FSU Update - Scoping out the Macro and Sovereign Debt Scene

> FSU countries continue to recover from pandemic, but pace of recovery remains unequal. Some countries, such as Russia and Kazakhstan, have already reached pre-Covid output levels, supported by the availability of vaccines and higher commodity prices. However, it may take Armenia and Georgia longer to recover from last year's sharp declines. Meanwhile, Uzbekistan and Tajikistan managed to eke out positive GDP growth last year and should see a pickup this year. For Belarus, political uncertainty and the new EU sanctions dim the growth prospects. > Fiscal spending grew last year, some consolidation to start in 2022. In the face of the global pandemic, all governments across the FSU region increased their spending. Since there was also a drop in tax revenues, budget deficits widened significantly. Most countries have maintained an accommodative fiscal policy this year, and most of their budget plans envisage consolidation as soon as next year. Despite the increased deficits, we do not foresee any problems with financing.> Inflation has been running way above central banks' targets, triggering rate hikes. The central banks of Russia, Ukraine, Georgia, Armenia, Belarus and Kazakhstan have all hiked rates this year. While the magnitude of the hikes has varied, all of the countries have been seeing above-target inflation and rising inflation expectations. Taking into account that inflation has probably peaked and should start to slow soon, we think we are close to the peak of where rates will reach.> In the high-yield sovereign Eurobond space, we prefer shorter Belarusian issues. We think the Belarus 23 looks cheap. It has not yet recovered from what we believe was an overreaction to the EU sanctions. We think investors would become more comfortable adding to positions in Belarus's sovereign Eurobonds if the country were to secure a new credit line from Russia (a loan to compensate for the impact on Belarus from Russia's tax maneuver is being discussed). > In regions with lower geopolitical risks, we prefer long-dated Uzbek and Kazakh issues, but the upside is limited. We expect the yield on the new Uzbekistan 31, issued in July, to ease by at least 20 bps in the near term, pricing in the country's solid economic position relative to peers. We also prefer the Kazakhstan 45 to the Russia 43 on a relative-value basis, as the current weakness in the former, owing to the state pension fund's selling due to withdrawals, should ease.