Russia Political & Economic Risk Analysis

Annual real GDP growth in Russia markedly decelerated to +1.3% in 2019, after it had risen to a six-year high of +2.3% in 2018. The economic performance was particularly weak in H1 (+0.7% y/y) as the VAT hike by +2pp at the start of 2019 curtailed the expansion of administrative & support services, retail sales and wholesale sales (the latter especially as large traders had increased stocks ahead of the VAT hike). Growth recovered to an estimated +1.8% y/y in H2. Details for Q4 and full-year 2019 are not available as yet, but monthly indicators suggest that strengthening domestic demand led the pick-up in growth in H2. In particular, consumer spending benefited from rapidly falling inflation and retail sales increased by +2% y/y in Q4. Meanwhile, balance of payments data indicate that external trade activity (both exports and imports) weakened markedly in 2019.

Going forward, the Russian economy is expected to maintain the momentum that it reached at the end of 2019, with looser monetary policy and some fiscal stimulus supporting growth in the next two years. However, a number of downside risks could dampen the outlook, including delays in planned government investment projects, oil price volatility, ongoing global trade tensions and the introduction of further sanctions against Russia. Overall, we forecast annual growth of +1.9% in 2020 and +1.8% in 2021.

In the medium to longer term, ongoing Western sanctions and, perhaps more importantly, persistent structural rigidities are likely to continue to curtail Russian growth prospects. These include the high dependence of the economy on commodities, notably the extraction of hydrocarbons, but also the large footprint of the state in the economy, as well as a still weak business environment. The hydrocarbons sector accounted for approximately 60% of merchandise exports and 30% of government revenues in 2018, much higher shares than in the year 2000. And the IMF has recently estimated that the Russian state has a share of 33% in GDP and 38% in formal value added. One reason is that state-owned enterprises continue to have a predominant role in the economy.

Regarding the business environment, the World Bank’s Worldwide Governance Indicators 2019 survey suggests that regulatory quality (rank 143 out of 206 economies), rule of law (rank 166) and percep­tions of corruption (rank 165) remain areas of serious concern in Russia. Moreover, there has been hardly any improvement in these areas over the past decade and Russia is now trailing peer countries. With regard to environmental sustainability, Russia also does not score well. The main issues are very low levels of renewable electricity output and recycling. The country fares somewhat better regarding energy intensity and CO2 emissions, while it does well with regard to water stress and vulnerability to climate change. Overall, Russia ranks 85th out of 210 economies in our proprietary environmental sustainability scoring.

Despite the oil price slump in 2014-2016, Russia’s current account remained in surplus, though it narrowed to +1.9% of GDP in 2016. As oil prices recovered, the surplus widened to +6.8% of GDP in 2018. Thereafter, it declined to an estimated +4.2% of GDP in 2019, mainly because merchandise exports dropped by -6%, which compares to a strong +25% increase in the previous year. The main triggers for the contraction in 2019 were lower global oil prices (benchmark Brent at 64 USD/bbl on average vs. 72 USD/bbl in 2018) and the oil output cuts agreed with OPEC and some other major oil producers (called OPEC+), which sent  oil and gas exports down by -9%. Moreover, the impact of new U.S. sanctions imposed on Russia in the course of 2019, combined with slower global trade growth, also contributed to the weaker performance in 2019 as non-oil and gas exports decreased by -1% (vs. +14% in 2018). Meanwhile, merchandise imports expanded by just +2% or +USD6bn to USD255bn in 2019.

In 2020, we forecast the current account surplus to increase slightly to about +4.5% of GDP, mainly for two reasons: (i) Russia’s exports should benefit from strengthening global trade growth in 2020, notably in USD terms (+2.6% vs. -1.9% in 2019). (ii) Oil output cuts agreed with OPEC+ will possibly be relaxed gradually in H2 2020. Beyond 2020, we expect solid, albeit somewhat smaller external surpluses to be maintained.

Meanwhile, the impact of foreign sanctions on financial flows to and from Russia appears to have moderated. Private-sector net capital outflows from Russia declined to just -USD27bn in 2019, down from -USD63bn in 2018 and well below the record highs in 2014 and 2008. The annual average over the last 10 years was -USD58bn. In 2020, we expect a similar amount of net capital outflows (as in 2019) of around -USD30bn for the Russian private sector.

Official foreign exchange (FX) reserves have continued to recover and reached USD444bn in December 2019, up from the temporary low of USD308bn in April 2015 and USD382 at end-2018. Current FX reserves are comfortable in terms of import cover (over 14 months). In other terms, reserves cover more than 300% of the estimated external debt payments falling due in the next 12 months (>125% is assessed as comfortable).

Gross external debt rose to USD481bn at the end of 2019, up from USD455 a year earlier. The rise in 2019 is almost entirely reflecting new, mostly RUB-denominated debt by the Russian government, the afore-mentioned pre-emptive stockpiling as the threat of further sanctions is looming. The current level of external debt is still moderate in relation to GDP (less than 30%) and export earnings (around 100%). The debt-service ratio is forecast at a manageable level of just below 20% in both 2020 and 2021.