Capital flight reversal ‘not due to Putin return’

The news this week that the economy recorded an inflow of capital in June for the first time in 11 months could not have come at a better time for Russia’s leadership, which is struggling to beat back negative perceptions of the country’s investment attractiveness. The data, released by the Central Bank on Wednesday, fit snugly with the widespread idea that the biggest driver behind outflows of around $120 billion since the start of 2011 was political risk. Nervousness ahead of the elections, coupled with increasing social unrest, caused wealthy Russians and foreign investors to pull funds out of Russia and stash them in safe havens abroad, the theory goes. And now that President Vladimir Putin is safely back in the Kremlin, money is flowing back in, accounting for the $5 billion surplus in June. But analysts say that while the political risk factor should not be overlooked, other factors are playing a much bigger role, presenting a much less rosy picture for the economy. One of the biggest drivers of the $80.4 billion that left the country in 2011, according to economists, was foreign banks, which borrowed heavily from their Russian subsidiaries to fund debt in their home countries in the struggling euro zone. “European banks borrowing from their Russian daughter companies was certainly a big problem in the third quarter,” Andrew Keeley, a banking analyst at Troika Dialog investment bank, told . “I know that UniCredit alone took out a few billion dollars.” Hedge fund Prosperity Capital Management told Business News Europe last month that it estimated around $40 billion of last year’s capital outflows, nearly half, to have come from foreign banks borrowing money from their Russian subsidiaries. The problem got so bad, that the Central Bank called a meeting last year with the heads of foreign banks to warn them that they faced restrictions if they did not stop pulling money out of Russia. Largely due to an easing of the European debt crisis in the opening months of this year, the financial sector contributed little to Russian capital outflows in the first quarter, which totaled $34 billion. Most of the “flight” came instead from oil companies keeping excess revenues from high oil prices in dollars to avoid making losses by transferring it to a strong ruble, Keeley said. “It makes sense to keep surplus revenues in foreign exchange reserves as a hedge for when the oil price comes down again,” he added. This resulted in a reversal of the process when the oil price and ruble dropped in the second quarter, although outflows from the corporate sector and from the general population remained high, around $20 billion, analysts said. The Central Bank’s first deputy chairman, Alexei Ulyukayev, said Wednesday that a major driver for the reversal in capital flight in June was banks reducing investments in net foreign assets, Vedomosti reported. The paper added that Russian banks recorded capital inflows of $11.6 billion in April-June, compared to an outflow of $9.7 billion in January-March. Increased political stability may have also had an effect, said Anna Bogdyukevich, an economist at Aton investment bank, but if it did, it is unlikely to be sustainable. “[The easing of political uncertainty] may only have a short-lived impact on Russia’s investment attractiveness, unless the government adheres to its announced reform schedule,” Bogdyukevich said. She dismisses parallels with 2008, another election year, when $24.3 billion left the country in the first quarter, but $40 billion flowed in in the three months after the election. “Few of the factors in place in 2008, such as an appreciating economy and high oil prices, are in place today,” Bogdyukevich said. “The ‘election factor’ alone is unlikely to reverse the direction of capital flow.” The Economic Development Ministry forecasts net capital outflow of $10 billion to $20 billion for the whole of 2012, which means Russia will need inflows of at least $23 billion in the second half. Analysts say that the forecast global economic slowdown makes it unlikely that capital will begin flowing back into Russia at this rate. Alfa-Bank analysts say they are maintaining their forecast for a full-year outflow at $70 billion. Uralsib analysts are even more pessimistic, saying levels may even exceed those recorded in 2011, adding, however, that outflows will decrease toward the end of the year. “Even though we expect capital flight to decrease toward the end of the year, we now think that total capital outflows in 2012 may exceed the 2011 figure of $80.4 billion,” Uralsib analysts said in a note to investors Wednesday. “[Central Bank] data show that despite stable revenue from commodity exports, Russia suffers from massive capital outflows, due to a lack of long-term investment opportunities and high economic risks.”