Chris Weafer


‘Buckle up, it’s going to be a rough ride for the next three to six months, but the long term outlook is not that bad…’

Despite all the hype and the disastrous backdrop prevalent throughout all of 2014, the results for the economy were actually not so bad. Many of the alarmist reports in both the international and domestic media, which, for example, suggested that the country would suffer a recession similar to that of 2009 or that there would be a severe credit problem which would hit the banking sector and even lead to problems for Russian companies servicing their international obligations, proved to be just that; alarmist.

But that is not to say that the economy has survived the crisis intact and all will be well from here, especially if the efforts to secure a lasting peace deal in eastern Ukraine are successful. Far from it. Almost regardless of where oil trades and how much optimism there may be over an easing in sanctions, the economic indicators for the next three to four months, possible the full first half year, will be borderline disastrous. That is now almost a given. What happens in the 2nd half and how much optimism there may be for a recovery in 2016 will be determined by oil, sanctions and whether we get an effective government strategy. But none of that will stave off the severe downturn the country is now in. The effects of that will hit almost everybody in the coming months and into early summer.

But first the good news. The economy actually grew in 2014, albeit by a very modest 0.5 per cent. The decline in retail growth, which over the past 14 years has been the main economic driver, to only 2.5 per cent and the contraction in investment spending and the construction sector were partially offset with a pick up in demand for locally produced goods. The sharply weaker rouble and the ban on some importer foods contributed to import substitution. The continuing rise in defence sector spending also contributed to the gain in the manufacturing sector and the housing market expanded by 15 per cent as people rushed to use depreciating roubles and lock in lower interest rates.

The federal budget would have reported a full year surplus equal to 0.9 per cent of GDP had the Finance Ministry not transferred 1 trillion roubles to a fund which will provide support for the banking sector this year. That transfer meant the budget actually reported a 0.5 per cent deficit. That is a very good result given the 52 per cent decline in the price of oil, which, along with the gas sector, contributes just about half of all budget revenues and two-thirds of exports. Capital Flight did rise, to over $150 billion last year, but most of that was the repayment by Russian companies of external debt (they had no choice due to last Augusts’ sanctions). Total foreign debt fell by $130 billion to end the year at $599 billion, or 30 per cent of GDP. Not a bad ratio when one considers the over 100 per cent debt to GDP ratio most developed countries, and China, have to service.

That’s where the good news mostly ends. The hangover from 2014 is now kicking in and it will be painful. At the end January, the headline rate of inflation was already at 15 per cent and it seems very likely to exceed 20 per cent in the early 2nd quarter. That means the Central Bank will not be able to cut its still crippling benchmark Key Rate of 15 per cent until it is convinced that the inflation rate has peaked and started to reverse. That may not be until its policy meeting on June 15th. Whether inflation will have peaked by then will be largely determined by where the rouble trades and that is almost solely a function of the oil price.


The price of Urals crude has defied most predictions and, by mid February had climbed back towards $60 per barrel rather then testing the 2009 low of $40 per barrel. It is far too early to be confident that the worst is over and interim bounces have been common during previous periods of oil price weakness. What we can say is that if the oil price does again track back to the low $40’s then the rouble will again test the high 70’s against the US dollar. The Central Bank will not use resources to prevent that as the weak rouble provides a lot of protection of budget rouble revenues and acts as a soft stimulus for domestic manufacturing. But, while there is a clear correlation on the downside, this is not the case when oil rallies. Instead traders switch their fears to eastern Ukraine, sanctions and the decline economic indicators. So the recent oil rally and the more hopeful news from Ukraine may combine to rally the rouble a little, but the greater likelihood is for a continuing nervous currency market, which a greater downside risk, between now and late spring.

Real disposable incomes fell by 1 per cent last year, the first decline since 2000, and that squeeze will be worse this year. Nominal wage growth is a lot less than inflation and Russian employers have a preference for cutting salaries rather than staff. So good for the unemployment statistics but another reason why retail sales and other consumer sectors will amongst the worst hit in the coming months. An early indicator was January’s vehicle sales, which were down 25 per cent on the same month last year.

The government’s crisis management, which was very poor in late 2014, has improved. Changes to personnel in the Central Bank and the trillion rouble transfer to support the banks are positive moves. There is also much greater clarity about exactly how much foreign currency debt needs to be paid in 2015, i.e. $60 billion when offshore centres are excluded, which is almost equal to the current account surplus of last year, and the fast-track support facility for 199 strategically important companies also adds some confidence compared to the fact vacuum of last year.

But while the newsflow is better, there is no doubt that the strategy from the Kremlin is one of survival and damage containment only. There is no recovery strategy and none is expected until there is stability and directional clarity in some of the key variables, such as oil and sanctions. The earliest we may start to see that response could be around the time of the big economic showcase set for late June in St Petersburg.

The main theme for that event this year is very likely to be self-reliance or import substitution. This is a theme, which President Putin has been beating the table about since late 2010 and without much progress. The current crisis, especially sanctions, provides him with another opportunity to pound the table harder. To make that work the country will need the continued involvement of western companies and experts. That is something, which was accepted many years ago and is not impacted by the reset in political relations. No doubt the Kremlin’s relations with western countries will remain bad indefinitely as a result of the events in Ukraine. But that should not affect the open door policy for western companies and investors. Previous assumptions that the so-called Asia pivot would replace the need for western expertise have been discredited; China has no spare cash for Russia and is only interested in the materials and transport sectors, which help bolster its economy.

In summary, the key message is ‘buckle up, it’s going to be a rough ride in the economy for the next three to six months’. But the country has the financial and cash flow base to survive the crisis and some positive, long overdue, changes may yet come out of this recession. That said, a return to the boom times is impossible as the base conditions have changed irrevocably. But, with the right strategy and some basic reforms, companies and investors will still be able to make above average returns in Russia.