Russia and Ukraine to contract by 5% in 2015, says EBRD

By bne IntelliNews January 19, 2015

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Russia's economy will contract by 4.8 % in 2015, according to a new forecast by the European Bank for Reconstruction and Development – putting it just behind the forecast of a 5% recession for Ukraine.

The 50% slump in oil prices over the past six months is set to trigger the Russian recession, with oil and gas comprising two-thirds of Russian exports and around 25% of budget revenues, while most of the rest of the economy is also dependent on oil and gas revenues, according to the EBRD.

The EBRD forecast is based on an oil price of $56 per barrel, although oil is currently just below the mark of $50 per dollar, implying plenty of downside risk to the forecast.

Adding to that, Western sanctions have cut off the economy from its other main source of funding – Western capital markets – so that a perfect storm is brewing, according to the EBRD. Eurobond issuance and syndicated borrowing by Russian corporates - not just the state energy companies and banks targeted by sanctions – plummeted by over 60% in 2014, while investments fell by around 3% in 2014, putting a question mark over future recovery.

“As the structural and cyclical negative factors reinforce each other, weak investment activity jeopardises long-term growth prospects,” write EBRD analysts. “A fast turnaround in the geopolitical crisis and strong improvement in the business climate would be needed to counteract the negative processes,” the international lender warns.

The EBRD put total capital outflow for 2014 at as much as $134bn.

Meanwhile a bank crisis is in the offing, as non-performing loans soar towards levels last seen during the global credit crunch of 2008-2009, with Russia's sovereign wealth fund committing RUB1 trillion to support the largest, mostly state-owned banks.

The only thing working in Russia's favour is that the ruble crash means that export revenues and hard currency reserves have soared in value in domestic currency, so that the budget will survive the plummeting oil price. But government plans to cut expenditure by around 10% will additionally impact on growth, warns the EBRD. Consumption and wage growth have already dropped significantly, as interest rates soared as the result of massive interest rate hike in December to 17% to stem a currency crisis.

Ukraine in agony

Ukraine is heading for a 5% slump in 2015 – but in contrast to Russia, which had an estimated 0.4% growth in 2014, Ukraine's slump comes on the back of a disastrous 7.5% GDP plunge in 2014, mostly as a result of the conflict in East Ukraine's Donbass region.

This brings Ukraine far closer to an all-out financial crisis than Russia. “Ukraine enters 2015 with incomplete external and fiscal adjustment, very low level of foreign exchange reserves, material external liquidity needs, uncertainty about international financial assistance and ongoing fighting in Donbass,” writes the EBRD. “Any stabilisation and rebound of growth will depend on both external and domestic factors: the ability of the government to implement reforms in key areas; the reduction of the regional geopolitical risks; and adequately timed and scaled international assistance,” the bank adds.

The extent of Ukraine's problems is shown by the fact that the hryvnia devalued by 50% against the dollar in 2014, but Ukraine still runs a balance of payments deficit, “partly because of the destruction of productive capacity in Donbass” because of the Russian-backed insurgency. This, together with large currency outflows, has forced regulators to retain heavy currency controls, which in turn have caused a black market in currency trading to emerge.

Ukraine’s international reserves fell to $7.5bn at the end of 2014 – just one month's import cover, down from $20.4bn on the year, and the overall budget deficit is expected at close to 10% of GDP in 2015, while public debt hit around 70% of GDP in 2014, up from 40% in 2013, and will further grow in 2015.

According to the EBRD, Ukraine's banking authorities closed more than 30 banks in 2014, and suffered large deposit outflows. “The banking sector (…) represents a major source of contingent liabilities for the government,” the report says.

As a result, Ukraine urgently needs more funds from international donors to survive 2015 than it is currently promised by the International Monetary Fund and other lenders, the report finds. “Ukraine needs a credible macro-stabilisation programme with additional international financing to cover the external financing gap. Longer-term stabilisation requires both international financial assistance and a major structural reform effort,” finds the EBRD.

Belarus struggling too

Belarus is also to suffer a contraction in 2015, but at 1.5% a relatively mild one compared to its two larger neighbours, according to the EBRD. Belarus’s high dependency on Russia represents a source of vulnerability, which is exacerbated by Belarus’s own very significant external imbalances, liquidity risks, low levels of reserves and structural limitations to economic growth,” writes the bank. The devaluation of the Belarussian ruble at the end of 2014, in reponse to the devaluation of the Russian ruble, will not help industry so much as hurt domestic demand, increase credit risks and trigger negative balance sheet effects in the banking sector, writes the EBRD in its report.

Central Asia and Caucusus feel Russia's pain

The sharp fall in oil prices is hurting Central Asian and Caucasus energy exporters. But the region's energy-importing nations are also feeling the pain as demand for their exports and remittances from Russia are declining, the EBRD says.

The low price of oil, which has halved since the summer, is also affecting energy exporters Kazakhstan, Turkmenistan and Azerbaijan, the EBRD says, but adds: “Even for energy importers in
Eastern Europe, the Caucasus and Central Asia, the oil price fall is a mixed blessing, as benefits are being outweighed by lower export demand and remittances from a weakened Russia.” 

Tajikistan, Kyrgyzstan, Armenia and Georgia are heavily dependent on remittances their nationals working in Russia send home.

The economy of Armenia is now expected to stagnate in 2015, while the depreciation of the ruble has increased pressures on the currencies of economies with strong trade, investment and remittances ties to Russia, with the sharpest declines expected in Turkmenistan and Armenia.

In addition to the low price of oil, the high share of non-performing loans (NPLs) is blamed for weak credit growth in Kazakhstan, where the NPL ratio exceeds 30%, the bank said.

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