Shrinkage Bottoming Out
Russia’s economic slump deepened in Q2. According to a preliminary Rosstat estimate, GDP fell 4.6% y/y, vs. a 2.2% fall in Q1. The recession is shifting toward investment and industry, while household demand is showing signs of stabilizing.
Weak external demand is hurting export industries. Corporate profits have increased, but investments keep falling. The high cost of borrowing, and uncertainty, are taking a toll on investment. We don’t expect progress this year on the lifting of sanctions. Western countries have expanded their sanctions recently. Russia has extended its ban on imports of certain food products for another year, to August 2016.
We affirm our forecast of a 3.2% y/y GDP contraction in 2015, and believe the economy will hit bottom in Q3. We expect household incomes to fall by 5%-5.3% y/y in 2015, which should reduce consumer spending by 4.2%-4.5% y/y. Growth in 2016-2017 will continue to be weak, as there are no evident reasons for acceleration. The forecast the Economic Development Ministry presented in May projects that the economy will grow 2.3%-3.1% y/y in 2016. But, without meaningful reforms, we’re unlikely to see such growth levels in the medium term.
The Central Bank decided to cut its key rate by 50 bp, to 11%, in late July, despite continued RUB devaluation. That decision, coupled with falling oil prices, caused rapid RUB decline. We expect that a new round of RUB devaluation will create another wave of inflationary pressure, in late 2015 to early 2016. In our baseline scenario, we see the currency basket approaching 69 RUB at yearend, with the key interest rate falling to 10%.
Of course, there’s no free lunch in Russian monetary policy. Inflation targeting requires higher CBR rates, even at the cost of a hit to economic activity. There’s a strong positive reaction of the RUB to interest rates levels (the “carry-trade” effect). The inability of the CBR to show its teeth, and a lack of credibility, creates risks of continued devaluation and rising inflation, while dampening economic growth. We see that there is a negative short-term effect of RUB depreciation on economic growth. The CBR’s monetary policy isn’t optimal -- which creates extra uncertainty, and increases RUB volatility.
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