The Russian central bank cut its key rate by a larger-than-expected 150bp during its meeting on April 30. This reflects that the panic that we saw at the end of last year which forced the CBR to hike rates to 17% in order to stem the slide in the ruble has abated. Meanwhile, the upward momentum in inflation is diminishing. It should soon start to come down as the rise in import prices on the back of the past weakness in the ruble will fall out of the annual comparison. Another reason that inflation will come down is that spare capacity will open up due to the deterioration of the economy. Incoming data suggest that output contacted by 3% yoy or so in Q1, as higher inflation bit into households’ real purchasing power, while firms shelved their investment plans due to the weak economic backdrop. However, with inflation coming down, the central bank should continue to loosen policy, while households’ purchasing power will be eroded at a slower pace. This should help the economy to stabilise, prompting companies to invest again. In short, the deepness of the recession should start to subside from Q2 onwards, with the economy set to stabilise in Q4, and post modest growth again in 2016.
CBR cuts rates by 150bp as panic abates,…
The Russian central bank reduced its main target rate by 150bp to 12.50%. The move, which marked the third consecutive decrease in a row, was larger than the 100bp rate cut that financial markets had been looking for. Since the start of the year, rates have now been lowered by a cumulative 450bp. All this reflects that the panic at the end of last year, which forced the central bank to hike rates to 17% in order to halt the steep slide in the ruble, has abated. Indeed, while the ruble weakened somewhat after the central bank’s announcement, it has appreciated by around 14% against the dollar since the beginning of the year, helped by a gradual rise in oil prices. Meanwhile, in tandem with an appreciating ruble, CDS-spreads have come down sharply, falling by around 250bp since their peak.
There are also some tentative signs that capital outflows are becoming less intense. Net private capital outflows were $32.6bn in the first quarter, a significantly smaller amount than the $77.4bn that was recorded in the final quarter of last year. Unfortunately, these data can be volatile from quarter to quarter. So the jury is still out whether the decrease in outflows will be sustained. But over the past one-and-a-half months, FX and gold reserves seem to have broadly stabilised at around $350bn.
…and upward momentum in inflation decreases
Another reason that probably prompted the central bank to cut rates by more than expected is that the upward momentum in inflation is decreasing. Consumer good prices rose by 1.2% mom in March, following a 2.2% gain in February, and a 3.8% increase in January. This suggests that inflation, which has been fuelled by the past weakness in the ruble and reached a staggeringly high of 16.9% in March, is about to peak in coming months. It should start to come down later in the year as the effects of higher import prices starts to fall out of the annual comparison, and spare capacity opens up due to the weakening of the economy. Incorporating these trends into our projections, we think that inflation will fall to around 11% at the end of the year.
…and economy sinks deeper into recession
A final reason behind the larger-than-expected rate cut is that incoming data are all suggesting that the economy is sinking deeper into recession. For instance, in March, real retail sales fell by 8.7% compared to a year ago, keeping the series on a steep downward trend. Consumers not only have to cope with a gradual rising unemployment rate, but the sharp rise in inflation has also dented their real purchasing power, forcing them to tighten their purse strings.
Meanwhile, investment has also continued to decline. It was down by 5.3% in March, as firms continued to shelve their investment plans against the weak economic backdrop. Finally, while industrial production held up better in March than the 1.9% drop that was expected, falling by just 0.6% yoy, the manufacturing PMI fell back from 49.7 to 48.1. It has remained below the 50-mark that separates growth from contraction for four months in a row. All this suggests that the economy shrank sharply in the first quarter of this year, probably by around 3% yoy or so.
Another sharp contraction in Q2 is on the cards,…
These trends should continue in the second quarter. Another sharp contraction in economic output is therefore a near certainty. However, as explained above, inflation should start come down sharply in the second half of the year. This should allow the central bank to continue to significantly loosen monetary policy. Indeed, barring another escalation of the Russia/Ukraine crisis and/or another sharp fall in oil prices, we expect the central bank to bring its key rate all the way to 9% at the end of the year. This should help financial condition to become less tight and hence support economic activity.
…but situation should gradually improve thereafter
Meanwhile, a drop in inflation in the second half of the year should also imply that consumers’ real purchasing power will be eroded at a slower pace, helping the fall in consumption to diminish. Finally, as the economic situation slowly stabilises, companies should gradually start to invest again. All this suggests that, as Russia’s economic headwinds slowly become less powerful, the economy should start to stabilise at the end of the year, before returning to modest growth in 2016.