Lean years ahead

RUSSIA ENERGY / FINANCE - Forecast 04 Sep 2018 by Leonid Grigoriev and Marcel Salikhov

The Russian economy stabilized in 2017-2018, but isn’t on track for sustainable high growth. The positive impact of higher oil prices is being tempered by a new round of already-introduced and expected sanctions. Dubious domestic structural policy is another negative factor.

The new government’s strategy is to make a large redistribution of incomes from households and corporates (around 1% GDP per annum in the next five years), and to pour it into state-supported investments in infrastructure and human capital. Theoretically, this should address structural bottlenecks, and lead to higher growth rates in the long run. At least official forecasters from the Ministry of Economic Development expect such an outcome (of 3%+ GDP growth starting in 2021). But the infrastructure package is still aimed at megaprojects, and positive impact on the economy is questionable. So, we doubt such a rosy scenario, and expect longer-term growth rates under current economic policy to be around 1.5% per annum. Basically, it is a scenario of structural stagnation.

Proposed measures to increase taxation (increasing the VAT rate from 18% to 20%, tax maneuvers in the oil and gas industry) are inflationary. In 2019, inflation will rise, with CPI exceeding 4.5% in H2 2019. But with structural weakness in household incomes and spending, we expect inflationary shock to be temporary, with inflation falling back to the 4% target.

On the brighter side, for foreign investors inflationary shock means the CBR will stay “higher for longer.” We expect the Bank to keep interest rates on hold for another 12 months; rates could even rise. With a lack of external foreign financing for Russian borrowers, monetary authorities will have no other option but to stick to tight monetary policy. Fiscal policy is also expected to stay tight, as new expenditures set by the “May decrees” will be more than fully financed by increased taxes.

New sanctions have led to an exodus of foreign investors, and to RUB depreciation. In fundamentals, we see the RUB as undervalued by 15%-20%. But it is hard to expect depreciation in the short run, as there is huge uncertainty over the Senate version of the new sanctions.Despite all of U.S. President Donald Trump’s pro-Russia tweets, relations between Russia and the West have fallen to one of their lowest levels since the Cold War ended, and have resulted in new American sanctions and restrictions. Without normalization of relations with Western countries, it will be hard for Russia to achieve high growth rates, or serious changes in its domestic economy.

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