Monday, June 27, 2016

Russian Markets Not Immune to Brexit’s Political Risk...

Russian politics is celebrating this week the prospect of weaker European foreign policy, with many Russian financial experts weighing on the likely impact on Russia. Alexei Kudrin, former Finance Minister, believes that Russia will not be affected by a Brexit: “We can be sorry about the British leaving the EU. But there will be no catastrophe, even though financial markets will go through a brief period of instability”. 

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Russian Economic Development Minister Alexei Ulyukayev declared on Thursday: “I believe that the markets have already taken under consideration the possible volatility and all the risks are taken into account. So I do not see any more risks”.

This view was also supported by some Western analysts. Michael McFaul, former US ambassador in Moscow Tweeted Friday: “Shocked by Brexit vote! Losers: EU, UK, US those that believe in utility of a strong democratic Europe. Winners: Putin.’

While any immediate economic impact on Russia might be muted, there is a real risk that the medium term political impact could have severe consequence for the outlook of the Russian market.

This risk begins with the process of Brexit decoupling. Though it is understood that a British exit will take at least two years, what no one can factor in is just how orderly this process will be. As reported in the Financial Times, Stephen Weatherill, professor of law at Oxford University said: ‘Leaving the EU is a daunting challenge with no clear precedent. Brexit would unwind economic relations of ‘incomparable complexity and depth’.

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Add to this the uncertainty, and potential ‘domino effect’ effect the Brexit could cause within the European Union, and there will only be further volatility.

Unpopular immigration policies across Europe has seen a growing rise in anti-establishment parties. A June poll reported by the BBC and released by the Pew Research Centre, found that only 51% of respondents across 10 European states still favoured the EU. France and Greece had unfavourable responses of 61% and 71% respectively.  In the unlikely event that a large integrated economy like France left the EU, a multi-year downward pressure on commodity prices would be the least of the market’s concerns.

It is this risk that is not accurately being factored in. As reported by Richard Barley from the WSJ: "Markets got Brexit dead wrong.’ ‘If you thought markets were uncertain and volatile before the U.K referendum on membership in the European Union, think again".

The view that a Brexit leave vote was a black swan event, has clearly either not been following, or purposefully ignoring recent European political debate. Britain’s clear message that immigration not the economy is the population’s chief concern means a potentially greater risk is not being factored. An article in May from the New York Times shows the significant growth of the ‘anti-establishment right’ across Europe.

Now in the face of Brexit shock, French far right leader Marine Le Pen, of ‘National Front’, has called for a referendum on France’s EU membership and the party’s platform of protectionism, anti-euro sentiment, and closed border policy is a common theme across Europe’s far right.

Isolationist policies are not conducive to a healthy, growing European economy and with Europe being not only Russia’s largest trading partner but also making up 75% of its Foreign Direct Investment (European Commission – Russian Trade), this will not be good for the Russian economy either.

While Russia’s economy has improved in line with oil’s rise this year, oil prices remain fundamentally lower and long term structural change within the sector brought about by the advent of shale oil and natural gas, as well as a slow-down in Chinese demand, means that downward pressure will remain.

Depressed oil and commodity prices will continue to put pressure on Russia’s already strained finances and ultimately any celebrated political gains from Brexit could be overshadowed by weakened demand created by growing political instability within Russia’s largest trading partner. 

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