Amid international pressure, Russia’s economy is a mix of the good, the bad and the ugly

  • Russia's economy is projected to grow by less than 2 percent this year, but has rebounded from a deep 2015-2016 contraction
  • Investors say resurgent oil prices are bolstering the economy despite Moscow being squeezed by sanctions
  • All said, parking money in Russia is definitely "risky," analysts tell CNBC.
Russian President Vladimir Putin speaks during a meeting with supporters at his campaign headquarters in Moscow, Russia March 18, 2018.
Yuri Kadobnov | POOL | Reuters
Russian President Vladimir Putin speaks during a meeting with supporters at his campaign headquarters in Moscow, Russia March 18, 2018.

Beset by tough sanctions and worldwide political isolation, a casual observer might be surprised to learn that Russia's economy isn't doing all that badly – even if it still has a litany of problems.

In fact, some investors are fairly bullish on the country, where the outlook is bolstered by surging oil prices. However, there are red flags everywhere, including a new round of sanctions against Russian companies and oligarchs aimed at pressuring President Vladimir Putin.

For the moment, 2018 will mark another year of recovery for the Russian economy after a steep recession triggered by oil's swoon during 2014. Russia's growth is expected to reach 1.7 percent this year, according to a World Bank forecast, largely in line with growth last year but well above the near 3 percent contraction the country saw from 2015-2016.

Russia "maintained strong growth underpinned by solid productivity, with a sustainable growth trend estimated at 2-2.5 percent," noted Denise Simon, head of emerging market debt at Lazard Asset Management.

However, the rebound obscures what Simon explained is "one of the few countries in the world with negative population growth, which reduces their overall growth potential." The population shrinkage — by some measures at around 0.4 percent — dampens productivity, making growth above 2 percent difficult to sustain.

Historically, Russia's market is volatile, and the geopolitical risks have heightened that effect. Meanwhile, Moscow is notorious for presiding over an opaque, corrupt and oligarch-dominated economy that gets low marks from freedom watchers.

That said, Russia's ability to weather geopolitical pressure and fluctuating oil prices has been sufficient enough for some market observers to tout investment opportunities in the country.

Investing in Russia is definitely "risky" amid the macroeconomic and geopolitical challenges, said Bin Shi, senior vice president and portfolio manager at Acadian Asset Management, with more than $73 billion in assets under management.

Yet Shi noted that the MSCI Russia, an equity index linked to the performance of the country's market, returned 54 percent in 2016 while the S&P 500 Index returned 12 percent during the same time. That came despite a grueling recession in Russia that began in 2015.

Riot police detain a man during an anti-corruption protest organised by opposition leader Alexei Navalny, on Tverskaya Street in central Moscow, Russia June 12, 2017.
Maxim Shemetov | Reuters
Riot police detain a man during an anti-corruption protest organised by opposition leader Alexei Navalny, on Tverskaya Street in central Moscow, Russia June 12, 2017.

'Acutely aware' of political risks

However, Russia's market has seen some rough days in the wake of new sanctions, tumbling 11 percent on April 6 alone. Meanwhile, international restrictions have banned equity investments in the companies hit by sanctions, and prohibits financial transactions — and even more sanctions could be in the offing.

"The damage to risky assets in Russia is likely to remain in the near term," Shi told CNBC. "Therefore, investors should be cautious despite a number of attractive valuations in the market."

Global investors unaffected by sanctions and seeking a contrarian play could gravitate to Russia. "If structural reforms takes place in the future, Russia could attract long-term investors. But this is unlikely in the near term," Shi said.

Yet not all investors are fleeing the growing risks, which include soaring debt yields and a falling ruble that plummeted 8 percent in one day last month. While the Russian market is not for the faint-hearted, the country's high-yielding assets do attract investors who know the landscape.

"Anybody present in the Russian market, however, is acutely aware of the geopolitical risks and adjusts their portfolio with respect to it," noted Ondrej Schneider, chief economist for Russia at the Institute of International Finance.

"Investors, who had been exposed to these shifts before have not fled the domestic Russian market so far," he said, adding that capital inflows turned positive again after a brief reversal in the wake of sanctions.

Currently, according to Paul McNamara, investment director and lead manager of emerging market bonds at GAM Investments, being a "minority shareholder, an outsider to companies or a small debtholder in the corporate paper is more risky than almost anywhere else."

On the other hand, McNamara pointed to Russia's current account surplus and "vanishingly little net public debt. The country has one of the most robust balance sheets in emerging markets."

Given that the Russian economy is in somewhat of a decent cyclical recovery after two years of private credit tightening and public spending restraint, energy prices are still of importance to both public and private sectors.

"The main economic risk we see is therefore a sharp drop in global energy prices," McNamara said, but oil prices are on the upswing and supported above $65 per barrel.

"Sanctions come a distant second – the impact of the recent sanctions was very hard on certain corporates, but it's difficult to see why they should have significant macroeconomic impact," he added.