June 19, 2017
Commodity exporters such as Russia have faced huge challenges over the past several years. After almost two years of contraction the Russian economy started to recover towards the end of last year. The recovery continued in 2017Q1 as growth stood at 0.5% YoY, driven mainly by investment demand. According to preliminary estimates, growth remained positive in April. We interpret the surprisingly high growth figures to indicate that the recession of the previous two years was driven more by business cycle than previously estimated.
At the same time, the ruble has gained strength on the back of higher oil prices, boosted by the agreement among oil producing countries. As a result of the stronger currency, large spare capacity, and declining food prices, annual inflation dropped from 7.5% in June 2016 to 4.1% in May 2017.
The Central Bank of Russia (CBR) started cutting interest rates in March and continued the easing cycle in May as inflation expectations decelerated. As inflation declined below the CBR’s forecast, they initiated a rate cutting cycle sooner and faster than the market expected. We project that inflation will dip even below the CBR’s inflation target of 4% in the coming quarters, and thus our Macro Forecast argues that monetary easing will continue in the foreseeable future. Our view is also supported by the CBR’s latest communication and President Putin’s comment that the government is working on “market-based measures” to affect the exchange rate instead of direct interventions.
Nevertheless, some risks related to the future path of inflation remain, namely the inertia of high inflation expectations in Russia (as often emphasized by the CBR), a possible switch of household behavior from saving to consumption, and the Finance Ministry-conducted purchases of foreign currency. We therefore see real interest rates declining only slowly.
Although economic growth is expected to continue in 2017, we remain pessimistic about Russia’s growth prospects in the longer run.
The strong ruble and tight monetary and fiscal conditions, together with the remaining sanctions, will constrain growth in the near future, and medium-term prospects will also be limited by structural weaknesses. The difficult geopolitical situation will restrain foreign capital inflows, complicating diversification of the economy away from energy-sector-driven growth.
The economist responsible for this story: Gyorgy Molnár
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