The Russian rouble and share indexes rebounded on Monday from a severe drop earlier in the day, boosted by President Dmitry Medvedev's statement the military conflict with Georgia might be nearing its end. The benchmark RTS stock index turned positive, reversing losses of more than 5 percent sustained in morning trading. State companies, including Sberbank and Gazprom, led the reversal.
"After Medvedev said the operation was finished, the market turned around and went up. But there is a lot of uncertainty ahead," a trader at a major Russian bank said. On Monday morning, the rouble fell 1.6 percent and the MICEX share index hit its lowest level since September 2006. Investor sentiment deteriorated following Russia's renewed bombing campaign in Georgia including areas outside the main conflict zone - Georgia's separatist region of South Ossetia.
US President George Bush denounced Moscow's "disproportionate response" to the South Ossetian crisis. But Medvedev said the operation was nearing its end while the Russian General Staff said that staying within the borders of South Ossetia was a "key principle". Medvedev also suggested sending international observers to the conflict zone.
The recovery seemed to underline the view of some analysts that Russian economic fundamentals remain solid and that any weakness is unlikely to last much longer than the conflict.
RTS stood at 1,728 points, up 0.34 percent at 1215 GMT while rouble-denominated MICEX was up 1.6 percent. The rouble was trading at 29.90 versus the central bank-monitored basket of 0.45 euros and 0.55 dollars, still weaker than Friday's close around 29.60, but off a session low of 30.10. The central bank intervened to support the currency.
"Given Russia's overwhelming military advantage, we would expect any potential combat to be short-lived, with the two sides back at the negotiation table in a matter of days or weeks," Dresdner Kleinwort analysts said in a research note. "Such a scenario would imply only limited impact on Russia's fiscal outlook, suggesting that any potential rouble and spread weakness in the short term could provide an attractive entry point," they added.
Russia, the world's second largest oil exporter running $600 billion in reserves, is much better positioned to weather the foreign investors' flight than tiny Georgia, which does not have substantial natural resources. Rating agencies downgraded Georgia after the start of the conflict and the spread on Georgia's debut sovereign bond due 2013, launched in April, widened by nearly 200 bps from launch levels, to 650 bps over US Treasuries.
Most analysts agreed that new risks for Russia's $1.6 trillion economy could arise from Western support for the Georgian government, as Russia and the United States resorted to Cold War rhetoric over the conflict.
"The Russian government obviously found regional dominance more important than keeping up global investors' already shaken attitude towards Russia. For the rouble, this is a disaster," said Ulrich Leuchtmann from Commerzbank. Most foreign investment into Russia comes from the West. The European Union is also Russia's largest trading partner. Russia's balance of payment has become more sensitive to capital flows after imports caught up with rising oil revenues.
"A protracted military conflict or a resurgence in equity market concerns could sustain the negative tone and cause the rouble to remain weaker than the strong end of the band," said Rory MacFarquhar from Goldman Sachs. Russia's stock market, once a top performer in the emerging world, is now down about 25 percent since January 1.
Analysts said Russia saw its sixth straight week of outflows as the combined effect of the Georgia conflict, a shareholder war between BP and its local partners, and an unexpected attack by Prime Minister Vladimir Putin on blue chip miner Mechel sustained an equity selloff. Russian 5-year sovereign credit default swaps - instruments bondholders use to insure themselves against possible default by an issuer - widened slightly to 119 basis points, compared with the previous 117 close.
Russia's Eurobonds remained largely unchanged due to Russia's strong fiscal position. Russia's portion of the benchmark EMBI+ index widened one basis point to 180. "As long as we do not move closer to any resolution of this, as long as Russian forces continue to raid or bomb inside of Georgia, I think the pressure on Russian markets will continue," said Lars Christensen, head of emerging markets research at Danske Bank in Copenhagen.
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