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Russia Rouble, Stocks Rebound on Hope of Conflict End

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.

Russia shares surged into positive territory, led by a rally in state companies such as Gazprom and Sberbank which had been heavily sold at the start of open hostilities last week.

"Investors always take news about the start of any military conflict negatively but the markets are probably hoping for a fast resolution of the conflict. We can see that from the recovery today," Aivaras Abromavicius, fund manager at East Capital.

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.

U.S. 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.

The RTS share index ended up 1.18 percent at 1,742.96 points, while the rouble-denominated MICEX was ended up 3.87 percent.

The rouble ended the day at 29.88 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.

Finance Minister Alexei Kudrin sought to reassure investors, promising the conflict would not hurt the macroeconomic outlook or require additional military funding.

"We are not afraid of any fluctuations," Kudrin told a news conference.

Dresdner Kleinwort analysts agreed, saying Russia's "overwhelming military advantage" would ensure a quick return to the negotiating table.

"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 gold and forex reserves, is much better positioned to weather the foreign investors' flight than tiny Georgia, which does not have substantial natural resources.

Risks to Rouble

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 U.S. 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.

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.

Under Pressure

Russia's stock market, once a top performer in the emerging world, is now down about 25 percent since Jan 1.

Analysts from EPFR 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 -- stabilized at 116-117 basis points, a trader said.

Russia's Eurobonds remained largely unchanged due to Russia's strong fiscal position.

Russia's portion of the benchmark EMBI+ index narrowed to 174.