A risk report I produced on Russia for my International Banking and Finance unit, highlighting key sovereign and foreign exchange risks facing the country. Obtained the highest grade of all students for the assignment.

1. [Type here]
UNIVERSITY OF PORTSMOUTH
Russia – A
Country Risk
Report
BSc Economics: International
Banking And Financial
Management
UP704520 27/11/2016 Word count: 2000

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The main objective of the Central Bank of Russia is to protect and ensure the stability of the
Ruble by the way of maintaining price stability, securing the purchasing power of the Ruble
on the foundation of a stable low inflation (Russia. The Kremlin. 2002). The confidence of
households and businesses in the national currency is supported by the lack of change in
purchasing power of the Ruble over time, encouraging both consumption and investment
spending which in turn boosts economic growth.
Foreign exchange risk
Russia currently operates a floating exchange rate regime (Central Bank of Russia, 2016),
signifying that the Ruble exchange rate against foreign currencies is determined by supply
and demand within the foreign exchange (FX) market. Up until 2014, however, Russia had
operated a managed floating exchange rate regime; with the Russian central bank allowing
exchange rates to fluctuate from day to day within a range, should it fall below or rise above
this range then the central bank would intervene to adjust it back. The central bank used the
US dollar and Euro basket as the operational indicator of its managed exchange rate policy,
meaning that the Ruble exchange rate with both the US dollar and Euro was monitored and
controlled (Central Bank of Russia, 2016).
As recently as December 2014, Russia experienced a currency crisis. The official exchange
rate of the USD against the RUB was set at the level of 32.6587 RUB per 1 USD as of
01/01/2014. However, the Ruble depreciated substantially to 56.2584 RUB per 1 USD by the
end of the year, a 72.26% increase (Database of the Central Bank of Russia, 2016). Since the
transition from a managed to a floating exchange rate regime, the Ruble has experienced
extremely erratic exchange rates (See Figure 1) which, should this unstable behaviour
continue, could result in the Russian Government resorting back to a managed floating
regime. The volatility of the Ruble exchange rate can be explained by three primary factors:
oil prices, economic sanctions and capital flight.
Russia is one of the major global suppliers of oil with a share of roughly 13% of the world
market. Russia’s exports of goods and services, with 80% of the total value being represented
by raw materials (namely oil and natural gas), accounts for roughly 30% of its GDP (Mironov
and Petronevich, 2015). Oil prices have experienced a sharp depreciation since 2014 (See
Figure 2) due to the moderate expansion of demand in main industrial countries and lower
growth perspectives in emerging markets. With Russia’s economic performance being so
heavily reliant upon its export industry, the depreciation of oil prices has significantly
affected the countries income and therefore can be seen to have a strong negative correlation
with the Ruble exchange rate (Mironov and Petronevich, 2015). From August 2015- April
2016, oil prices decreased by 32% due to expanding supply from members of the
Organization of the Petroleum Exporting Countries (OPEC) attempting to gain market share
and risk-off behaviour in financial markets (IMF, 2014). Forecasts of future oil prices remain
uncertain. With unclear aims of many OPEC members in regards to capping oil production
and intense unrest in the middle-east, oil prices could be impacted both positively and
negatively (IMF, 2014). These unsettled predictions will no doubt lead to extreme precaution
being made by potential investors of Russia’s oil producing organisations which could hinder
its capital flows and therefore negatively impact the demand for Rubles. Nevertheless, the
reverse effect could arise should low oil prices remain sustained in which case a price
recovery may occur in the long term in response to high-cost producers seizing production.

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Figure 1
Source: Bloomberg
Figure 2
Source: Bloomberg
The annexation of Crimea in July 2014 was condemned by many western economies;
resulting in numerous economic sanctions being enacted upon the Russian Federation.
Examples include the restriction of access to Western Financial markets and services for
designated Russian state-owned financial institutions, energy and defence companies,
restraining the ability of these Russian enterprises to obtain funds from Western markets
(Rodionov, Pshenichnikov and Zherebov, 2015). The restriction of opportunities in attracting
foreign capital, including loan refinancing, has heavily affected the financial condition and
investment strategies of many Russian entities. It has also meant that the Russian budget has
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
0.04
11/21/2011 11/21/2012 11/21/2013 11/21/2014 11/21/2015
Exchangerate
Date
Ruble ExchangeRate 21/11/2011 - 21/11/2015
RUB/USD RUB/EUR
0
20
40
60
80
100
120
140
11/21/2011 11/21/2012 11/21/2013 11/21/2014 11/21/2015
DollarsperBarrel
Date
Brent Crude Oil Spot$/barrel21/11/2011 -
21/11/2016

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been heavily burdened (See Figure 3) due to the need to support these state-owned
institutions as they are unable to obtain capital elsewhere. Not only has this resulted in a
negative impact upon Russia’s economic growth, it has also produced large capital outflows
from Russia. The large capital outflows mean that demand for the Ruble against foreign
currency has fallen, producing a weaker value of the Ruble. With the somewhat erratic
behaviour of Russia in terms of foreign policy and its continued involvement in the conflict
in Syria, economic sanctions against Russia are likely to be imposed regularly in the future
which will again cause uncertainty as to the ability of Russian businesses to obtain
investment funding and the projections of capital outflow from the economy which can
seriously influence the Rubles value.
Figure 3
Source: Bloomberg
Russia has experienced large-scale capital outflows (See Figure 4) as a result of the inability
of refinancing debt for private sector organisations, culminating in growth of foreign debt
repayment as well as the increase of dollar deposits by Russian citizens in response to the
weakening of the Ruble. This, in-turn, has led to a further depreciation of the Ruble as
demand for the currency has depreciated. Additionally, the financial sanctions imposed on
Russia post-Crimea have prevented western companies from investing within the country.
This, combined with the inability of state-owned institutions to refinance debt, has led to
large overall negative capital flows. Capital flight in Russia has also been a spill over effect
from the fall in oil prices. With profit margins within the oil industry in Russia falling as a
consequence of the deflation in oil prices, foreign companies have been discouraged from
keeping invested capital within the country’s industry. However, despite these impacts,
capital outflows have eased within the first half of 2016, and have reduced to $9.6 billion for
the period January 2016- September 2016, five times less than the same date in 2015 (See
Table 1). Reasons for this have been attributed to either the belief that investors no longer
wish to abandon Russia in an attempt to strengthen its economy or that simply all major
investments have already left the economy in the preceding years.
-4
-3.5
-3
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
12/1/2011
3/1/2012
6/1/2012
9/1/2012
12/1/2012
3/1/2013
6/1/2013
9/1/2013
12/1/2013
3/1/2014
6/1/2014
9/1/2014
12/1/2014
3/1/2015
6/1/2015
9/1/2015
12/1/2015
3/1/2016
6/1/2016
RussiaBudgetasPercentageofGDP
Date
Russia Budget Balance (% of GDP) 01/11/2011 -
01/06/2016

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Figure 4
Source: Bloomberg
Overall, the value of the Ruble has been and still is, strikingly inconsistent. With future
predictions of the exchange rate of the Ruble remaining highly uncertain it is recommendable
that organisations exposed to the future value of the currency to have appropriate FX hedging
strategies, such as spot contracts or dealing in the FX forward market, to help eliminate the
risk of fluctuations in the value of the Ruble negatively affecting the business.
Sovereign Debt Risk
Russia has been awarded a long-term sovereign credit rating of BB+ by Standard & Poor’s
Sovereign ratings agency (Trading economics, 2016). A BB+ grade signifies that there are
still major current uncertainties and exposure to adverse business, financial, or economic
conditions which could lead to Russia having inadequate capacity to meet its financial
commitments (Standard and Poor’s, 2016). The most recent long-term credit ratings of other
major credit rating agencies (See Table 2) such as Fitch and Moody’s, also place Russia on
the borderline between the investment and speculative grade. A rating of BBB- from Fitch is
an indication that the agency has a low current expectation of default risk with adequate
Table 1
Time
Period
Net Capital
Flow Net
inflows (-)/
outflows
(+) Billions
of USD
Jan-Sep
2015
48.1
Jan-Sep
2016
9.6
Source: The Central Bank of Russia
34.433.6
4.6 7.6 8.1
27.9
5.1
10.5
16.8
47.5
21.5
7.2
75.8
32.9
18.6
-3.4
9.4 8
-0.9
2.6
-10
0
10
20
30
40
50
60
70
80
12/1/2011
3/1/2012
6/1/2012
9/1/2012
12/1/2012
3/1/2013
6/1/2013
9/1/2013
12/1/2013
3/1/2014
6/1/2014
9/1/2014
12/1/2014
3/1/2015
6/1/2015
9/1/2015
12/1/2015
3/1/2016
6/1/2016
9/1/2016
BILLIONSOFUSD
DATE
Russia Net Private Sector Capital Flow
(Net inflows (-)/outflows (+))

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payment capacity which is subject to influence from changing economic and business
conditions (Fitch, 2014). The rating of Ba1 from Moody’s simply symbolises substantial
credit risk (Moody’s, 2016). These ratings most likely correspond with the vulnerability that
Russia has with its dependence on the oil market and its price as a source of income for the
economy. With uncertain predictions of future oil prices comes uncertainty of the amount of
income the Russian economy can generate. It can, therefore, be deemed that Russia is not
creditworthy and any lending or investments made through the purchase of Russia
Government bonds are exposed to possible defaults depending on the future performance of
the oil market. The lack of consistency in the Credit ratings awarded and outlook (See Table
2) by these agencies further emphasises the uncertainty of both the current and future
sovereign risk of Russia.
Oil, although the main determinant of Russia’s ability to generate income to meet its debt
payment requirements, is not the only factor that could impact how creditworthy Russia is in
the future. Extensions of economic sanctions imposed on Russia could also negatively impact
its credit ratings. With the inability of selected state organisations to conduct operations
within foreign markets in an attempt to obtain foreign investment and refinancing, the
Russian government is forced to provide this funding themselves. With this being the case, an
extension of existing sanctions could result in further increases in the Russian budget deficit
which will limit the country’s ability to meet its debt obligations and increase the possibility
of defaults occurring on Russian government bonds.
Table 2
Fitch S&P Moody’s
Credit
Rating
BBB- BB+ Ba1
Outlook Stable Stable Negative
Source: Trading Economics
Figure 5
Source: Bloomberg
0
100
200
300
400
500
600
700
11/21/2011 11/21/2012 11/21/2013 11/21/2014 11/21/2015
5-yrCDSSpreadUSD
Date
Russia 5 Year CDS Spread 21/11/2011 -
21/11/2016

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The uncertainty of Russia’s ability to meet its debt obligations, both in the past and present, is
also reflected in the trading of Russian sovereign credit default swaps (CDS). In the wake of
the announcement of economic sanctions and the oil price crisis, Russian 5-year CDS spreads
escalated (See Figure 5) indicating that predictions of future credit defaults increased and as a
result the perceived credit risk of Russian Federation bonds had also increased. Since then, 5-
year CDS spreads have fallen and stabilised slightly (See Figure 5). Still, however, figures
have not reached the levels seen pre-currency crisis which would suggest investors are,
although optimistic, still precautious of the future of Russia’s economic performance.
Recent unstable perceptions of Russia’s sovereign risk is further exhibited in the price and
yield of 10 year Government bonds issued by the federation. Slumps in the price and
increases in the yields of the bonds during 2013 and 2014 (See Figure 6 and Figure 7)
reflecting the fall in demand for Russian Government bonds and again echoing the impact
that the plunge in oil prices and economic sanctions had upon the perceived sovereign risk of
Russia.
This analysis of the sovereign risk of Russia suggests that the country’s ability to meet its
debt obligations is profoundly dependent upon the behaviour of oil markets and prices. Being
a key contributor to the country’s GDP, Russia is highly exposed to the performance of oil
prices and therefore any investments into the country, such as the purchase of Russian
Government bonds, should take thorough consideration of the impact that potential deviations
in the price will have on the risk and value of the investment. The risk of potential
investments are also subject to any externalities that economic sanctions possess upon the
income of the country and hence should also be taken into consideration.
In conclusion, the past, current and future economic performance of Russia, and therefore the
foreign exchange and sovereign risk of the country, can be seen to be heavily dependent on
Figure 6
Source: Bloomberg
60
65
70
75
80
85
90
95
100
105
110
2/1/2012 2/1/2013 2/1/2014 2/1/2015 2/1/2016
Yield
Date
Russia 10 Years Bond Auction AverageAccepted
Price 01/11/2012 - 26/10/2016

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oil prices. With this being a major contributor to the country’s GDP, the fluctuation of prices
in the past and uncertainty of prices in the future has, and is likely to have, significant
impacts on the value of the Ruble and perceptions of the country’s sovereign risk.
Additionally, other factors such as economic sanctions and capital flight have been seen to
also have consequences upon the foreign exchange and sovereign risk of Russia. This being
said, it is highly recommendable that organisations that have future transactions denominated
in RUB to have appropriate FX hedging strategies in place, helping eliminate the risk of
fluctuations in the value of the Ruble negatively affecting the business. It is also advisable
that organisations wishing to invest within Russia appropriately analyse forecasts of future oil
prices and other impacts on the Russian economy’s income to examine the potential
influences these might have on the sovereign risk of Russia.
Bibliography
Figure 7
Source: Bloomberg
2
2.5
3
3.5
4
4.5
5
5.5
6
3/30/2012 3/30/2013 3/30/2014 3/30/2015 3/30/2016
Yield
Date
Russia GovernmentBonds 10 Year Generic Bid
Yield 30/03/2012- 18/11/2016

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Russia. The Kremlin. (2002). RUSSIAN FEDERATION FEDERAL LAW On the Central Bank
of the Russian Federation (Bank of Russia). Retrieved from: https://www.cbr.ru/Eng/today/
Central Bank of Russia. (2016). The bank of Russia FX policy. Retrieved from:
http://www.cbr.ru/eng/dkp/?PrtId=e-r_policy
Dreger, C., Kholodilin, K. A., Ulbricht, D., & Fidrmuc, J. (2016). Between the hammer and
the anvil: The impact of economic sanctions and oil prices on Russia’s ruble. Journal of
Comparative Economics, 44(2), 295-308.
Mironov, V. V., & Petronevich, A. V. (2015). Discovering the signs of Dutch disease in
Russia. Resources Policy, 46, 97-112.
Rodionov, D. G., Pshenichnikov, V. V., & Zherebov, E. D. (2015). Currency Crisis in Russia
on the Spun of 2014 and 2015: Causes and Consequences. Procedia-Social and Behavioral
Sciences, 207, 850-857.
Database of the Central Bank of Russia (2016). Foreign currency market. Retrieved from:
https://www.cbr.ru/eng/currency_base/daily.aspx?date_req=01.01.2014
IMF. (2014) World economic outlook: April 2014, recovery strengthens, remains uneven.
United States: International Monetary Fund (IMF).
Trading economics. (2016) Russia Credit Rating. Retrieved from:
http://www.tradingeconomics.com/russia/rating
Standard and Poor’s. (2016) S&P Global Ratings Definitions. Retrieved from:
http://www.spratings.com/en_US/understanding-ratings#secondPage
Fitch Ratings. (2014). Definitions of Ratings and other Forms of Opinion. Retrieved from:
https://www.fitchratings.com/definitions
Moody’s. (2016). Rating Symbols and Definitions. Retrieved from:
https://www.moodys.com/Pages/amr002002.aspx