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Russia: bottoming out?

Country Report


Flag Russia
The Russian economy might be finally bottoming out after recording a 4.6% yoy contraction in 2Q15, the sharpest in six years. However the growth outlook remains bleak due to structurally lower oil prices, existing sanctions and lack of structural reforms.

Strengths (+) and weaknesses (-)

(+) Strong external position

Despite adverse developments that have significantly weakened the country’s external position in 2014, Russia’s external position remains strong. The country has been running trade and current account surpluses for years in a row and still possesses vast amounts of FX-reserves.

(+) Strong fiscal position

Even though government debt as a percentage of the GDP has been steadily increasing Russia still has a relatively low government debt of around 13% of GDP (2015e). The 3% budget deficit for 2015 and 2016 will be covered from the reserve fund.

(-) Weak governance and weak rule of law

Corruption is a deeply embedded phenomenon, severely hindering the business environment, especially (but not only) for foreign investors.

(-) High dependence on single commodity export revenues

Lack of diversification makes the Russian economy more susceptible to the falling demand on the commodities markets. Government revenues are highly dependent on revenues from fuel exports, therefore any adverse fluctuations feed into the government budget balance.

Key developments

1. The economy is in recession, stagnation is the most likely perspective for 2016-2017

The Russian economy, severely hindered by the low commodity prices and sanction regime, has been showing disappointing results. GDP declined in excess of 4% yoy in both 15Q2 and 15Q3, which represents the steepest decline in 6 years. Some believe that the long awaited bottom has been reached and the economy is about to bounce back, however, given how fragile the Russian economy is to external factors, risks are tilted to the downside. Throughout 2015 GDP growth estimates have continuously been adjusted downwards. Hence it still remains a question whether the Russian economy will indeed show a clear return to growth in 2016. Domestic demand likely remains supressed as inflation, which is still in excess 15%, continues to take its toll on real wages. Foreign direct investment has been severely undermined, with net FDI of USD 2.6bn in 15H1, the lowest reading since 2006.

In October, the Russian government approved the 2016 budget, with relatively realistic assumptions of the oil price at USD50/barrel and GDP growth of 0.7% in 2016. The projected 3% deficit will be financed from the Reserve Fund which currently holds USD 71bn. The fund will be unable to fully cover another deficit of similar magnitude in 2017. This situation underscores the need for structural economic/budgetary reforms, as using the funds in such a manner is not prudent. Given Russia’s low sovereign debt, issuing new bonds remains a viable option in the short run, though no sustainable long term solution.

2. Ruble continues to show volatility

The beginning of the 2015 has been marked by the Ruble reaching its historical peak exchange rate of RUB 70/USD, as well as vast amounts (USD 150bn) of the FX reserves having been burned in the course of 2014 to support the currency. As a result of positive oil price developments and the conclusion of the Minsk peace agreement the Ruble managed to strengthen to RUB 50/USD during the 2015, allowing the Central Bank to further lower the interest rate and start rebuilding the FX reserves. However the situation has proven to be extremely unstable: driven by the resumed downward pressure on energy and commodity markets and sporadic intensification of the conflict in the Eastern Ukraine, the Ruble has resumed a depreciation trend again, exceeding RUB 70/USD by the end of August 2015. In September and October 2015 the Ruble has been bouncing back and forth, currently remaining in the bandwidth between 60 and 70 RUB/USD, which is further confirming Ruble exchange rate’s extreme correlation with the oil price movements. On the back of a depreciating ruble and persisting inflationary pressures the Central bank has slowed down its pace of interest rate cuts (currently at 11% since August 2015). The FX reserves have remained rather stable throughout 2015, currently standing at USD 375bn, including gold reserves (October 2015), which represents an improvement compared to the trough of USD 356bn seen this spring. At current levels, FX reserves (excluding gold) cover more than 170% of the 2015 debt service, or 12 months of the 2015 imports.

Figure 1: Ruble volatility and oil prices
Figure 1: Ruble volatility and oil pricesSource: EIA, Central Bank of Russia
Figure 2: Economic indicators
Figure 2: Economic indicatorsSource: EIU

3. The focus is shifting from the conflict in Ukraine to Syria

After a turbulent year where Eastern Ukraine has been shaken by a military conflict with alleged Russian involvement, the ceasefire was finally achieved in September 2015. Also local elections scheduled for the end of October 2015 have run smoothly, while the separatists abandoned the idea to run their own elections. The EU sanctions on Russia are to expire in January 2016, and the asset freezes and travel bans in March 2016; an extension of the sanctions is off the radar at the moment, especially given the role that Russia has been playing in the Syrian conflict that is directly connected to the critical refugee situation in Europe. At the end of September 2015 Russia has launched an airstrike campaign in Syria targeting ISIS and other terrorist groups (also termed moderate opposition by the countries backing them), and at the same time supporting Assad’s forces. While the West supports Russia’s efforts in fighting the terrorism, there is no consensus (also in the middle east) on Assad’s involvement in the resolution of this conflict. The US, Saudi Arabia and Turkey want Assad to quit immediately, while Russia and Iran are opting for a transition period that would allow him to stay in power, whereas the EU lacks uniformity in its position. Even though the political resolution to this conflict has yet to be found, Russia has in fact reinstated its position of a global player on the geopolitical arena.

Factsheet Russia
Factsheet RussiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Since the break-up of the USSR in 1991, Russia’s democratic ambitions have shifted in favour of a centralized semi-authoritarian state. Also Russia’s economy has undergone significant changes moving from an isolated, centrally-planned economy to a more market-based and globally-integrated one. In the 1990s most important industries were privatized, whereby strategic state assets ended up in hands of a small group of individuals, creating an oligarchic economy where the wealthy few had also considerable influence in the Kremlin. However, since 2000, the power balance gradually began to shift and currently Kremlin maintains a firm grip on this elite. However, according to most indicators governance standards have deteriorated in the past decade and corruption remains deeply embedded on all levels, posing a challenge for businesses and individuals. Currently Russia is still in the top 10 largest economies in the world. Demographics remain unfavorable, as the population of Russia has shrunk by 6m since 1992 driven by a lower birth rate, low male life expectancy from a European perspective and immigration. The Russian labor force is skilled, but there are shortages especially in management and engineering. While the level of infrastructure varies throughout the country, the roads are generally poor. Although the country’s economy is somewhat diversified, the non-energy sector is largely uncompetitive. Therefore, the economy is overly dependent on commodities production, particularly on the oil and gas sector that constitutes 2/3 of total exports. To sustain economic growth in the longer term, Russia has to find ways to diversify its economy away from the hydrocarbon sector, especially by improving the business climate and introducing structural reforms.

Economic indicators of Russia
Economic indicators of RussiaSource: EIU
Ksenija Vojevoda
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 52447

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