viernes, 15 de agosto de 2014

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Smart Money

August 13, 2014 8:55 am

Sanctions must prompt a rethink on Russian investments

Escalation in tensions will eventually affect market valuations



Investors have already navigated a global financial crisis, experimental monetary policies and a frustratingly weak western recovery.

Now they face an additional challenge: how to deal with politically motivated sanctions on Russia that are both broadening (targeting whole sectors rather than individuals and particular firms), and morphing (from being imposed by the west on Russia to involving counter sanctions).

Few feel confident enough to predict an end to the sanctions escalation, notwithstanding the recent ascendancy of Ukrainian government forces in the eastern part of the country.

As such, Investors should consider how sanctions could affect their portfolios, in three relatively predictable ways, and another three that are more complex due to their uncertain tipping points.

First, companies operating in areas covered directly by sanctions experience sudden, and mostly unanticipated, “exogenousdisruptions to supply chains and customer demand. Production costs increase while sales fall. If many of these companies find it difficult to quickly reorient their activities, the resulting hit to profits can prove hard to reverse, leading to lower share prices and wider credit spreads and borrowing costs.

The damage is more significant for those investing in companies with less diversified business platforms, and is particularly harmful for western investors in Russian companies, with patchy market liquidity accentuating the losses.

Bank exposure to Russia


Second, national and global economic activities are negatively affected at a time when the underlying resilience of both Russia and the west is already stressed. While benefiting from relatively high energy prices, Russia has not progressed sufficiently in diversifying its economy.

For its part, western Europe is struggling to engineer a meaningful recovery after the deep recession occasioned by a debt crisis that almost demolished the eurozone.

Citizens in both regionsbe they consumers, producers or job seekers – will face additional headwinds on account of this new set of economic complications.

Third, the longer sanctions prevail, the greater the likelihood that the prior twoincomeeffects will contaminate a growing set of balance sheets. This is particularly relevant for European banks with relatively large exposures to Russian entities.

Fourth, a further escalation of geopolitical tensions could, at some stage, undermine investors’ faith in the effectiveness of the central bank policy support that has empowered them to buy on market dips, making previous market corrections both temporary and reversible.

Such investor resilience is also essential for maintaining the artificially high asset prices through which central bankers are seeking to stimulate western economies. Should it be shaken – and the exact tipping point is hard to predictmarkets and economies would suffer from the declining potency of monetary policy, both real and perceived.

Fifth, reputational and other strategic considerations can encourage portfolio repositioning among institutional and (especially) government investors that, at least initially, have little to do with underlying fundamentals. As an example, Norway’s sovereign wealth fund has already indicated that it is reviewing its holdings of Russian assets given the political climate.


Foreign reserves


Meanwhile, Moscow is reportedly considering altering the allocation of some of its foreign exchange reserves currently held in European and US government bonds, also reflecting political rather than commercial considerations. While again the tipping point is hard to predict, such shifts could induce other investors to be more defensive, amplifying the market impact.

Finally, the next steps in a never-ending sanction escalation would logically involve broader legal limits on investors’ ability to acquire and hold certain assets, as well as blacklisting particular clients of institutional asset managers.

As such, both investment and business decisions become subject to a new set of compliance reviews that, similar to the prior five considerations, would affect the sources and uses of investable funds. And if mishandled, they would expose market participants to financial fines and regulatory rebukes.

Up to now, investors have been rewarded by dismissing geopolitical tensions as concerns for politicians rather than markets and portfolios. But should the escalation of sanctions and counter-sanctions continue, it becomes only a matter of time until they are hit with demand and supply disruptions that could broadly and materially affect market valuations.


Mohamed El-Erian is chief economic adviser to Allianz, chair of President Barack Obama’s Global Development Council, and author of “When Markets Collide”



Copyright The Financial Times Limited 2014

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