By Katya Golubkova

MOSCOW, (Reuters) – Russian assets are under stress as investors fear the possibility of new EU sanctions targeting officials and banks or the energy sector if Moscow strikes Ukraine – a move Russia insists it has not planned.

Russian stocks market lost about 20% after hitting records in October. Rupee has dropped to more than 8 months lows and yields on Russia’s 10 year benchmark OFZ government bonds shot up to almost six-year highs in January.

Russian assets dropped again on Friday morning while the markets awaited the meeting between U.S. Secretary of State Antony Blinken in Geneva and Russian Foreign Ministry Sergei Lavrov.

Russian officials claim that the economic fundamentals in Russia are solid and the volatility of the rouble is only temporary, despite dangerous geopolitics.

What are the Russian finances like?

ROUBLE

After western sanctions following Russia’s annexe of Crimea, Ukraine in 2014 and to preserve gold and other foreign currency reserves, the central bank allowed the rouble to flotilla free-floating in 2014.

A 2017 fiscal rule was adopted to support the National Wealth Fund (NWF). Russia purchases foreign currency at high oil prices and then sells it when they fall below $44/barrel. This protects the Russian rouble against oil price swings.

Russia had FX sales in 2020. This helped to reduce rouble loss amid a slump in oil prices, the COVID-19 pandemic, and geopolitical threats.

Sberbank CIB reported that oil and gas prices have remained high. They believe geopolitical factors are the major factor in the rouble’s decline, not macro-indicators.

CURRENT ACCOUNT AND CAPITAL OUTFLOWS

ING reported that a historic high of $120.3 billion in Russian current account surplus, equivalent to 7% gross domestic product, was rouble-supportive. This is due to the rise of gas prices and high oil prices.

However, net capital outflows increased to $72 Billion last year. This is its highest level since 2014. It was also higher than $50.4 billion for 2020. “This keeps the local currency undervalued, making it continuously favourable for the trade balance,” ING added.

INFLATION

Although it is supportive of the budget revenue, inflation can be caused by a weaker currency. This week’s annual rate reached 8.62%, twice the target, and close to six-year highs.

Alfa Bank stated that “given the high volatility in Russian financial markets these days, the) possibility for the central bank raising the key rate by 100 basis point is increasing.” It forecasted the 8th consecutive hike to 9.5% in February.

RESERVES & BUDGET

Renaissance Capital stated that the Russian gold-and forex reserves were at an historical high of more than $630 billion. That’s enough to finance 25 months worth of Russian imports and Russia’s $490 trillion total external debt.

Russia had a surplus budget of almost $7 billion in the last fiscal year due to the low energy prices and weak ruble. The NWF’s liquid resources – the funds held by central banks – reached $113.5 Billion, which is 7.3% GDP.

In times of stress, this can be used as a budget tool.” Morgan Stanley (NYSE:) said.

RUSSIAN OFZ BONDS, JOINT MARKETS

Foreign investors bought OFZ Treasury bonds worth $22.8 billion at 214 billion Russian rubles in November and December. The foreign investor share fell by 1.1 percent to 19.5% year-end.

Under existing law, although the central bank cannot buy OFZs directly from the market, according to the finance ministry, Russian banks might step in and boost their domestic bond portfolios.

U.S.-based investors represent around three quarters of the foreign OFZ portfolios. That’s less than VTB, Russia’s second largest bank. It has almost 2 trillion roubles worth OFZs.

This week, high volatility caused the finance ministry’s cancellation of bond auctions. According to the finance ministry, Russia’s strong fiscal situation allows it borrow less. Russia’s average debt to GDP ratio is 20%, which is below the 60% for emerging markets.

Gazprombank noted that Russia’s stock market is nearly five times as cheap than those in emerging markets. Gazprombank indicated that the average dividend yield is 10%. This could offer attractive returns and solid returns.

The bank stated that “But, the level of uncertainty still remains high”.

($1 = 76.7020 roubles)