- Q1 growth figures came in slightly below consensus
- New US sanctions will have little impact on growth
- Ruble has been hit by sanctions, less so by EM wobbles
- May inflation hit 2.4%; still well below the CBR target …
- … but the CBR expects inflation to rise in the second half of 2018
- The CBR paused its easing cycle on 15 June …
- … and we expect only one more 25bp cut in the second half of 2018
Out of recession, but growth still lacklustre
Russia finally emerged from recession in 2017. While growth powered ahead in the second and third quarter of 2017, it slowed again in the fourth quarter of 2017 (0.9% yoy growth) on the back of lackluster investment. Growth picked up in the first quarter of this year to 1.3% yoy, still slightly below consensus forecast. Growth was mainly driven by consumption, on the back of the low unemployment rate, rising wages and improving consumer sentiment.
Monthly indicators draw a somewhat more positive picture for the second quarter of this year. Industrial production growth accelerated in April and May. Retail sales grew c.2.5% yoy in April and May, which is slightly higher than February and March. While the PMI (Markit) was very strong in April (51.3), it fell below 50 in the May (49.8). Brent crude oil prices have contintued to trend upwards in Q2, from USD66/bbl in March to around USD 75/bbl currently. On the back of higher oil prices the Ministry of Finance revised the 2018 budget in May this year, projecting a budget surplus instead of a deficit. Furthermore, Russia is currently hosting the FIFA World cup, which will have a postive effect on tourist revenues. On the downside, the government raised the VAT rate by 2 percentage points (from 18% to 20%). This could dampen consumer demand, which has been the biggest growth driver over the past year. However, the exact impact is hard to quantify, as higher government income may result in more government spending. We think that economic growth will contintue to trend upwards for the remainder of the year. As such, we maintain our 2.0% growth forecast for 2018 (consensus: 1.5%).
Imposition of sanctions does not cloud the current growth outlook
The new sanctions against Russia, which were announced on Friday 6 April, triggered a sharp correction in Russian assets on financial markets (see: Russia Insight: From the US with love). However, we continue to think the new sanctions will probably have a very marginal impact on economic growth. The tariffs on steel and aluminium should result in only a small decline in Russia’s export volumes. According to the IIF, 50% of Russian steel exports and 96% of aluminium exports are subject to the new sanctions. However, the two commodities comprise only around 1% of the total exports, resulting in a marginal effect on GDP growth.
Troubles in the banking sector continue to unfold
After the sanctions in 2014, privately-owned bank balance sheets grew rapidly via dollar loans from the CBT, which was used to provide credit to sanctioned firms. However, as these sanctioned firms found themselves in financial difficulty, this spilled over to the banks. In mid-2017, the central bank took over two private banks (Otkritie, B&N Bank), in a move to avoid bankruptcies. Then in mid-December, the CBR announced the bailout of Promsvyazbank, the third large private bank. Promsvyazbank was rescued via the Banking Sector Consolidation Fund (BSCF). The share of state-controlled banks in Russia then increased to nearly 70 percent. In April this year, the CBR announced that it will create a ‘bad bank’ to transfer RUB1.1trn in distressed assets from the three bailed-out banks. Despite these developments, credit growth to the corporate sector accelerated and overall financial sector indicators remained broadly stable.
Inflation picture looks rosy…
Inflation has continued to trend lower in recent years, and has held well below the inflation target of 4% of the CBR in recent months. Inflation picked up slightly in March, to 2.4% yoy, and remained at this level since then. Inflation has been curbed by good harvests in 2016-17, a relatively strong ruble against the USD, and relatively tight monetary policy. At the March meeting the central bank cut the policy rate to 7.25%. During 2017, the CBR cut interest rates by a total of 2.25pp, less than the decline in headline inflation, thereby raising real interest rates by approximately 75bp.
… but inflationary pressures building, and the CBR is vigilant
At the latest rate decision on 15 June, the CBR paused its easing cycle and struck a unexpectedly hawkish tone by saying the risk of inflationary pressures had risen. The CBR pointed to the planned increase in the base VAT rate by 2 percentage points as the main reason. The central bank warned that this higher VAT could push price inflation higher by around 1 percentage point. Furthermore, the tight labour market will put pressure on wages and hence raise headline inflation by the end of this year. That said, we would not overstate the impact of wage growth on inflation, as real disposable income growth, while being positive for the last two months, was 0.3% in May this year. Moreover, the depreciation of the ruble, mainly as result of the sanctions, will feed into higher imported inflation in the coming months. With the CBR turning hawkish, we raised our end-2018 policy rate forecast from 6.75% to 7.00%. In other words, we think that there will be only one further 25bp cut in the second half of 2018, rather than the two we had previously forecast.
Ruble hit by sanctions
So far this year, the Russian ruble has weakened by more than 9% versus the US dollar, and by around 6% versus the euro. This weakness has been mainly the result of the announced sanctions earlier this year. Higher oil prices and Russian real yields have dampened the downside in the ruble, and have shielded it from the kind of weakness other emerging market currencies have faced from a rise in the US dollar and Fed rate hikes (see: Emerging Markets Watch: Singling out the weakest links). This year, the ruble has moved in tandem with the country’s CDS spread. It is likely that (geo)political factors will continue to be the main drivers for the remainder of this year. Our analyst sees downside risks to the oil price from current levels. Long positioning in oil is extended and profit-taking in the near term is likely. If this were to happen, this would also weigh on the ruble. There have been reports that president Trump and president Putin will meet in the near term, which could lead to investors speculating on an easing of sanctions. Later in the year we expect the oil price to rise again, the US dollar to peak, and Fed rate hikes to be fully anticipated by financial markets. Then we expect the ruble and other emerging market currencies to recover. We have adjusted our year-end forecast for USD/RUB from 58 to 61 to reflect the impact of the sanctions.