Russia Country Report Jan17 - January, 2017

February 6, 2017

Russia had a much better 2016 than initially feared. The economy contracted by 0.8% in 2016, less than expected at the start of the year, but the federal budget deficit was -3.7% of GDP, which was more.

However, the government has managed to maintain is gross international reserves (GIR) at just under $400bn, or a whopping 24 months of import cover that gives it a large cushion to deal with future external shocks. Having said that the Ministry of Finance spend about 70% of the Reserve Fund which fell from over $70bn at the start of the year to $16bn by the end. This fund is expected to be exhausted in 2017 – even if oil prices remain above $50 MinFin said an extra money would go to the budget and not to replenishing the fund – but there is a second National Welfare Fund holding some $72bn which can also be used to prop up the budget this year if needed.

Industrial production finally bounced back as the year came to a close,  up 3.2% in December and 1.1% on the year, bolstering confidence that Russia’s economy will return to modest growth in 2017 of about 1%. Manufacturing in particular did well as has done the service sector which was putting in particularly strong PMI index results in the second half well above the 50 “no change” mark.

But the really stellar story was in Russian securities. Russia’s ruble was the best performing currency in the world. The dollar denominated Russia Trading System (RTS) index was up some 54% y/y in 2016 as foreign investors finally woke up to the strong corporate stories at a microeconomic level, even if the macroeconomic story is less good. Likewise, foreign investors poured into Russian bonds over the year driving yields down to a 3-year low. Foreign ownership of Russian bonds rose from 26% to over 45% in the year and analysts expect the rally to continue – albeit at a slower pace. MinFin intends to double its issuance of the local OFZ treasury bond to RUB1 trillion ($16.9bn), while the RTS index is expected to rise 15%-20% this year.

On the political front president Vladimir Putin maintains his record high popularity and is basking in the positive sentiment following the election of US president Donald Trump. However, in its few candid comments on Trump, the Russian foreign ministry has admitted it still has no real idea of what Trump’s policies to Russia will be. Trump has already suggested that he could remove sanctions in the Russians were to trade a reduction in nuclear missiles – something the Russians rejected out of hand – in what was a classic Trump “deal” format. This suggests that relations will not be made by policy, but by offer and counter offer. But it is still too early to say with any certainty.

Finally, Russia has the upper hand in Syria as the main players other than the EU and US went to the Kazakh capital of Almaty in January for talks. While the summit produced no concrete results it did highlight that Russia has the initiative on Syria and is sidelining the west in an eventual resolution. More talks are due later this year in Geneva where the west needs to make a come back to stay in the game.

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