Four-fold crisis: politics, confidence, oil revenues and currency
Since Q1 2014, Russia has faced a political crisis and a sharp loss of market confidence, as a result of the annexation of Crimea, its continued involvement in the conflict in east Ukraine, and the ensuing response of Western nations in the form of sanctions against it. In H2 2014, sharply falling global oil prices adversely impacted Russian exports and government revenues which was exacerbated by an equally sharp depreciation of the RUB. The economic fall-out has been severe.
Deep recession forecast in 2015
According to a flash estimate by RosStat, real GDP increased by +0.6% in full-year 2014. Support for the modest growth came mainly from moderate private consumption (+1.9%) and from net exports (+1pp) due to a plunge in imports (-6.8%). Exports fell also (-2%), as did fixed investment (-2.5%). Inventories subtracted 1pp from overall growth. Data and details for Q4 2014 are not available as yet but given that GDP grew by +0.8% y/y in Q1-Q3 and was flat in q/q terms in each of the first three quarters, it is likely that the economy entered recession at the end of the year.
In our baseline scenario, Euler Hermes expects a sharp contraction of GDP by -5.5% in 2015. High inflation and the weakened currency will hit private consumption and lower oil revenues will dent public spending. The already negative investment situation will further deteriorate given the political and economic prospects for 2015. Real exports are likely to decline as well due to much lower oil revenues even though some other export sectors may benefit from the RUB depreciation. But real imports will drop much sharper owing to the weakened RUB. As a result, net exports will provide some mitigation of the overall contraction of GDP but this will only mask the weakness not remove it.
Currency crisis with severe adverse effects
The „perfect storm“ of sanctions, capital flight and, in particular, falling oil prices has had a severe impact on the Russian currency. Since the start of 2014, the RUB has lost about half of its value against the USD, despite heavy foreign exchange (FX) interventions by the Central Bank of Russia (CBR). In mid-December 2014, the RUB dropped to new record lows against the USD (1:73) and the EUR (1:92), before it recovered somewhat to USD1:RUB60 and EUR1:RUB72 by the end of 2014, in part because the government obliged the country’s largest state exporters to sell part of their FX revenues. In 2015 year-to-date, the RUB has remained volatile and lost another 10% against the USD (1:67 on 6 February). Going forward, the course of the RUB will depend more on developments on the oil price and economic sanction fronts than on CBR actions, including interest rate changes. Under the assumptions of our baseline scenario that sanctions against Russia do not change substantially in 2015 and the average Brent oil price is USD60/barrel, the USD:RUB exchange rate could stabilise at around 1:65 at some point in H2 2015. In H1 volatility will remain high and the USD:RUB rate could temporarily reach as much as 1:100, especially if the oil price remains below USD50/barrel for some time.
The sharply weakened RUB will have a severe impact on companies that have significant FX-denominated liabilities and will have difficulties to refinance maturing debt. Taken together with the effects of the expected deep recession, Euler Hermes forecasts corporate insolvencies to surge by +30% in 2015.
Inflation to remain in double-digits while monetary policy focus shifts to growth
Due to the RUB depreciation, inflation accelerated from 6.5% at end-2013 to 11.4% at end-2014 and 15% y/y in January 2015. During 2014, the CBR had raised its key policy interest rate by a cumulative 1150bps to 17% and announced an inflation-targeting plan after the free floating of the RUB in November. Despite this we expect inflation to average 14% in 2015 and 10% in 2016 due to the much weakened currency as well as increased food prices in the wake of Russia’s ban on certain food imports from the EU. As the CBR’s measures were not successful in containing depreciation and inflation, but probably also because of political pressure, it cut the policy rate to 15% on 2 February, shifting its focus to address concerns about the banking sector and economic growth.
Banking sector remains vulnerable
Russia’s banks have been hit by higher interest rates and understandably rising non-performing loans. The government has announced a USD35 bn anti-crisis programme and the CBR also rolled out a number of measures, mostly aimed at supporting large banks and companies. While the amount may be insufficient and need to be raised, the authorities should have the resources to avoid a systemic crisis and we are not concerned at present about their resolve to provide support. However, many of the 900 odd smaller banks will be at risk of bankruptcy or losing their licence.
Sovereign default unlikely in 2015
Russia’s fiscal position remains robust. Public debt (16% of GDP in 2014) will remain low even if the fiscal deficit increases from -1.5% of GDP in 2014 to an expected -2% in 2015. Moreover, two sovereign Wealth Funds worth about USD160 bn (14% of GDP) will provide resources to finance a fiscal deficit and anti-crisis measures in 2015.
Capital flight weakens external position
The current account surplus increased from +1.6% of GDP in 2013 to +3% of GDP in 2014, mainly due to the drop in imports due to the RUB’s collapse. In 2015 we see a surplus of more than +2% of GDP. However, the 2014 surplus was more than offset by net capital outflows of the private sector which surged from USD61 bn in 2013 to USD152 bn in 2014. As a result, FX reserves have dropped from USD470 bn at end-2013 to USD338 bn at end-2014. While the current level of FX reserves is still comfortable in terms of import cover (9.5 months) or in relation to external debt payments falling due in the next 12 months (estimated at about USD150 bn), the future development has to be monitored closely and is not fail safe.
Gross external debt decreased by USD129 last year and stood at USD600 bn (32% of GDP) at end-2014. It should decline further in 2015 but rise to about 46% in relation to GDP as the latter will drop significantly in USD terms.
© Copyright 2015 Euler Hermes. All rights reserved.