Not as bad as you may think

RUSSIA ENERGY / FINANCE - Forecast 21 Dec 2018 by Leonid Grigoriev and Marcel Salikhov

2018 was moderately successful for the Russian economy. Despite new round of the US sanctions in April 2018 and lower oil prices in 4Q18, GDP is set to grow 1.6% in 2018.

The current strategy of the Government outlined by the presidential May decrees is to increase taxation while using these funds to invest in infrastructure. We note that major increase in taxes will start next year while the quality of ‘priority projects’ remains low. We expect investments to accelerate next year supported by the public infrastructure investments. At the same time we highly doubt that it will help to increase long term growth as officially expected.

In the meantime, fiscal policy will stay conservative. Federal budget surplus in 2018 is expected to be around 2.5% of GDP supported by surge in oil & gas revenues. We believe that until average Urals price in 2019 stays above $53/barrel, the federal budget will be in surplus. We forecast Urals to average $60 in 2019 and expect federal budget to stay at surplus of 1.6% GDP.

Inflation started to accelerate in 4Q18. New shock will come again due to higher VAT rates and higher excise taxes. We believe that by the end of 1Q19 inflation will reach and probably exceed 5% but then will start to decline.

CBR started new round of policy tightening in 2H18. The last rate hike was at December meeting. The key rate was increased 25 b.p., to 7.75%. We believe that the last hike was more a precautionary measure. CBR is uncertain about the inflationary reaction of household and businesses to increased taxes. Another risk factor is renewal of FX purchases as a part of budget rule implementation. Purchases were temporarily halted in September 2018. But CBR plans to restart open market FX operations in 2019. We believe that another 25-50 b.p. hike is probably in 1Q19 depending on inflation indicators. We believe that later in 2019 CBR will start softening of the policy.

Currently CBR expects that by the end of 2019 inflation will reach 5-5.5% that we see as rather pessimistic scenario. As real incomes are not expected to grow next year, we expect that inflation will subside in 2H18 and it will be a driving factor for further easing.

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