igor Emelyanov, managing director of the trade and export finance department at VTB, says: “We see the growing potential in Mena and Africa, but we should also consider the availability of trade financing. Traditionally all financing was in dollars and euros, but now these currencies are less available for Russian banks. That means we need to create financial instruments in national currencies, but everybody lacks experience in that field.”

While largely publicised, the US$25bn-worth, three-year rouble-renminbi (Rmb) swap agreement signed in October 2014 between the Russian and Chinese central banks does not seem to have been used so far, and other currency swap negotiations are still in their infancy.

There doesn’t appear to be a quick fix for the conundrum Russia is finding itself in, but this could be the best time for Russia to start reforming its economy.
“If there was ever a time for reform, it is now,” says Randolph at IHS. “There are several strands that need to be worked on, including predictability for investors, and a reliable legal environment. That is fundamental to developing SMEs and re-attracting foreign investment.”

With Exiar, Russia hopes to increase its percentage of non-commodity exports and support its SMEs, but whether policy announcements will turn into long-lasting change in a society dominated by oil empire oligarchs remains to be seen.