DOI:10.21686/tmsfm/6.2018

Russia Dropped the US Treasury Securities

PLEKHANOV RUSSIAN

UNIVERSITY OF ECONOMICS

2018 Working paper №6

TRENDS OF THE MONETARY SYSTEM AND FINANCIAL MARKETS

Content:

The Bank of Russia Has Given a Gift to Speculators

2

The Market Assesses the Risk of Russian Bankruptcy Poorly

3

Russian Banking Leaders Are Losing Investment Appeal

4

The Loss of the Bank of Russia Is Not a Cause for Concern

5

In Search of Refuge in the Cryptocurrency Market

6

The Growth Rates of Lending to the Population Surpassed the Business

7

The deterioration of political relations between Russia and the United States - reflected in the new wave of US sanctions, taking place from the beginning of April - has led to serious de-cisions in the field of financial management by the leadership of the Russia's international re-serves.

Figure 1 represents the dy-namics of Russian investments in US Treasures. Before April 2018, investments in these as-sets showed insignificant fluctu-ations of about $100bln. How-ever, more than $80bln has been withdrawn from these assets just within 2 months since March this year.

As a whole, amid the grow-ing international reserves of the country, this indicates a sharp change in the management posi-tion towards other instruments of the financial market such as bonds of other countries or funds on accounts in foreign banks.

Apart from the “political” reasons of such drastic changes in the Russian position, an eco-nomic one can be added: market prices for US bonds are declin-ing due to the continuation of the upward cycle of the US Fed-eral Reserve interest rate. It does not make any sense to keep falling securities in the portfolio until the end of the upward cy-cle of the interest rate by the US regulator.

This is contrary to the posi-tion in relation to US assets as

Fig.1 Russian international reserves, bln USD

Fig.2 Annual growth rate of investment in US Treas-uries, %

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Russia Saudi Arabia

observed in Saudi Arabia. As a matter of fact, this country is making up for the shortfall in Russian investments in US Treasuries. In early 2012, Russian invest-ments amounted to $145.7bln, while in Saudi Arabia they were equal to $75.0bln. As at April of the current year, Russia had $48.7bln, whereas Saudi Arabia increased its investments up to $159.9bln. Yet the total amount invested during the

period under review indicates modest fluc-tuations in recent years. In other words, the Russian-sold portfolio of American securi-ties is being transferred to the Saudis.

In just two Spring months, Russia dropped from 15th to 22nd place in the world in terms of investments in US Treas-uries.

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Russianinvestments inUS Treasuries(left scale)

Russianinternationalreserves (rightscale)

Page 2 Trends of the Monetary System and Financial Markets

Nowadays in the world economy virtually none of the countries suffers from high infla-tion. Hyperinflation has been observed only in Venezuela and Southern Sudan. Over the past year, consumer prices have grown on average ninety-fold in the Latin American country and 2.1 times in the African country. A similar situation is in the countries torn apart by civil wars or interethnic conflicts such as Sudan, Syria, Congo and CAR, where prices are growing at a fairly high rate between 30% and 50% per annum.

According to the statistical data provided by the Bank for International Settlements (BIS) on a monthly basis, only 7 countries out of the monitored 55 have experienced infla-tion above 4%. Among those are Argentina (29.5%), Turkey (15.9%), Romania (5.4%), Mexico (4.7%). Other countries have an aver-age annual inflation of 1.8%.

The current period in the world economy is marked by unprecedentedly low inflation, which indirectly affects the monetary policy of most countries. The level of nominal inter-est rates is at the lowest levels for the entire period under review.

Countries where Central Banks target in-flation are mostly in favor of soft monetary policy. There the interest rates established by their monetary regulator are lower in compari-son with inflation. The lowest real interest rates with values below -1.5% have been ob-served in Switzerland (-1.9%), Norway (-2.1%), Sweden (-2.6), Romania (-2.9%). Moderately low negative real interest rates are in the Eurozone, Denmark, Philippines, Japan, Canada and USA.

A positive level of real interest rates is no-ticeable in all BRICS countries. Strict mone-tary policies should help to contain credit bub-bles among the BRICS countries. Monetary policy has reached the highest degree of rigid-ity in Russia, where the real interest rate is 4.8% (Fig. 3). This situation looks anomalous on the background of universal slow down of global inflation. The average real interest rate in the world economy does not exceed 0.5%, which leads to the neutrality of monetary policy.

The increase in geopolitical risks expressed in the weakening of the Russian Rouble in

The Bank of Russia Has Given a Gift to Speculators

April this year forced the Bank of Russia to announce a pause in the cycle of a phased reduction of the key interest rate.

Thus, among the variety of factors determining the decisions of the Bank of Russia, geopolitics has come to the forefront. This shows not only the weakness of the Russian economy and the vulnerability of its finan-cial market to external threats, but also the dependence of the domestic regulator in making decisions on both speculative movements of the Russian currency and prices for Russian financial assets.

In view of the mentioned above, the independence of the Bank of Russia from public authorities in arriv-ing at the decisions on monetary policy should not be replaced by its dependence on speculative capital flows. The fear of strengthening the sanctions regime against Russia weakened the Russian currency against the weighted average level by almost 15%. But this does not need to be the reason for adding automatical-ly a speculative premium to market players.

The Bank of Russia frequently prefers caution when is necessary to take into account the easing of inflation, and, conversely, the rigidity in case of aggra-vation of political risks.

The actions of the regulator suggest that the macro-economic data is secondary to it. Therefore, it is im-possible to assume stability in the Russian financial market. Thus, serious fluctuations in prices for Rus-sian securities and the exchange rate of Rouble are ex-pected to continue in the event of toughening the geo-political situation and vice versa; in case of sanctions weakening, the markets will react still further: specula-tors will rush for profit prepared for them by the regu-lator in advance.

Fig.3 Real interest rates, y/y %

Working paper №6

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Russia

Brazil

South Africa

China

India

Page 3 Working paper №6

The assessment of the credit risk for sover-eign debt is best explored by the current quotes for the values of credit default swaps (CDS). This is a real market instrument for trading the credit risk of the issuer's failure to fulfill their obligations within a certain period of time. The CDS market is hard to blame for political en-gagement, because its participants really risk their own money. That is why it more accurate-ly reflects the current assessment of credit risks than the opinion of rating agencies owing to their considerable inertia in time.

The most liquid CDSs are 5-year contracts. Current quotes of CDSs worldwide show a slight probability of defaults on government bonds.

Macroeconomic indicators of the overall lev-el of debt burden lose out significantly to politi-cal factors in the assessment of credit risk. Countries with unstable political regimes, even with a low level of public debt relative to GDP, are estimated by the market much lower than countries with stable political systems. Table.1 represents quotes of 5-year CDSs for Ukraine, Bahrain, Egypt and Turkey, which are signifi-cantly higher than the corresponding quotes for Hungary, Poland, the UK, although the level of debt burden for these groups of countries is comparable.

CDSs quotes for Russia are below South Af-rica, Brazil and Turkey but higher than Mexico, Colombia and Indonesia. This means that the market estimates adequately Russia's political risks and thus defaults on its state debt obliga-tions.

The aggravation of the geopolitical tensions in April affected the quotations of sovereign CDSs of Russia insignificantly. During April, they increased from 122.7 to 131.1 points. That month on April 9, the quotes reached a peak of 151 points.

After the emergence of the threat of new sanctions for purchasing a new Russian govern-ment debt, CDS quotes in August reached 165 points.

As of today, the market probability of the de-fault in Russia on sovereign debt is about 12%. To compare, during the fall of 2008 it rose to 60%.

The Market Weakly Estimates the Risk of Bankruptcy of Russia

Trends of the Monetary System and Financial Markets

Country

5-year CDS, as at

18.08.2018

Estimated probability of default

Sovereign debt / GDP

2017

Argentina 558.85 40.4% 57.1%

Turkey 511.92 35.4% 28.3%

Ukraine 502.93 33.5% 79% (2015)

Bahrain 355.61 25.6% 90.6%

Egypt 344.92 23.5% 101.2%

Italy 260.68 18.9% 131.8%

Brazil 237.29 15.7% 74.0%

South Africa 223.18 14.5% 53.1%

Russia 164.94 11.9% 12.6%

Indonesia 123.96 9.3% 28.7%

Mexico 118.64 8.9% 47.9%

Colombia 110.79 8.5% 48.5%

Hungary 92.13 7.3% 73.6%

Qatar 92.11 7.1% 54.4%

S. Arabia 89.70 7.0% 13.1%

United Arab Emirates

89.17 7.2% 20.7%

Romania 88.19 6.9% 35.0%

Peru 80.34 6.4% 25.5%

Israel 67.93 5.0% 61.9%

China 62.07 5.2% 47.6%

Chile 51.66 4.4% 23.6%

Poland 50.90 4.3% 50.6%

Slovakia 45.59 4.2% 50.9%

Czech Re-public

35.71 3.7% 34,6%

France 26.97 2.5% 97.0%

Japan 26.78 2.5% 253.0%

United King-dom

25.77 2,1% 85.3%

USA 17.97 1.7% 105.4%

Germany 11.61 1.2% 64.1%

Table 1

Indicators of credit risk of individual countries

Trends of the Monetary System and Financial Markets Page 4

Russian Banking Leaders Are Losing Investment Appeal

Recent developments in the banking sec-tor were expected to lead to a significant consolidation of assets between the two leading Russian banks: Sberbank and VTB. Together, these two banks have accumulat-ed 57.8% of deposits belonging to individu-als (Fig.4) and 44.5% of organizations' funds (Fig.5).

The peak of the cross-flow of funds from minor to leading banks of the Russian mar-ket took place in 2016. Since then, the share of deposits placed in minor banking institu-tions consists of about 43-45% of individual deposits and around 55% of funds belonging to organizations.

This means that the funds of the banks’ clients whose licenses are revoked are not transferred to the first two banks but go to the others. This fact indicates that the mar-ket leadership of Sberbank and VTB will not be particularly suitable for them.

The combination of mass revocation of licenses, substantial innovations in banking services and expectations of conducting shareholder-friendly dividend policy on the part of Sberbank has provoked the “rally” of this issuer in the share market (Fig.6). Thus, during the second half of 2017, the quotes of its common shares increased by 52%; and since the beginning of 2018, it has added 22% more.

But the fundamental indicators of Sber-bank are not adequate to such investors’ op-timism. In our view, the growth potential of this share is clearly limited. This is likely to form a negative trend towards eliminating the imbalance between the market and fun-damental assessment of the leader in the banking sector.

The market “successes” of Sberbank's shares look particularly excessive in the light of the weak market valuation of VTB Bank. This is confirmed by a 22% drop in the market quotes of the latter in the second half of 2017, and since the beginning of 2018, the dynamics of VTB shares have been close to neutral.

Given the above-mentioned, investments in the leaders of the Russian banking sector, made in anticipation of their market share growth, will not bring positive results.

Fig.4 Segmentation of banks by the share of deposits belonging to individuals

Fig.5 Segmentation of banks by the share of funds belonging to organizations

Working paper №6

Fig.6 Quotations of shares of Sberbank and VTB on the Moscow stock exchange, share prices in Rub

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Page 5 Working paper №6

The Bank of Russia has published its an-nual report for 2017, following which the regulator recorded a loss of 435.3 billion Roubles. Its value could have amounted to 367.6 billion Roubles if it had not been forced to transfer to the federal budget 67.8 billion Roubles of income received by the Bank of Russia from participation in the cap-ital of Sberbank, a leading Russian bank.

The negative financial result of the past year is almost comparable with the profit of the Bank of Russia, which it earned over 4 years from 2013 to 2016.

However, the size of profit or loss of the Bank of Russia is not a key indicator charac-terizing its financial stability. What is signif-icantly more important is the dynamics of the funds constituting its capital (Fig.7). It is known that the bulk of the regulator’s assets falls on foreign investments. Therefore, the Fund of accumulated exchange differences is a real “safety cushion” which currently ex-ceeds 6 trillion Russian Roubles.

Thanks to the weakening of the Rouble since 2014, the value of capital belonging to the Bank of Russia has become comparable with the aggregate capital of all commercial banks in the Russian Federation (Fig.8). In other words, in case of extreme necessity, the Bank of Russia can “buy out” all Russian commercial banks by using funds accumulat-ed through investing in foreign currencies and precious metals”.

In 2017, the regulator acquired a share in the capital of several large banks. As a re-sult, provisions increased to 385.6 billion Roubles, and their dynamics ceased to corre-spond to the dynamics of the net interest in-come received by the Bank of Russia (Fig.9).

The Loss of the Bank of Russia Is Not a Cause for Concern

Fig.7 Dynamics of components making up the capital of the Bank of Russia, trn Roubles

Trends of the Monetary System and Financial Markets

Fig.9 Provisions and net interest income of the Bank of Russia, bln Rub

Fig.8 The total capital of commercial banks and the Bank of Russia, bln Rub

0

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Page 6

The collapse of the Bitcoin exchange rate, which occurred in the first quarter of the current year, forced market participants to seek refuge for their virtual capitals dis-tributed among a wide range of instruments.

One of the effective options for invest-ment protection proved the Tether (USDT) crypto asset, whose value is equated to the US dollar.

The issue of Tether is tied to the amount of funds deposited by its Issuer in Bank ac-counts in Fiat money - issued by Central banks.

Players on cryptocurrency exchanges can go out of Bitcoin and other crypto-currencies in Tether and “sit out” the wave of falling quotations of other crypto-currencies, because its value does not change to the US dollar. After the end of the sales, speculators resume buying crypto-currencies for Tethers in the hope of making a profit on the growth of the value of crypto-

In Search of Refuge in the Cryptocurrency Market

currencies in relation to Fiat money. Despite a number of scandals that have

erupted in recent months - the theft of 30 million Tether as a result of a hacker attack; the breach of the agreement with the auditor; the blocking of the account in the US Bank Wells Fargo - the issuing company is afloat, and the value of Tether is close to $1.

Tether turned out to be a convenient bridge between the crypto-currency market freely traded on crypto-exchanges and Fiat money of investors of this market.

Gradually, the crypto-currency market - where Tether takes second place - made leaders in capitalization and turnover of trades stand out (Table 2). As soon as the is-sues with the reliability and auditing of cryp-tocurrency issuers that are inked linked to the funds of Fiat money available to them are finally resolved, it is highly likely that an-other surge of interest in crypto-currencies will again spur their cost.

Trends of the Monetary System and Financial Markets Working paper №6

Cryptocurrency Ticer Volume in

August 2018, bln. USD

Market Capitalization, bln. USD

Mining possibility

Bitcoin BTC 133,4 109,6 Yes

Tether USDT 81,9 2,7 No

Etherium ETH 11,1 29,3 Yes

EOS EOS 4,4 4,5 No

Stellar XLM 2,6 4,2 No

Bitcoin Cash BCH 2,4 9,4 Yes

Etherium Classic ETC 2,0 1,3 Yes

Ripple XRP 1,9 12,6 No

Litecoin LTC 1,6 3,3 Yes

Qtum QTUM 1,1 0,4 No

Table 2

Indicators of exchange trading in some cryptocurrencies

Page 7

The Growth Rates of Lending to the Population Surpassed the Business

Working paper №6 Trends of the Monetary System and Financial Markets

In the current year, the growth of

consumer lending has accelerated

and exceeded the growth of the same

indicator in the corporate sector. As

of 1 May 2018, the annual increase in

accumulated credit debt of citizens

amounted to 16.6%, and of organiza-

tions and entrepreneurs to 8.2%

(Fig. 10).

This trend fits into the logic of the

beginning of a new phase of growth

in lending activity in the Russian

economy. But when comparing the

indicators of lending to the population

with the corporate sector in some re-

gions, conclusions are drawn about

their considerable unevenness. More

specifically, in 2009 the accumulated

debts of citizens surpassed the accu-

mulated debts of organizations and

entrepreneurs only in 7 regions of the

country; in 2013, the number of such

regions increased to 19. Finally, in

2018, they grew up to 39. (Table 3).

In the economically prosperous

regions, the accumulated debt of the

corporate sector is much higher than

the debt of the population. Converse-

ly, in the depressed regions, the abso-

lute value of debts collected by citi-

zens are 3-5 times higher than the

debts of corporate borrowers to

banks. Among them are the Jewish

Autonomous Region, the Republics of

Tyva, Kalmykia, Komi, North Ossetia

and Khakassia.

Fig.10 Annual increase in credit debt to the Russian banking system as of 1 May of the relevant year, %

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Физические лица

Организации и индивидуальные предприниматели

Individuals

Organizations

Indicators 2009 2013 2018

The number of regions where the debt of indi-viduals to banks ex-ceeds the debt of or-ganizations and individ-ual entrepreneurs

7 19 39

Ratio (debt of organizations and individual entrepreneurs / debt belonging to individuals):

- In Russia in the whole 3,44 2,44 2,4

- in the region with the minimum value of the indicator

0,17 0,25 0,16

Nenets Au-tonomous

Okrug

Republic of Tyva

Jewish Autono-mous Oblast

- in the region with the maximum value of the indicator

9,44 7,64 8,58

Moscow Moscow Moscow

Table 3

Dynamics of some aggregated indicators of accumulated credit debt to banks

Address: 36,Stremyanny lane,

Moscow 117997, Russia

Tel: +7(499) 237-84-87 E-mail: nio_reu@mail.ru

Scientific Supervisor:

DE Sergey Valentey

Responsible Editor:

Irina Guseva

The Authors:

Denis Domaschenko

Irina Guseva

https://www.rea.ru/en/Pages/analytical-expertise.aspx

Statistic Data:

The Bank of Russia, Thomson Reuters.

www.rea.ru

Trends of the Monetary System and Financial Markets

Scientific and Research Union of PRUE

Working paper №6

E-resource: DOI:10.21686/tmsfm/6.2018