With commodity prices dropping sharply over the past 15-18 months, many economies have been hit hard. Oil-rich Saudi Arabia issued its first government bonds since 2007 earlier this year as it looked to cover a widening budget deficit caused by the collapse in oil prices, while commodity-dependent Brazil and Russia have entered outright recession this year.
It is the latter of these countries that is the focus of this article, and in particular Russia’s steelmakers. How have they coped with the significant falls in domestic GDP this year, of some 3.5-4%, as well as a sharply weakened currency and a large jump in inflation and interest rates?
The chart above shows the drastic changes seen in the value of the Russian rouble over the past couple of years. Whereas 1 US dollar used to be equivalent to around 32 roubles, that same dollar now (as of writing) buys some 64 roubles. This in turn has made imports into Russia more expensive and inflation has shot up. Interest rates have duly risen in order to try and tame inflation. And, although rates have since been pared downwards following the initial panic, the cost of debt remains higher than it was.
Russia’s steelmakers appear to be coping just fine, however. Although recently-released results for the third quarter continue to show lower revenues, on the back of falling steel prices, nominal profits (and hence margins) are up.
So what explains such good performance at a time when Russia’s domestic economy is shrinking?
In short, Russia’s steelmakers are benefitting from having a large part of their costs in roubles, and a large part of their revenues in dollars.
It makes sense of course that a weakened currency should be beneficial for Russia’s steel producers. On the whole they do not rely on imports for their raw material needs, with large producers such as MMK, NLMK, and Severstal all vertically integrated to varying degrees in iron ore, coke, scrap etc. Thus costs have not increased sharply. In fact, their costs have fallen sharply, as illustrated in recent investor presentations (see page 10).
Meanwhile, as imports of finished steel have become more expensive, Russia’s steelmakers have become more competitive in the domestic market and have been able to grab some of the market share previously taken by imports.
On the flipside of imports into Russia being more expensive as a result of a weakened currency, exports out of Russia have also become much cheaper. Russia’s steelmakers have therefore been able to increase their exports even at a time when global steel demand has been stagnating. In the year-to-August (the latest month for which data is available), Russian exports of steel products increased by some 8% year-on-year, while imports are down by around 40%.
Of course, there are dangers. Most notable among these is the fact that the majority of the debt held by the country’s steelmakers is denominated in US dollars. The burden of this debt has therefore increased with the sharp weakening of the rouble. Some steelmakers will be more affected than others, with Evraz and Mechel being particularly leveraged while Severstal and other companies are less exposed.
And there is the danger that the rouble continues to weaken, further undermining domestic demand and driving debt costs even higher. For now, however, it appears as though Russia is trying to manage a weakened rouble in order to enjoy the boost to competitiveness that this has brought.
The country’s minister of economic development, Alexei Ulyukayev, has spoken of the exchange rate having a fundamental range of US$1:RUB50-60, while interest rates were cut quickly earlier this year and purchases of foreign currency by the central bank have also increased, both helping to keep downward pressure on the rouble. Certainly there is no strong desire on behalf of the Russian government to see the rouble strengthen back toward previous levels in the short term. And, having clearly benefitted so far, most of Russia’s steelmakers will generally be happy for the rouble to remain around current levels. Struggling steelmakers elsewhere, from Europe to the Middle East and India, will not.
This article was also published for Metal Bulletin Research in November 2015