Vladimir Putin's territorial ambitions are bumping up against financial markets.
As the Russian president plots his next move on Ukraine, investors are giving his inner circle pause for thought. Since Putin annexed Crimea in March in the teeth of international outrage, Russian stocks have become the most volatile since 2009. Swings in the ruble against the euro are now the most extreme on record while expectations for fluctuations in the currency against its emerging-market peers are at the highest in two years.
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That's making investors more reluctant to gamble on a country that is already close to a recession and dependent on natural resources to lead economic growth. While Putin is motivated more by the desire to assert his nation's power in the world, invading eastern Ukraine would have provoked harsher international sanctions and risked accelerating the flow of money out of Russia.
"We got to the point where the market speaks and politicians are forced to listen and adjust," Mansur Mammadov, a money manager at Kazimir Partners Ltd. in Moscow, which oversees $300 million in emerging-market equities, said by phone on May 29. "The volatility was like a tsunami and it would be just logical to assume that it made the politicians realize the cost of Russian expansion in Ukraine was too much for the slowing economy."
A gauge of price swings in Russian stocks jumped to a more than four-year high compared to shares of developing nations. Historical volatility for the benchmark Micex index in Moscow reached 29.7 percent on May 30, almost three times the level of the MSCI Emerging Markets Index and up from 12.7 percent at the end of February, based on three-month data compiled by Bloomberg.
Moves in the ruble also amplified after the U.S. and European Union imposed sanctions including travel bans and asset freezes on Putin allies in Russia and Ukraine. The currency's three-month historical volatility rose to 11.3 percent from 7 percent at the end of 2013, according to data compiled by Bloomberg. That compares with 4.4 percent for the euro as the gap between the two gauges reached 6.92 percentage points on May 30, the widest since Europe's common currency was introduced in 1999.
A gauge of expected swings in the currency against the dollar was at the highest since October 2012 on April 25 compared with developing-country currencies such as the Turkish lira and the Chinese yuan, according to three-month implied volatility data compiled by Bloomberg and JPMorgan Chase & Co.
The Micex gained 2.4 percent to 1,466.12 by 3:54 p.m. in Moscow as Ukraine made its first payment in months to OAO Gazprom and Russia's natural-gas export monopoly gave the former Soviet republic an extra week to pay in advance for this month's supplies. Ukraine may still avoid the move to prepayment and win a lower price by settling its debt for previous gas supplies by the new deadline of June 9, Gazprom Chief Executive Officer Alexey Miller said in e-mailed statements.
The increased volatility threatens to intensify the slide in the economy. Russia faces stagnation this year, Herman Gref, OAO Sberbank's chief executive officer and a former economy minister, said at the St. Petersburg International Economic Forum on May 22. The probability of a recession in the next 12 months is 50 percent, according to a survey of 15 economists by Bloomberg.
Gross domestic product grew 0.9 percent in the first quarter from the same period of 2013, the slowest pace in a year, the Federal State Statistics Service said May 15.
Fixed-capital investment slumped for a fourth month in April while inflation jumped to an 11-month high of 7.3 percent as the ruble's slide drove up the cost of imports. The country posted capital outflows of about $55 billion in the first four months of the year, approaching the $63 billion lost in all of 2013, according to comments by central bank Chairman Elvira Nabiullina on May 23.
With the economy reeling and the threat of further sanctions looming, Putin toned down the rhetoric in the immediate aftermath of billionaire Petro Poroshenko's victory in Ukraine's May 25 presidential election.
Russia said it respects the outcome and is ready to negotiate with the new leader. A pullback of troops from the Ukrainian border continued, with the U.S. reporting that the majority of forces had been withdrawn as of May 29.
"Putin very clearly got the signal that sanctions had sent," Vadim Bit-Avragim, who helps oversee about $4.1 billion at Kapital Asset Management LLC in Moscow, said by phone last week. "He realized that it's better not to aggravate the rest of the world and turn the country into a pariah and lead it to isolation. This won't benefit him at all."
With Putin softening his stance, the U.S. will refrain from escalating punitive measures, according to 66 percent of respondents in a survey of 32 economists, compared with 28 percent in April. The EU will hold off on sanctions according to 84 percent, it showed.
The reduced threat of tougher sanctions has helped Russian assets rebound to levels seen before Putin's incursion into Crimea. The Micex stock index had its best month since 2011, gaining 9.6 percent in May and leaving it 0.9 percent below its Feb. 28 level. The ruble advanced 2.2 percent against the dollar in the period after plunging 7.8 percent in the first four months of the year. It has advanced 2.8 percent since the end of February.
Russia's financial and energy resources have helped contain losses during the crisis. The country's $468 billion of international reserves are the fifth highest in the world. The country sought to strengthen its status as the world's largest energy exporter by signing a long-term gas-supply deal with China last month that will reduce its dependence on buyers in the EU.
In what Putin called an "epochal event" capping more than a decade of negotiations, state-run energy exporter Gazprom signed the agreement on May 21 to supply fuel to China for 30 years.
At the same time, Putin is more reliant on global markets than his Soviet predecessors ever were.
Russia has been turning to international debt markets since its default on domestic debt in 1998. Companies raised $42.5 billion through foreign-currency bond sales last year, according to data compiled by Bloomberg. The Ukraine conflict halted that borrowing. Not a single Russian company has sold foreign- currency bonds since March, leaving offerings this year at just $6.4 billion.
Currency traders and analysts are showing no confidence in the ruble's rebound. The currency will slump about 3.9 percent versus the dollar by September, according to strategists surveyed by Bloomberg. Among major currencies, only the Argentine peso is forecast to slide more during that time. Option contracts show traders see a 68 percent chance that by year-end the ruble will slide back to the record-low levels it reached in March.
"Eastern Ukraine became an expensive idea and it seems Russia doesn't want it anymore," Ilya Kravets, the New York- based director of investment research at Daniloff Capital LLC, said in a May 30 phone interview. "There would be serious sanctions if Russia were to annex more territories from Ukraine, and the market reaction to that would be even more severe."
--With assistance from Shin Pei and Nikolaj Gammeltoft in New York.
To contact the reporters on this story: Ksenia Galouchko in Moscow at kgalouchko1bloomberg.net; Halia Pavliva in New York at hpavlivabloomberg.net; Ye Xie in New York at yxie6bloomberg.net To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoftbloomberg.net; Wojciech Moskwa at wmoskwabloomberg.net Stephen Kirkland