Russia Country Report Feb19 - February, 2019

February 8, 2019

Russia’s banks and companies are back in profit, but the population are miserable and feel poor. Last year Russia earned a record current account surplus of $114.9bn, but real incomes in 2018 fell for the fifth year in a row. There was a federal budget surplus of 2.2% -- the first surplus in years – but growth for the full year came in at three quarters of what the government was predicting at the start of 2018 at 1.5%.

The short answer is although at the macroeconomic level Russia is back on an even keel, because of sanctions the government is running an austerity budget and that is hurting.

There is an enormous amount of cash in the system ($467bn in reserves, or over 23 months of import cover), the sovereign external debt is ridiculously low, 15% of GDP, trade is booming and Russia Inc. is currently a more profitable concern than it was in the boom years during the noughties.

All these numbers are far in excess of what is needed to ensure the stability of the economy or the national currency. Yet instead of leveraging these rock solid fundamentals CBR governor Elvira Nabiullina chose to hike interest rates at the last Central Bank of Russia (CBR) meeting of last year when she didn't have to. She was not looking to promote growth, but to anticipate volatility on the currency markets in case the US imposed fresh “crushing” sanctions on Russia in the first quarter.

The government is attempting to transform itself through 12 national projects that are mandated by president Vladimir Putin’s May Decrees. The state is going to spend an extra RUB2 trillion ($30bn) a year on these programmes on top of the usual RUB16 trillion budget and hopes the first effects will be felt by 2021 when growth is supposed to rise from the current 1.5% to 3%.

Economists are not optimistic that the plan is going to work. Part of the problem is Russia is intending to do this investment on its own and has largely abandoned all hope of attracting any significant foreign direct investment (FDI) or even much outside funding for the programme. The danger is that Russia will stagnate and even if the economy is growing, it will grow more slowly than the rest of the world and so inexorably fall behind.

More concretely Russian inflation is in focus for 2019 as prices began to rise at the end of 2018 and ended the year slightly above the Central Bank of Russia (CBR) target rate of 4%. However, the World Bank says that inflation will remain low this year and growth will be the same 1.5% as in 2018, according to the multilateral’s January 2019 World Economic Outlook.

The US government has threatened to impose “crushing” sanctions on Russia that are scheduled to be considered in the first quarter. The CBR is already in defensive mode, anticipating severe sanctions with a pre-emptive rate hikes in September and December at a time when inflationary pressures remained under control.

"Although economic sanctions tightened, Russia experienced relatively low and stable inflation and increased oil production. As a result of robust domestic activity, the Russian economy expanded at a 1.6% pace in the year just ended," according to "Global Economic Prospects. Darkening Skies," the January 2019 World Economic Outlook by the World Bank.

Russian oil production rose to a post-Soviet record high of 11.16mn barrels per day (bpd) last year on an annual average basis, data from its energy ministry showed on January 2.

The World Bank also predicted that oil prices would average $67 in 2019, which is an increase from the $54 average in December, but less than the $75-plus oil prices average for most of the third and fourth quarter of last year. Even at $67 the oil price won’t hurt Russia’s economy badly as the budget currently breaks even at $50, according to BCS Global Markets. Indeed, a slightly lower oil price will help hold inflation down closer to the CBR’s target of 4%.

In 2020 and 2021, the World Bank expects an increase in the growth rate of Russia's GDP to 1.8%. The official forecast is for an even lower 1.5%, although in January the Ministry of Economy increased its forecast to 2% for 2019. In October, the International Monetary Fund (IMF) raised its forecast for Russia's GDP growth in 2019 by 0.3%, to 1.8%. The IMF maintained its forecast for GDP growth in 2018 at 1.7%. At the same time, the IMF expects inflation in Russia in 2018 at the level of 2.8% due to moderately tight monetary policy.

“There are growing signs that slack in the economy is being used up, and this seems to be happening a bit more quickly than we had previously anticipated. Early last October, we estimated that the so-called ‘output gap’ in Russia’s economy was about 1% of potential GDP, suggesting strengthening demand could result in above-potential GDP growth,” Capital Economics said in a note.

Amongst the many targets Russian president Vladimir Putin set in the decrees is for Russia’s economic growth to outpace global growth. That task has been made easier after the World Bank predicted that global growth will slow to 2.9% in 2019 in its January economic outlook.

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