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Summary of Emerging Markets Russia Report

Core Content

This report provides an analysis of the Russian economy and financial markets as of January 30, 2018, with a focus on macroeconomic performance, monetary policy, and fiscal outlook. It outlines the key developments and forecasts for the year 2018, including the impact of sanctions, inflation trends, and the role of the ruble in the economy.

Main Points

Sanctions and Market Reaction

• The US Treasury released a list of Russian individuals linked to Putin, but did not extend sanctions to sovereign debt or financial derivatives.
• The release sparked a relief rally in Russian assets, with the ruble strengthening to around 55.9 against the USD.
• The report on the potential impact of extending sanctions is expected on February 2.

Economic Growth

• Economic growth slowed in Q4 2017, with 4 out of 5 main sectors experiencing a decline.
• Industrial production saw the largest slowdown, dropping from +1.2% YoY in Q3 to -1.7% YoY in Q4.
• Retail trade growth improved, reaching 3.0% YoY in Q4, driven by rising wages, credit growth, and consumer confidence.
• Full-year real GDP growth is expected to be 1.7%, with a likely improvement to 1.9% in 2018 post-Presidential elections.

Inflation Trends

• Headline inflation ended 2017 at a historic low of 2.5%, below the 4% target.
• Annual average inflation was 3.7%, a 3.4pps decline from 2016.
• Food prices, particularly fruits and vegetables, rose in December after a period of decline.
• Core inflation continued to decline, reaching historic lows of 2.1% YoY (ROSSTAT) and 2.3% YoY (CBR).
• Inflation is expected to trend back towards 4% in 2018, though the pace of decline is likely to slow in the first half of the year.

Monetary Policy

• The Central Bank of Russia (CBR) cut the key policy rate by 50bps in December, easing to 7.75%, which was more than the market consensus of 25bps.
• The CBR is expected to follow a data-driven approach in the future, with further easing likely in H1-2018.
• A pause in rate cuts is expected in Q4-2018 as inflation converges towards the target from below.
• Money supply growth is increasing as monetary policy begins to impact the economy.
• The ruble is considered undervalued, and further strengthening is anticipated to aid disinflation.

Current Account and External Accounts

• The current account posted a large surplus in Q4, jumping from -USD2.5bn in Q3 to USD17.8bn in Q4.
• The improvement was driven by higher goods exports (both oil and non-oil) and lower services imports.
• The surplus was offset by a large net financial outflow, particularly in the banking sector.
• Reserve accumulation is expected to continue despite the outflow.

Fiscal Policy

• Fiscal policy is expected to remain tight over the medium term.
• The Ministry of Finance (MinFin) aims to reduce the 2017 deficit to 1.4% of GDP in 2018.
• The share of oil in total exports is declining, indicating a diversification trend.
• Government debt is among the lowest in emerging markets, and external debt is projected to decline as financing moves towards domestic sources.

Key Macroeconomic Indicators (Dec-17)

• Real GDP growth: 1.8% YoY
• CPI: 2.5% YoY
• Core CPI: 2.3% YoY
• Policy rate: 7.75%
• Real policy rate: 5.1%
• Current account surplus: USD17.8bn
• FX reserves: USD346.5bn
• Federal budget balance (ytd): -RUB1336.4bn

Key Information

• The ruble has shown a stronger correlation with oil prices post-sanctions, but this relationship has weakened in 2018.
• High-frequency indicators suggest a further slowdown in Q4, with the real GDP growth expected to be 1.7% for the year.
• Inflation expectations remain high and volatile, posing upside risks.
• Banks are experiencing a decline in NPLs and FX exposure, indicating improved financial stability.
• The CBR is expected to maintain a cautious easing stance in the first half of 2018.
• The current account surplus is expected to support further reserve accumulation.

Conclusion

The Russian economy is showing signs of resilience and structural adjustment, with a focus on reducing external debt and improving domestic financial stability. The CBR is expected to continue its easing cycle, while fiscal policy remains tight, and inflation is projected to trend back towards the 4% target. The ruble's strengthening and improved financial conditions in the banking sector indicate a positive outlook for the Russian economy in the coming year.