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8/13/2019 Investing in Emerging Markets_en_1135050[1]
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CIO WM Research 9 December 2013
Investing in emerging marketsUkraine: Little direct exposure toEM assets
The Ukrainian government's decision to suspend the EU-UkraineAssociation Agreement has led to an escalation of political tensions
in the country, leading to a potentially protracted stalemate
situation. The near-term outlook for the Ukraine is thus clouded
by uncertainty, given an already weak domestic economy, a fragile
external position, presidential elections next year, and ongoing
political protests.
The developments in the Ukraine are of broader geo-politicalsignificance for the region, but the direct overall asset class exposure
for Emerging Markets (EM) is not material. The largest exposure of
EM assets overall is via Ukraine sovereign bonds which make up 3%
of the JP Morgan EMBI Global Diversified Index. These are of a highly
speculative nature and may therefore contribute to relatively higher
volatility for EM sovereign bonds than for EM corporate bonds on an
index level, given only a 1.2% Ukraine exposure to the JP Morgan
CEMBI Broad Diversified Index. Ukrainian bonds are not covered by
CIO Research.
On the EM equities side, there is no impact from any direct exposure.The Ukraine is not part of the MSCI Emerging Markets index, the
leading EM equity index. The most important potential indirect
impact on EM equities is via Russian equities, which make up 5.8%
of the MSCI EM. While Gazproms sales may be affected, we regard
the impact as manageable and maintain Russia as one of our
most preferred EM equity markets, given its solid external position
in a tapering environment, particularly versus our least preferred
markets in the EMEA region, South Africa and Turkey.
The indirect impact of the Ukraine on EM assets overall is viaRussian corporate bonds and equities of companies with exposure
to the Ukraine. The level of disclosure varies widely from company
to company. VTB, Gazprombank, Sberbank and VEB which are
quasi-sovereign Russian banks along with Gazprom have recently
attracted particular attention in relation to their Ukrainian exposure.
We see their overall exposure as manageable. Should headline noise
around the Ukraine persist, we would not rule out seeing a certain
exacerbation in volatility in Russian corporate bonds.
Kilian Reber, analyst, UBS [email protected]
Tatiana Boroditskaya, analyst, UBS [email protected]
Serhan Gok, analyst, UBS [email protected]
Rudolf Leemann, analyst, UBS [email protected]
Related reports:
Emerging Markets Bond List, published on a bi-weekly basis
Fig. 1: The Ukraine faces a dire economicoutlookReal GDP growth (yoy%) and current accountbalance (% of GDP), including IMF projections
-20
-15
-10
-5
0
5
10
15
2000 2002 2004 2006 2008 2010 2012 2014E 2016E 2018E
Real GDP growth (yoy%) Current account balance (% of GDP)
Source: IMF, UBS, 6 December 2013
Fig. 2: Markets pricing in rising risks for theUkraineSpreads over US Treasuries, in basis points
0
500
1'000
1'500
2'000
2'500
3'000
3'500
2006 2007 2008 2009 2010 2011 2012
EM sovereigns Ukraine sovereign
Source: Bloomberg, UBS, 6 December 2013
This report has been prepared by UBS AG. Please see important disclaimers and disclosures that begin on page 5. Past performance is no indication of future performance. The
market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication.
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The Ukrainian government's last minute decision to suspend the EU-
Ukraine Association Agreement has led to an escalation of political ten-
sions in the country, leading to a potentially protracted stalemate situation.
Uncertainty is high and the Ukraines outlook is clouded by a weak domesticeconomy, a fragile external position, presidential elections next year, and
ongoing political protests. Rating agencies have been downgrading the
Ukraine sovereign over recent weeks, with the ratings currently standing at
Caa1 (Moodys) and B- (S&P and Fitch), all with negative rating outlooks.
The rating agencies point out that key drivers for the downgrades have
been the Ukraine's increasingly fragile external financing position, based on
rapidly falling foreign exchange reserves, as well as heightened constraints
on the sovereign's ability to borrow in foreign currency, and broad-based
political uncertainty. Ukraine bonds are not covered by CIO Research.
The developments in the Ukraine are of broader geo-political significance
for the region, but the direct exposure for EM assets overall is not material.Below, we first give our conclusions for EM assets as a whole, and then go
into the details for EM corporate bond issuers.
Overall impact on EM bonds is limited
The largest direct impact is on EM sovereign bonds, of which the Ukraine
makes up 3% in the JP Morgan EMBI Global Diversified sovereign bond
index, whereas it makes up 1.2% in the JP Morgan CEMBI Broad Diver-
sified corporate bond index. Given the highly speculative nature of Ukraine
sovereign bonds, the situation in Ukraine should keep EM sovereign bonds
slightly more volatile - other things being equal - than EM corporate bonds.
While CIO WM Research does not cover Ukrainian sovereign bonds, a
long-term sovereign default study from Moody's ('Sovereign Default and
Recovery Rates, 1983-2010', published by Moody's on 10 May 2011)
shows that, on average, the Caa-C rating bucket has exhibited a cumulative
default rate of 23.6% over a period of 1 year for sovereign issuers. The
Ukraine situation therefore leads to a slightly higher tail-risk in EM sovereign
bonds compared to EM corporate bonds.
Overall impact on EM equities is small
On the EM equities side, there is little potential impact from any direct
exposure. The Ukraine is not part of the MSCI Emerging Markets index. It is
part of the MSCI Frontier Markets, but only makes up 1.13% of the whole
index, according to Bloomberg data. The most important potential indirect
impact on EM equities is via Russian equities, which make up 5.8% of the
MSCI EM, of which Gazprom (1.25% of the MSCI EM) which has material
exposure to the Ukraine, makes up 22%.
While the index heavy weight Gazprom may be negatively impacted from
a natural gas price discount offer to Ukraine, we expect the impact to be
manageable (see our comments on Gazprom further below). This does not
change our most preferred status for Russia as an EM equity market. We
reiterate that our preference is based on (i) the resilience of the Russian
economy and the rouble to Fed tapering, particularly relative to its more
vulnerable EM peers South Africa and Turkey, (ii) the attractive valuation of
Russian equities on a PE and PB basis relative to the MSCI EM, and (iii) the
high dividend yield of the Russian equity market.
Table 1: Little direct Ukraine exposure for EMassetsUkraine exposure in major EM benchmarks
Asset class benchmark Ukraine share (%)
EMBI Global Div ersifie d 3%
C EM BI B ro ad D iv er si fi ed 1 .2 %
GBI-EM 0%
MSCI EM 0%
MSCI Frontier 0.13%
FXELMI+ 0%
Bonds
Eq.
Source: JP Morgan, MSCI, Bloomberg, UBS, 6 December 2013
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Issuer views: Russian corporate bonds
Below we look at Russian companies under our coverage and consider theirexisting exposure to Ukraine.
Oil and gas
Within the Russian oil and gas sector, Gazprom's exposure to Ukraine
is the most visible. Gazprom's exposure to the Ukraine comes primarily
from two sources: natural gas transit to Europe and direct natural gas
sales to the Ukraine. In 2012 gas sales to the Ukraine contributed 7% to
Gazprom's total gas sales in terms of volume, which represents around
50% of Gazprom's gas exports to the Commonwealth of Independent
States (CIS). We remain comfortable with Gazprom as a credit, given its
strong operational profile, close links with the state and solid credit metrics.
Gazprom Neftopened its first retail fuelling station in Ukraine in 2012.
We see existing exposure to this segment as marginal.
Lukoilsold its refinery located in Ukraine in July 2013. Existing exposure to
Ukraine includes a petrochemical plant, where production was suspended
in 2012 due to a weak trading environment and was expected to resume
in 4Q13, and 5% of its retail fuelling stations. We view this exposure as
manageable.
Rosnefthas a refinery in Ukraine where production was suspended in 2012
due to a weak operating environment. The company also has a number of
retail fuelling stations, which provide a marginal contribution to its revenues
and EBITDA.
Banks
Recently Russian president Mr Putin stated that Gazprombank, Sberbank,
VEB and VTB have provided loans to the Ukraine totalling around USD
28bn. We note that Sberbank, VTB and VEB have subsidiary banks in the
Ukraine, while Gazprombank does not have one. Three Ukrainian sub-
sidiaries of these banks combined had assets of USD12.1 bn as of 2012 and
loans of USD 8.8 bn. The remaining USD 19bn are likely to be exposure to
Ukraine sovereign and corporates, with the latter to certain degree secured
by Gazprom's gas deliveries. We note that USD 28bn represents a mere
4.3% of the loan book of these four banks as of 1H13. These four banks
are directly or indirectly majority state owned and in our view represent the
backbone of the Russian banking sector, with the state support likely to beprovided in case of need.
VTB Bank is the second largest bank in Russia by total assets with the
Russian government holding a majority 60.93% stake in the bank. The
bank has a subsidiary bank and a leasing arm in Ukraine. In 2012 the
subsidiary bank was loss making and contributed 1.7% to VTB's total
assets. On a 9M13 conference call, held on 5 December 2013, VTB man-
agement stated that VTB has RUB20 bn (USD 607mn) of exposure to
Ukrainian sovereign debt, including loans and securities. The bank is com-
fortable with this exposure and does not plan to increase it. VTB also has a
certain exposure to Ukrainian corporates. According to management, the
Ukrainian subsidiary is currently profitable.
Sberbank is the largest bank in Russia by total assets and the Russian
central bank owns a majority stake of 50% plus 1 share in the bank. The
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bank has a subsidiary bank in Ukraine, which contributed 0.7% to the
bank's total assets and 0.4% to its net profit as of 2012.
VEB is 100% owned by the Russian government and is a developmentbank. The bank has a subsidiary bank in Ukraine, which was loss making
in 2012 and contributed 5% to VEB's total assets.
Gazprombank is the third largest bank in Russia by total assets, with
Gazprom holding 35.54% stake directly and another 47.38% stake
indirectly. The fully (100%) state owned VEB holds a 10.19% stake.
Gazprombank has no subsidiary bank in the Ukraine. A Reuters report
dated 3 December quotes Gazprombank board member Ms Ekaterina
Trofimova stating that the bank has credit exposure to Ukraine in the form
of contract-based secured lending. These in our view are likely to be mostly
loans secured by Gazprom's gas deliveries to Ukraine.
Telecoms
MTShas a subsidiary operating in Ukraine. As of 9M13 this subsidiary con-
tributed 10% to MTS revenues and 12% to its EBITDA. We note that in light
of higher uncertainty, the use of mobile services in Ukraine could potentially
increase in the immediate future.
Metals and mining
Evrazoperations in Ukraine include a steel mill and an iron ore facility and
steel coke facility. Ukrainian operations represented 4% of Evraz's EBITDA
as of 1H13 and 6% of crude steel production as of 9M13. In 2012 Ukrainian
operations were loss making on EBITDA level (EBITDA of negative USD
2mn).
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Appendix
If you require further information on the instruments or issuers mentioned in this publication, or you require general information
on UBS CIO WM Research including research policies and statistics regarding past recommendations, please contact either your
Client Advisor or the mailbox [email protected] your country of residence.
Disclosures (9 December 2013)Evraz 7, Gazprombank 3, 7, 8; Gazprom Neft 5, Lukoil 2, 3, 5, 6, 7, MTS 5, Rosneft 1, 3, Sberbank 2, 3, 5, 7, 8; VEB FINANCE
LIMITED 3, 4, VTB 3, 7,
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the prior month's end if this report is dated less than 10 working days after the most recent month's end).
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company/entity or one of its affiliates within the past 12 months.
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Appendix
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Appendix
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