“Too risky to deal” is the today’s mantra repeated religiously on the Lombard Street, especially when you ask a Street dealer anything Russia related. To be honest, liquidity is dry on a lot of financial instruments this morning. How did it come to this and what can we expect going forward? Find out in this brief article.
When you came into the office today, you probably noticed that the world looks a bit different than it was earlier, so let’s take it step by step. First of all, we’re entering a fifth consecutive day of full-blown Russian aggression on Ukraine and so far the most visible distress sign is 400k Ukrainian refugees in neighboring countries. So far, Russian army failed in occupying any larger Ukrainian city such as Harkiv or Mariupol, apart from the ones it already had under control (like Donetsk). Russian advances were made on sparsely populated Ukrainian areas but were met with stiff resistance once the more populated areas were reached. During the weekend global financial community was glued to Twitter and Linkedin wallpapers with news about escalating sanctions and countermeasures introduced by a series of Western countries.
So far the most important countermeasures targeting the Russian economy were focused on the Bank of Russia (BoR, i.e. the central bank) and the Russian commercial banks. Let’s go through the details. BoR has about 630bn USD in FX reserves and Credit Suisse analyst Zoltan Pozsar estimates that about 450bn USD are in non-gold financial assets. A more detailed report from BoR’s Foreign Exchange and Gold Asset Management report tells us that about 20% of Russia’s non-gold FX reserves were in USD assets and let’s be clear, these are not US treasury bills. Russia sold off all of its TB holdings back in 2018, so currently, all the USD assets they have are basically FX swaps. These are likely targeted by western sanctions and could be frozen for the time being. On top of that, Pozsar estimates both BoR and Russian private sector (i.e. commercial banks) have deposits in other banks in size of 50bn USD each – these funds are also currently frozen and could not be used. Adding all of this together yields about 200bn USD that are put out of force, which is the bedrock of Mr. Pozsar’s expectation that FED would have to intervene in one way or the other to provide liquidity. Also, pay attention that these are only USD FX reserves and there is a lot more in EUR deposits that would be frozen in a subsequent, but a different set of sanctions introduced by the European Commission.
Norwegian sovereign wealth fund is divesting Russian assets, BP is retreating from Rosneft and just last night news came through the wires that BoR asked Russian market makers not to quote bids on Russian international bonds in order to prevent more cash drain from the central bank. From our understanding, the central bank has been intervening all the way in order to curb FX volatility, albeit the recent 30% plunge in EURRUB might have been a free fall with no intervention from BoR – could be the central bank is saving the last of the ammunition for when it really needs it. At the same time, BoR raised the reference rate to 20% (from 9.5%) in order to make life harder for the short sellers and we’ll just have to see how much effect that really has.
Why is all of this important for us, CEE/SEE fixed income investors? Well, we have listed this chain of events just to see how dire the Russian economic situation really is and that Russian policymakers want the peace agreement really badly. This is what’s going on behind the warmongering rhetoric and it’s no wonder both sides are prepared to enter negotiations on the Ukrainian-Belarussian border, albeit with very low expectations.
Where does that leave us with Croatian international bonds? Currently, the liquidity is really tight and we don’t see any buyers or sellers at all, obviously because the situation can develop either way. The yield rise/spread widening has been the most pronounced on CROATI 3.875 05/30/2022€, but on the other hand, the paper has a rather short duration and a could of pips in lower price make up a huge difference. We don’t believe you could actually buy a couple of millions of these at 1.84% YTM, meaning that the screen might be a bit misleading. On the other hand, it’s possible to buy plenty of CROATI 3 03/11/2025€ very close to 1.00% and this is exactly where most of the buying flow is concentrated. We have seen some bottom fishing on CROATI 1.5 06/17/2031€ and CROATI 1.125 03/04/2033€, but the sizes were really shy. On Friday afternoon, one false dawn caused a really strong buying spree on Romanian Eurobonds up to 10Y duration and at some point in time, the Street dealers were flat. However, it’s quite clear that in order for that to continue, we need a couple of more good news from the border between Belarus and Ukraine. Fingers crossed that this good news does get to us.
Today, ECB rated Sberbank Europe AG in Austria and its two subsidiaries in Croatia and Slovenia likely to default. Sberbank Europe AG is a subsidiary group of Sberbank of Russia, which has full ownership of the Group.
The valuation of the Group was passed after deposit outflow which is a direct result of geopolitical tension due to the Russian invasion of Ukraine. We should note that each deposit (up to EUR 100k) is protected with the national insurer of deposit – the Croatian Deposit insurance agency for Croatia. The outflow of deposits worsened the liquidity position of the Group, and ECB states there is no realistic expectations to improve Group’s and its subsidiary’s financial position.
Due to the mentioned outflow, Single Resolution Board, as central resolution authority within the Banking Union, decided on the moratorium for Sberbank which will last for two days. Meanwhile, citizens and companies are free to dispose daily deposits up to c. EUR 1k. Croatian National Bank also highlighted that more than 90% of all depositors are protected with deposit insurance.
We also highlight that Russia’s central bank raised its key interest rate to 20% (from 9.5%) to compensate for the increased depreciation and inflation risk after the country was hit by powerful new Western sanctions over the weekend. Early Monday, the Russian ruble plunged around 33% to 120.64 rubles to the euro from around 90.8 from the beginning of last week.
On Friday, the Croatian Bureau of Statistics published its first estimate for the GDP in 2021, showing that in real terms, it increased by 10.4% YoY. At the same time, in Q4 2021, the GDP increased by 9.7%.
According to the 1st estimates of the Croatian Bureau of Statistics, GDP in real terms increased by 10.4% YoY. When looking at Q4 2021 data, seasonally adjusted data showed a slight decrease of -0.1% QoQ. Compared to Q4 2020, seasonally adjusted growth was 9.9% QoQ. This would also mean that in Q4 2021, Croatian GDP surpassed the decline experienced in 2020 due to the COVID-19 pandemic.
Final consumption, the main contributor to GDP, increased by 9.3% in Q4 2021, as the economic recovery experienced during the year continued, on the back of relatively relaxed pandemic measures (as compared to the EU). It should also be noted that Croatian fundamentals look even better compared to before the pandemic, due to the increasing wages, strong saving rates, strong tourist season (over 70% of 2019 levels in Q3), and strong inflow of investments largely in part thanks to the EU funds. This is even more prominent when we look at the main contributors to the final consumption expenditure; Households, the largest contributor to final consumption (71.8% of total) grew by 7.7% Q4 2021 vs. Q4 2020. At the same time, General Government, which takes the remaining 28.2%, had an increase of 14% in the same time period. Gross fixed capital formation increased by 0.8% YoY. It is expected that this will continue growing in 2022 as more funds are used from the EU (e.g. Next Generation EU instrument).
At the same time, Export of goods and services increased markedly, with a growth of 31.7% YoY. Breaking this down further, the export of goods increased by 24.7% YoY, while the export of services increased by 49.1% YoY. This can be attributed to the strong recovery of the tourism industry, as well as improving economic conditions in Croatia’s main trading partners. Import of goods and services also increased, growing by 16.4% YoY. Breaking this down even further, import of goods increased by 15%, while import of services grew by 23.8% YoY. In total, exports outweigh the imports in Q4 by HRK 8.7bn, leading to positive net exports.
If we were to look at the yearly levels, in total, the GDP increased by 10.4%, and in current prices, amounted to HRK 431.45bn (EUR 57bn). The aforementioned increase in GDP is the largest in the country’s history (so far, 1997 was the best year with a 6.1% GDP growth).
The recovery and growth experienced in 2021 should continue, as the current pandemic measures are relaxed, the next tourist season is coming (which is projected to be similar to or better than 2019), strong saving rates and solid personal consumption numbers continue supporting further growth.
Croatian GDP, Real Growth Rates (%, YoY)*
*Quarterly Gross Domestic Product, seasonally adjusted real growth rates