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How have Russia’s steelmakers coped with this year’s drop in domestic GDP of some 3.5-4%? How have they dealt with a sharply weakened currency and a large jump in inflation and interest rates?
The chart below shows the dramatic changes seen in the value of the Russian rouble over the past couple of years.
While $1 used to be worth around 32 roubles, that same dollar would buy some 65 roubles at the time of publication. Over time, this change has made imports into Russia more expensive, and the country’s rate of inflation has shot up.
In response to this, interest rates rose to try to keep inflation under control. And, although rates have been pared downward since the initial panic, the cost of debt remains higher than it was previously.
As things have turned out, however, Russian steelmakers are coping just fine.
While recently released results for the third quarter of 2015 showed lower revenues because of falling steel prices, nominal profits (and hence margins) were up.
Furthermore, a number of expansions are being planned by the country’s steel mills as they try to increase their production of higher-value-added products, such as coated steels.
What explains such a good performance at a time when Russia’s domestic economy is shrinking?
In short, Russian steelmakers are benefiting from having a large part of their costs denominated in roubles, and a significant part of their revenues in dollars.
It makes sense 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, and so on.
This means that their costs have not increased, but have in fact fallen.
As highlighted in MBR’s Global Steel Cost Service, the cost of producing slab among Russia’s most efficient integrated steelmakers slipped to less than $250 per tonne in the past quarter, more than $115 per tonne lower than in the corresponding period last year.
Meanwhile, as imports of finished steel have become more expensive, domestic steelmakers have become more competitive in their home market and have been able to grab some of the market share previously taken by imports.
And while imports into Russia have become more expensive as a result of the weakened currency, exports out of Russia have become much more attractive. Its steelmakers have therefore been able to increase their export volumes 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 were down by about 40%.
Of course, there are dangers. Most notable among these is the fact that the majority of the debt held by Russian steelmakers is denominated in US dollars. The burden of this debt has therefore increased sharply in line with the dramatic weakening of the rouble.
Some steelmakers will be more affected than others, with Evraz and Mechel being particularly leveraged, while Severstal, for example, is less exposed.
There is also the danger that the rouble will continue to weaken, further undermining domestic demand and driving debt costs even higher.
For now, however, it appears that 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 $1 to 50-60 roubles, while interest rates were cut quickly earlier this year and purchases of foreign currency by the country’s central bank have also increased, both helping to keep downward pressure on the rouble.
There is certainly no strong desire on the part of the Russian government to see the rouble strengthen toward previous levels in the short term. And, having clearly benefited so far, most of Russia’s steelmakers will generally be happy for the rouble to remain around current levels.
However, struggling steelmakers elsewhere, from Europe to the Middle East and India, will not share that enthusiasm.
This article was written by MBR’s steel analysts. For a free sample of their regular analysis, click here.