RaboResearch - Economic Research

Country Report Russia

Country Report


Flag Russia

The Russian economy is forecasted to shrink by around 4% in 2015, after a contraction of 0.6% in 2014, due to the fall in the oil prices and the imposition of sanctions. The outlook for the coming years also remains bleak due to low investor confidence and a tightening of the government’s control over the country.

Strengths (+) and weaknesses (-)

(+) Strong external position

Russia has a net international investment surplus, a vast amount of FX-reserves which covers 12 months of imports (2014) and an has been running trade and current account surpluses for years in a row. We note however that Russia’s external position has significantly weakened in the past year.

(+) Strong fiscal position

Russia has a low government debt of only around 10% of GDP.

(-) Weak governance and weak rule of law

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

(-) High dependence on single commodity export revenues

The oil and gas sector dominates the economy by making up 2/3 of total exports and contributing nearly 1/3 to GDP. Government revenues are highly susceptible to global oil price fluctuations. 

Key developments

1. Weak short term economic outlook

While even before the conflict in eastern Ukraine erupted economic growth in Russia already slowed down to just 1.3% in 2013, the combination of sanctions, low oil prices and the resulting deteriorating of economic sentiment have taken a big hit on the economy. According to various estimates the economy is going to contract by 3.4%-4% (IMF -3.4%, Central Bank of Russia -4%) in 2015, after growing by just 0.6% in 2014. This would be mainly caused by a contraction in the domestic demand as depreciation of the ruble and an inflation of 15.8% (May 2015) had a strong hit on real wages (-9% yoy, March 2015). This in its turn impacted consumer spending, which decreased by 8.7 % yoy in March 2015. Meanwhile, Ministry of Economic Development in its base case expects investment to contract by 10.6% this year. The 2015 budget deficit is estimated at roughly 3.7% of GDP (compared to the previously planned figure of 0.6%) and will be financed with funds accumulated in the Reserve Fund (USD 77bn as of 1 March 2015). According to the latest data, Russian economy has already contracted by 2.4% (yoy) in the first 4 months of this year. However, both the Central Bank of Russia and IMF forecast that the recession will be short lived and the economy will start to grow slightly in 2016. These rather optimistic forecasts are driven by the faster than expected recovery of the oil prices that is positively impacting the ruble exchange rate, as well as a slightly faster retreat of inflation. However, any adverse change in above mentioned parameters or any escalation of the conflict in eastern Ukraine could lead to weaker or even negative growth.

2. Renewed fighting in eastern Ukraine undermines recent stabilization of the economy

Russia’s alleged involvement in the conflict in eastern Ukraine has largely determined the country’s economic and political trends in the past year. A major milestone was achieved in February 2015, when the Minsk Peace protocol (also known as Minsk II) was signed. Its main goal was establishing a ceasefire combined with a removal of heavy weaponry from the front lines. Fighting indeed eased this spring, although international observers regularly noted minor violations on both sides. The western stance towards Russia remained wary. In March US decided to extend current sanctions impacting Russia’s finance, defense and energy industries by one more year. In April, the EU came out with the statement that the removal of its sanctions would be tied to the full implementation of the Minsk peace agreement, despite the negative sentiment towards the sanctions of certain member states (e.g. Greece, Hungary, Slovakia, Bulgaria). It appeared to be quiet at the front lines until the beginning of June, when fighting unexpectedly intensified in Donetsk region. This has assured EU in necessity of officially extending the sanctions till at least January 2016, and the risk that new sanctions will be imposed has increased.

3. Ruble crisis: free fall reversed, however the currency is still fragile

In autumn 2014, the Central Bank of Russia (CBR) intervened heavily in the foreign exchange (FX)-market to support the ruble. Due to the imposition of sanctions, falling oil prices and restricted access to international capital markets, the ruble was under strong downward pressure. In November 2014, the CBR decided to let the ruble float freely. As a result the ruble continued to depreciate, falling to RUB 70/USD in January 2015, while the FX reserves decreased by nearly USD 150bn in just one year. Afterwards, supported by rising oil price and the conclusion of the Minsk Peace agreement, the ruble began to appreciate and stabilized as of April 2015 at the level of RUB 50/USD. In response to the positive dynamics, the CBR has further lowered the interest rate to 12.5% (from 17% in December) and announced to start rebuilding its reserves with daily purchases of USD 200m as of mid-May 2015. Pressure on the FX reserves (currently at around USD 356bn), as well as on the banking system, has thus been eased. At current levels, FX reserves cover more than 100% of the 2015 debt service, as well as 10 months of the 2015 imports. Nevertheless, the ostensible stability has proven to be rather fragile and highly sensitive to oil price developments and an escalation of the conflict in Ukraine. In the beginning of June the ruble exchange rate immediately fell by 5% in a couple of days when oil prices slightly decreased and fighting in eastern Ukraine intensified.

Figure 1: Pressure on the ruble
Figure 1: Pressure on the rubleSource: Reuters Ecowin, Central Bank of Russia
Figure 2: Consumer spending severely hit
Figure 2: Consumer spending severely hitSource: Bloomberg

4. Banking sector remains under pressure

Russian banks rely heavily on external financing, most of which is dollar denominated. The depreciation of the ruble and restricted access to the international capital markets have left Russian banks highly vulnerable. Capital ratios came under pressure as the non-performing loans ratio has increased, while due to depreciation banks were required to increase their capital buffers (i.e. in ruble terms) for assets denominated in foreign currencies. In December 2014, three large banks (Gazprombank, VTB and National Trust Bank) received a capital injection from the government of around USD 7.5bn in total. Currently planned consolidation in the industry takes place as 19 licenses have been recalled from the beginning of this year. Current regulatory relaxations for loan-loss provisions and asset valuation were meant to last until the 1 July this year. But in May 2015 the Central Bank of Russia bank extended the relaxation relating to loan-loss provisions until the 1 October 2015, and introduced revised (still lower than actual) exchange rates for valuation of banks' risk-weighted assets denominated in foreign currencies, in order to release the pressure on capital ratios. This clearly indicates that the banks have not weathered the storm well. However, the Central Bank of Russia remains committed to extend support should the banking sector be hit by new adverse developments.

5. The government continues tightening its controls

Besides the (indirect) effects from the sanctions, the business climate in Russia also seems to be affected by the government’s efforts to centralize its control over strategic industries. The tactics employed by the Russian state are rather alarming. In October 2014, the Moscow arbitration court ruled that Sistema Group (Russia’s largest holding company) should transfer its 82% stake in Bashneft (one of the largest independent oil producing companies) to the Russian state. This outcome was a result of a lawsuit brought by the Russian state against Sistema's chair and co-owner Vladimir Yevtushenkov, who was accused of the acquisition of “unlawfully privatized” Bashneft assets at an artificially low price, while being aware of underpaying. Sistema did not appeal the decision. This case clearly reflects the twisted reality in which Russian businesses operate, as the state often arbitrarily and not always lawfully intervenes in the private sector of the economy.

Furthermore, two important laws aimed at tightening capital controls entered into force per 1st of January 2015. One of them obliges Russian citizens who hold accounts in foreign banks to quarterly share their bank statements (notary certified translations) with the tax authorities back home. Another federal law amending the Tax Code subjects Russian controlled, but foreign registered entities to Russian tax regulation. In response, several major Russian companies have moved their assets back to Russia.

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 has shifted its post-Soviet democratic ambitions in favour of a centralized semi-authoritarian state. Russia’s economy has undergone significant changes since 1991, moving from an isolated, centrally-planned economy to a more market-based and globally-integrated economy. In the 1990s most important industries were privatized, whereby strategic state assets ended up in hands of a small group of individuals for a fraction of the real value, 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 6mn since 1992 driven by lower birth rate, one of the lowest male life expectancies in Europe 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 the 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.

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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