HAS RUSSIA SEEN THE WORST ?
Russia’s recent economic woes can mainly be ascribed to the decline in oil prices, given the country’s high dependence on hydrocarbon. A strong correlation can indeed be observed between the rouble (the Russian currency) and oil prices. The abrupt drop in oil prices during the summer of 2014 led to a sharp drop in the rouble, pushing the Russian economy into the notoriously vicious circle of higher inflation, higher interest rates, lower growth and, in turn, an even weaker currency.
That being said, the Central Bank of Russia (CBR) has been able to begin loosening monetary policy in 2015, thanks to some oil price strengthening during the first half of the year. Going forward, in line with the US Energy Information Administration, we expect a slight rebound and stabilisation of oil prices in the USD 50-70 per barrel price range. Should this prove correct, it could give the Russian economy a welcome breather.
So, will the Russian economy also rebound and stabilise?
To answer this question, four key elements need to be reviewed: monetary policy, fiscal policy, external debt and investment.
Starting with monetary policy, the good news is that the rouble has likely bottomed out, barring negative surprises on oil prices. Inflation should thus recede, enabling the central bank to adopt an easier stance – within limits.
Indeed, the CBR is currently facing capital outflows, which can be countered in two direct ways. The first is to sell part of the large pool of international reserves accumulated during the boom oil years and use the proceeds to purchase domestic assets. This has already led to a USD 150 billion decline in Russian reserves over the past 2 years. Although they do remain very large at USD 371 billion, such a pace of sales cannot be sustained forever. The CBR has thus also had to resort to the second tool at its disposal: maintain interest rates at levels sufficiently high to attract capital. Unsurprisingly then, the end of 2014 saw the key central bank interest rate rise in tandem with foreign direct investment outflows.
Since then, thanks to a stabilisation of inflation, the CBR has been able to lower its policy rate to 11%, significantly below the peak of 17% reached in December 2014. Going forward, a lessening of price pressures should justify some further easing. However, interest rates might not come down as sharply as could be hoped for until inflation gets closer to the official CBR’s 4% target and outflows abate.
Turning to fiscal policy, the Russian economy has avoided the worst. Indeed, with close to half of government revenues coming from oil and gas, the country’s budget deficit could have soared dramatically. Thankfully, the large currency depreciation offset the impact of falling oil prices, as evidenced by the fact that the price of oil in rouble terms has held up. As a result, the budget deficit only deteriorated to 2.9% in June 2015. That being said, the government’s 3% budget deficit target is in view, implying that fiscal policy should not provide strong support going forward, which is unfortunate in a context where both consumption and investment are already faltering.
Russia’s external debt burden has taken a substantially hit from the weakening of the rouble and consequent one third drop in the USD value of the country’s GDP (using IMF data and forecasts for 2015). Indeed, although the absolute level of Russia’s external debt labelled in foreign currency has shrunk by over USD 100 billion since the beginning of 2014, its share of GDP has risen above 30%. There is no cause for alarm at this point, since Russia’s international reserves still cover roughly 80% of its external debt in foreign currency. But we are far below the 125% levels seen in 2012, and further external deleveraging will be an additional obstacle to a revival of investment, consumption and growth.
Finally, investment and productivity perspectives remain bleak. They have been declining for some 5 years now (see chart 8, page 3) and the current environment is clearly not conducive to a trend reversal with, amongst others, the international sanctions related to the Russo-Ukrainian conflict, the Russian businesses’ lack of confidence in future economic perspectives and numerous geopolitical uncertainties, the latest being the Syrian conflict. Not to mention that Russia is only 62nd in the 2014 World Bank “ease of doing business” ranking, and 136th out of 175 countries in the transparency International 2014 corruption perception index. On that front, government economic reforms could be a welcome sign of a future revival in investment.
Overall, the current economic snapshot of Russia is mixed. Positives include very low public debt levels, large reserves and a positive current account balance. Negatives include rising external foreign currency debt as a share of GDP (although default is very unlikely), a deteriorating budget deficit and very depressed growth levels. Finally inflation remains high and monetary policy tight, even though the worst is likely behind.