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Why to Dump Russia ETFs Despite Higher Oil Prices

Just as Russia’s economy started to benefit from a rebound in oil prices, alarming bells began started ringing. The economy witnessed the sixth straight quarter of growth after two years of contraction in Q1 of 2018.

Prolonged oil price woes previously weighed on Russia equities as the country is an exporter of oil. However, an uptick in oil prices this year as evident from some 15% year-to-date gains in United States Oil (USO) has played its role in shoring up Russia’s GDP of late.

Still, there are some reasons to be worried about (read: Top ETF Events of 1H to Watch in 2H).

Diagnosing the Pain

In April, the United States imposed sanctions on Russian billionaires in connection to their influence on the 2016 elections. Moreover, the chemical attack in Syria has increased tensions pertaining to U.S.-Russia relations (read: Russia ETFs Hit by Sanctions and Syria Attack).

The Economic Development Ministry has cut its forecast for Russia's GDP growth in 2018 from 2.1% (guided in April) to 1.9%. The ministry also curtailed its projections for 2019 GDP growth from 2.2% to 1.4%. There will be an uptick in inflation. Inflation in Russia will likely be in the range of 2.9-3.1% in 2018, up from 2.8% expected earlier. The forecast for inflation in 2019 was upped from 4% to 4.3%, per the source.

Russia is due for an increase in value added tax (VAT) in 2019. This planned tax hike will push up inflation and eat into real wage growth. This in turn would put pressure on consumer spending. The adverse impact of a tax hike will likely be realized in the first half of 2019, per the government source. Real wage growth expectations for 2019 were reduced from 1.3% to 1%.

According to preliminary estimates, Russia has to shell out a minimum of eight trillion more rubles ($126,7 billion) over the next six years to reach economic targets set by President Putin in his May decrees. In order to haul in extra funds, the government has proposed to raise VAT from 18% to 20% from 2019. This tax hike should be able to gather at least an extra 600 billion rubles a year.

Plus, there is Fed policy tightening. Since the Fed is expected to hike rates faster than expected ahead due to an improving U.S. economy, the greenback is likely to gain strength. This has already dealt a blow to emerging market currencies. In light of this, the average annual exchange rate in 2018 will likely be 61 rubles per dollar against 58.6 rubles predicted in April.

Trade war tensions initiated by President Trump with the imposition of import tariffs on a host of goods from China, EU, Canada and Mexico are an added-on worry. The contagion of this move can cut short global growth in the days to come.

Investors should note that emerging markets witnessed the “worst start to a year since the 2013 taper tantrum.” The double whammy of Fed policy tightening and trade tensions “put equity gauges worth $8 trillion in a bear market” (read: 5 Broad EM ETFs That Lost the Least in Q2).

ETFs in Focus

Against this backdrop, investors may want to stay away from Russia investing at this moment. Two Russia ETFs, namely VanEck Vectors Russia ETF RSX and iShares MSCI Russia Capped ETF ERUS, have a Zacks Rank #4 (Sell). The funds gained in the range of 0.8% to 2.0% this year against 4.2% returns offered by the S&P 500 (as of Jul 17, 2018).

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US-OIL FUND LP (USO): ETF Research Reports
ISHARS-MS RUSSA (ERUS): ETF Research Reports
VANECK-RUSSIA (RSX): ETF Research Reports
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