Are rigid US sanctions able to seriously weaken Russian ruble?

According to a model developed by Citigroup Inc, the Russian ruble could plunge by as much as 15% and borrowing costs would spike to a three-year high if the U.S. goes ahead with proposals to impose sanctions on Russian government bonds.

According to the banks analysts, such extreme moves would come from a 'worst-case scenario' of sanctions that bar foreigners from holding domestic sovereign bonds (OFZs). They said that move to sanction only new issuance would weaken the ruble by about 5%.

"While no sanctions by the U.S. Congress seem likely for now due to the summer recess, risks that such restrictions will be implemented later on remain," Bloomberg cited Citi analysts' research note as saying. "The additional capital outflows generated by this event could ultimately weaken the ruble."

Sentiment toward Russian debt and the ruble has been dented in recent weeks by renewed calls in Washington for more hard-hitting sanctions to punish the Kremlin for interference in the 2016 presidential elections. The nuclear option of going after sovereign debt is still seen as an unlikely scenario after a Treasury report earlier this year highlighted that it would be damaging to foreign investors who own about 28% the market.

Yields on 10-year OFZs are up about 70 basis points since the U.S. implemented its last round of penalties against Russia in early April, imposing the harshest sanctions yet against a string of companies and individuals.

The ruble weakened for a third day on Wednesday, dropping 0.2% to 63.17 versus the dollar. Yields on 10-year OFZs climbed 3 basis points to 7.76%. Citi’s worst-case scenario puts them at 11.9% by the end of 2019, a level not seen since the 2015 oil-price crash.

The Citi analysts said their forecasts would be "somewhat moderated" if the government was able to find buyers, but that may be hard to achieve since foreigners own about $35 billion of local debt.

The impact of foreign participation in the OFZ market was in evidence last year when yields ground steadily lower as the share of non-residents climbed to a record high. The Citi model finds that a 1% increase in the share of non-resident participation in the OFZ market reduces yields by around 10 basis points.

"Should sanctions on the Russian sovereign be introduced, leading to a significantly lower or zero foreign participation in the domestic bond market, the effect on OFZ yields could be quite large," the analysts conclude.

In July, US senators Lindsey Graham and Bob Menendez said they are working on a draft law that would impose sanctions on Russian sovereign debt and energy and financial sectors.

The head of the department of stock markets and financial engineering of the Faculty of Finance and the Banking Business of RANEPA, Konstantin Korischenko said, speaking with Vestnik Kavkaza, that this forecast is exaggerated. "Approximately 2 trillion rubles, or $35 billion of the Russian national debt are held by non-residents. The acquisition of such a volume of currency will, of course, affect the ruble's exchange rate, but by only 1-2 rubles. Of course, if Russian participants are not get involved in this speculation. Although in this case, a 10-15% drop, that is, 6-9 rubles, is an unlikely scenario," he warned.

According to the expert, it will not affect the Russian economy as a whole. "The fact is that today the amount of excess liquidity hoarded by Russian banks is approximately 1.5 times higher than all assets of non-residents in the state debt. Therefore, as soon as non-residents go out, our banks will buy these securities at an attractive price," Konstantin Korishchenko said.

The professor at the department of the stock market and investments at the Higher School of Economics, Alexander Abramov, said that Citi's report is realistic, noting that about a third of the national debt is held by non-residents. "Accordingly, if they stop participating in acquiring new issues, the Finance Ministry will have to ease monetary policy. But it seems to me that it will not happen, because when such sanctions are imposed, the Ministry of Finance and the Central Bank can take measures to support the ruble exchange rate," the expert explained.

According to him, such sanctions will not have a big impact on the Russian economy. "In general, the Ministry of Finance has a sufficiently large program of domestic borrowing for this year. And if it happens, some opportunities for financing corporate bonds from the market will decrease. But I think that in this case they will find a way to compensate it," Alexander Abramov said.