EBRD sees Russia's GDP contracting by 4.5% in 2015

By bne IntelliNews May 14, 2015


The European Bank for Reconstruction and Development (EBRD) expects deep recession in Russia to have a larger-than-expected negative spill-over effect on countries with strong ties with its economy, the bank says in its latest Regional Economic Prospects report published on May 14.

Russia's GDP is seen contracting by 4.5% in 2015, with the recession easing to 1.8% decline in 2016, attributed to oil prices stabilising at $60 per barrel and prudent macroeconomic management. But GDP will remain affected by unsolved deep-rooted structural issues and economic sanctions.

This is much less optimistic then the official forecast of 3% GDP decline in 2015 by the Ministry of Economic Development, which recently argued the recession would not last until the fourth quarter of 2015. In its latest outlook, the European Commission expected Russia's GDP to contract by 3.5% in 2015, with some stabilisation to follow in 2016 with 0.2% economic growth.

Despite the deepening recession, Russia is seen by the EBRD as having significant reserves to mitigate it. While retail sales and incomes have been in decline, pressure on the ruble has subsided because of the recovering oil price. The country's current account is also in surplus due to shrinking imports.

While capital outflows continue, the decline of Russia's international reserves evened out after losing 30% to about $353bn by end-April. Fiscal policy is set to loosen, having a widening 3.7% of GDP deficit in 2015.

Economic policy of the Russian authorities is balancing several objectives, in the bank's view: preventing a large drop in international reserves through a flexible exchange rate, allowing a cautious fiscal easing without risking remaining fiscal buffers, and supporting key banking sector players in the face of the worsening balance sheets.

Despite the large depreciation of the real exchange rate, a stated policy goal of import substitution has proved challenging. Agriculture is suffering and industrial production has failed to pick up the slack of declining imports. Recent strengthening of the ruble and fast adjustment of ruble prices may discourage investment in import substitution projects, although real wage drops could support its profitability, the EBRD believes.

The swift stabilisation of the ruble to RUB50 to the US dollar as of the end of April is driven by several factors identified in the bank's report. As well as increased oil prices, stabilisation of the geopolitical crisis has significantly reduced Russia's risk premiums, with the spread of credit default swaps almost halving to 350bp; the decision of Russia's central bank to extend $30bn in Fx repos to banks helped them to deal with foreign debt repayment, and the stabilisation of the ruble prompted households and corporations to reconvert some of the Fx purchases made in December.

Financing conditions will remain tight, however, as indicated by weak syndicated lending. "The market is basically closed," reads the EBRD report. At the same time, the Russian Ministry of Finance began considering a Eurobond placement in 2015, given the recent decline in yields on sovereign bonds.

The EBRD finds it hard to see a rebound in the Russian economy going forward without the reversal of its ongoing de-coupling from the rest of the world, and the introduction of major structural reforms. The economy may therefore face a protracted period of slow growth and stagnation.

Overall, the bank notes, the positive sign for the whole region is that risks related to the Ukraine crisis appear to have been contained at a higher level, with the February 'Minsk 2' peace accords so far generally holding. The situation is still seen as volatile, with EU and US sanctions against Russia remaining in place.

Ukraine, worse for war

Across the border in Ukraine, the EBRD forecasts a 7.5% slump in GDP in 2015, caused by "massive pressure" exerted on the economy by the conflict in the eastern Donbas region, the country's former industrial powerhouse.

Donbas has been the centre of a pro-Russian insurgency for more than a year, causing a massive contraction in production and exports and resulting in Ukraine's hryvnia currency losing two-thirds of its value since January 2014.

The knock-on effects of the turmoil, according to the EBRD, include deteriorating bank balance sheets, hikes in energy tariffs, tight economic policies and credit contraction. Further banking problems result from Ukraine's non-transparent financial practices, such as the "heavy legacy of related-party lending", the report says.

Despite the size of the devaluation, the bank criticises Ukraine's latest currency stabilisation efforts as "incomplete", forecasting that current and capital accounts will remain negative in 2015. Current support for the hryvnia relies on tightened monetary policies and significant currency and capital controls, according to the EBRD.

The anticipated 7.5% drop in real GDP supplants the bank's early 5% contraction forecast in January. The economy should then recover by 3% in 2016, assuming that the security situation does not deteriorate and the IMF loan programme provisionally agreed in March remains on track.

Closure of Ukraine’s external funding gap in 2015-2018 during the term of an IMF extended funding facility will depend on the outcome of the country's ongoing debt re-restructuring negotiations with private bondholders and creditors, the EBRD says.

Belarus, still reform-resistant

Belarus, which continues to tread a precarious line between its key trading partner Russia, and its European neighbours to the West, fared somewhat better in the outlook, which foresees only a 2% year-over-year contraction of the republic’s economy.

Abrupt currency depreciation at the start of 2015 affected consumer demand in Belarus, while a tightening of monetary and fiscal policies stabilised the exchange rate, enabling currency and price controls imposed in late 2014 to be reversed. Currency pressure subsequently abated, with international reserves remaining low (around $4.5bn) but stable in spring.

However, external risks remain very high for Belarus, due to significant foreign exchange refinancing needs and unfavourable terms of trade. The EBRD forecasts a contraction of 2.5% in 2015, and 0% growth in 2016, unless there are significant domestic reforms, an improved improvement external environment, and a solution is found for Belarus’s external liquidity and refinancing risks.

Meanwhile, the EBRD remains the republic’s top outside investor, having put 1.6bn int0 30 major projects in the ex-Soviet republic to date. This month the bank also confirmed its planned  25% stock acquisition in the state-owned Belinvest bank and said it will assist with its privatisation.

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