Cautious and well-tuned economic policies have provided some cushion against new sanctions since 2018 and should continue to do so in the near term. These include monetary policy credibility, diligent fiscal policy and export diversification. Furthermore, the Russian government is supposedly pursuing the de-dollarization of the economy. A reduced dependence on the USD would lower the vulnerability to external shocks; however, implementation is not easy and will take time.
Monetary policy set to ease but remain well-tuned and credible
In the aftermath of the currency crisis and the resulting surge in inflation in 2014-2015, the Central Bank of Russia (CBR) embarked on a credible inflation targeting regime under Governor Elvira Nabiullina. Monetary policy was gradually eased in line with falling inflation until mid-2018. When inflation expectations began to rise again due to the anticipated VAT hike in 2019, policy interest rates were pre-emptively hiked from September 2018. Then, in June 2019, the CBR changed course again and cut its key policy interest rate by a cumulative 150bp to 6.25% in December 2019, citing slowing inflation and the weak economic momentum in most of 2019. Crucially, the policy rate remained well above the inflation rate (3.0% y/y in December 2019). Governor Nabiullina has also shut down many non-viable banks, though more needs to be done on this end. Overall, the CBR currently enjoys a high degree of independence and credibility, especially as compared to peer countries.
Nonetheless, currency risk remains on the agenda, although an equally steep RUB depreciation as in 2015 (-59% vs. the USD on average) is highly unlikely until end-2020. But after rebounding by +13% in 2017, the RUB experienced volatility again and lost on average -8% in 2018 and -3% in 2019, mainly responding to sharp oil price moves or disturbing political events, including new sanctions.
In January 2020, headline inflation dropped to a 19-month low of 2.4% y/y, mainly reflecting the unwinding of the +2pp VAT hike a year earlier. As a consequence, the CBR lowered its policy rate further by 25bp to 6.00% in early February 2020. We expect consumer price inflation to remain low in the first half of 2020 before edging up moderately in the second half, resulting in an average 3.1% or so in the year as a whole. We also expect a further 50bp of rate cuts to 5.50% by the middle of 2020. These forecasts also include the assumption that the RUB will depreciate only moderately by around -3% vs. the USD.
Fiscal prudence to be relaxed but not abandoned
Fiscal policy has been diligent in recent years. In the wake of the currency crisis and recession in 2015-2016, Russian authorities have prioritized financial stability over economic growth. Public spending growth has remained modest (+2.5% peak in 2017, +0.9% in 2018) so that government expenditure in Russia is still fairly moderate as compared to other countries, accounting for around 35% of GDP. This is, for example, similar to the ratio in China but lower than in South Africa (39%), Poland (41%), Hungary (47%) or the EU average (46%). At the start of 2019, the government increased the VAT rate from 18% to 20%, a step in the right direction in order to diversify its fiscal income base and reduce its vulnerability to global commodity prices. And Russia issued more debt than needed in 2019, apparently in a pre-emptive stockpiling as the threat of further U.S. sanctions was looming (and materialized to some extent).
However, the Russian government had also announced a set of so-called National Projects, an investment program estimated at RUB25tn (about USD400bn) running from 2019-2024. The aim was to boost growth and living standards, which have suffered markedly since the 2015-2016 crisis. But this program did not really take off in 2019. The formation of a new government in early 2020 was likely intended to speed up public investment. It remains to be seen how well this will work overall, but we expect at least some fiscal stimulus with positive growth effects to come, especially as there will be legislative elections in 2021.
Russia’s fiscal balance shifted back to a surplus of +2.6% of GDP in 2018, which narrowed to an estimated +1.8% of GDP in 2019 amid slower growth. As a result of the expected fiscal stimulus measures, we forecast annual surpluses to decline to around +1% of GDP in 2020-2021.
Overall public debt is still low in Russia, estimated at 15% of GDP currently, and should remain in check in the next few years.