- The recession deepened significantly during the second quarter,…
- …but there are some tentative signs that the economy has passed the eye of storm
- Recent bout of ruble weakness unlikely to stop process of monetary policy easing
- Growth set to return in 2016, though oil price weakness poses a downside risk
Steep contraction in Q2 on the cards,…
Incoming data suggest that Russia’s recession deepened significantly during the second quarter. The surge in inflation, while recently having come down somewhat, has continued to erode households’ real purchasing power. As a result, real retail sales were down by almost 10% in June. The economic weakness has also made companies reluctant to invest. Investment fell by more than 7% (yoy) in June. Against this background, industrial production has fallen significantly, with output being down by almost 5%. Taken together, monthly data are in line with a contraction of the economy of around 6% in Q2. This marks significant deepening of the recession compared to Q1, when the economy shrank by 2.2%.
…despite deep fall in imports
The worsening of the economy probably would have been even more severe, if it had not been for the steep depreciation of the ruble. Granted, this sharply raised import prices, but it also led to a significant fall in imports. According to detailed National Accounts data, imports fell by 25% yoy in the first quarter of the year. Moreover, given the softness in domestic demand and ongoing weakness in the ruble, we think that the slide in imports has much further to go.
Signs that economy has passed the eye of the storm
What is more, although the recent renewed weakness in oil prices is providing some downside risks to the economic outlook, there are some tentative signs that that the economy has passed the eye of the storm.
For instance, after having fallen for three quarters in a row, consumer confidence rose from -32 in Q1 to -23 in Q2. In addition, once having corrected for seasonal patterns, it appears that vehicle sales have found a bottom, while the decline in real retail sales is levelling off.
Inflation has started to come down…
Meanwhile, after peaking at 16.9% in March of this year, inflation declined to 15.3% in June. The recent weakening of the ruble might lead to some upward pressure on prices again. However, the big picture is that inflation will continue to come down steadily once the effects of the ruble dropping off a cliff at the end of last year and the beginning of this year will fall out of the annual comparison, and the weakness of the economy will weigh on prices.
…prompting the central bank to continue to loosen policy
This has prompted Russia’s central bank to aggressively loosen monetary policy. It has lowered its key policy rate from 17% to 11.5% over the past months. We think that this process has further to go. Admittedly, the renewed ruble weakness that we saw over the past days brings back memories of the financial crisis at the end of last year, prompting the authorities to take a more cautious stance. For instance, while we think that the CBR soon will start to buy foreign FX again, it recently paused its purchases. We also think that the central bank will cut its key rate at a gentler pace than earlier this year at this Friday’s meeting. But, the bigger picture will be that falling inflation and a weak economy will keep the CBR in a loosening mode. We therefore continue to think that its key rate is heading to 9% at the end of the year.
FX reserves have stabilised
Another positive development is that the central bank’s FX reserves have stabilised, after these between the beginning of last year and March of this year declined by a total of $153bn. This partly reflects that the CBR has bought around $10bn of foreign FX since the middle of May, but the more important reason is that capital outflows have receded. While in the fourth quarter of last year, a staggeringly large $76.2 flew out of the country when the financial system was on the verge of collapse, the amount of money that was withdrawn in the first quarter declined to $32.5bn, before falling to $20 in the second quarter.
Economy to grow again in 2016, but lower oil prices a risk
Taken everything together, we think the recession will slowly start to moderate in the second half of the year. Lower inflationary pressures should give households more breathing space, helping consumption to stabilise. Meanwhile, reduced uncertainty should also help investment to start growing again. The upshot is that the economy should bottom out around the turn of the year, before growing modestly next year. The big question, of course, is how the economy will deal with the renewed bout of oil price weakness. Indeed, we recently lowered our 2016 year-end forecast for Brent oil from $80 a barrel to $65 a barrel. For now, we keep our 2016 GDP growth forecast of 0.5% unchanged, but lower oil prices do pose a downside risk to our growth outlook.