- Higher oil prices versus new U.S. sanctions
- Prudent economic policies and robust fundamentals
- Long-term structural bottlenecks
Higher oil prices versus new U.S. sanctions
The U.S. imposed new sanctions against Russia in April and August 2018 and a number of further sanctions have been discussed since the summer by the U.S. Congress (for an overview of new and potential sanctions see the Box on the opposite page).
The Senate was more active in urging new sanctions while the hitherto Republican-dominated House was hesitant before the mid-term elections. Now that the House will be controlled by the Democrats, it may be more amenable for tighter sanctions as the Democrats are still upset by alleged Russian interference in the 2016 U.S. presidential election, amongst others.
We expect further U.S. sanctions affecting banking, air transportation and international trade-related sectors at the beginning of 2019. They will have a negative impact on already fragile investment activity. If the U.S. also sanctioned Russian sovereign debt, capital outflows should intensify. However, such sanctions are not part of our baseline scenario as their impact would not be limited to Russian businesses but also affect the competitiveness of large U.S. asset managers.
Back in 2014, the U.S., the EU and other countries imposed a first wave of sanctions on Russia in the context of the conflict in Ukraine.
These sanctions caused large-scale capital outflows and forced the Russian private sector to deleverage. Combined with sharply falling global oil prices from mid-2014 to early 2016, they also triggered a strong currency depreciation and a recession in Russia. A look at Figure 1, however, suggests that the exchange rate of the RUB versus the USD was mainly driven by the oil price and only marginally by sanctions. This seems to have changed now.
The sanctions imposed in 2018 so far appear to be the first ones that have had an impact on the RUB. While the price of benchmark Brent followed a broad uptrend from 45 USD/bbl in June 2017 to a peak of 86 USD/bbl in October 2018, the accompanying RUB appreciation ended abruptly in April 2018 when the first phase of tougher U.S. sanctions was imposed. And, although the oil price has markedly retreated since early October, its average in 2018 year-to-date is still +33% above the average in 2017. At the same time, the RUB has lost an average -7% against the USD in 2018 year-to-date.
The immediate impact on the economic performance has been negative, apparently. Preliminary estimates indicate that real GDP growth decelerated to +1.3% y/y in Q3, down from +1.9% in Q2.
The outcome in Q3 was disappointing as increased oil production and higher oil prices as well as the FIFA World Cup had led to expectations of stronger growth. But monthly activity data painted a mixed picture. Real retail sales growth edged down to +2.9% y/y in Q3 from +3.1% in Q2, indicating that private consumption remained the key albeit slowing growth driver in Q3.
The increase in calendar-adjusted industrial production picked up to +2.8% y/y in Q3 from +2.6% in Q2. However, agriculture dropped by -6.1% y/y and construction output fell by -0.4%. Uncertainty regarding the new U.S. sanctions possibly curtailed corporate investment in Q3.
However, early indicators point to a rebound of economic activity in Q4 2018. Industrial production growth accelerated to +3.7% y/y in October.
And the Manufacturing PMI improved to a six-month high of 51.3 points in October, up from an average 49.0 in Q3 and back into growth territory, supported by robust and faster increases in output and new orders, including new export orders. Moreover, the Services PMI jumped to an 11-month high of 56.9, also driven by strengthening output and new orders.
Overall, we assume that the impact of the new U.S. sanctions on economic growth was temporarily negative in Q3. But going forward, any negative impact should be mitigated by higher oil prices as well as by increased oil production in the near term.
We forecast the average oil price of benchmark Brent at 72 USD/bbl in 2018 and 69 USD/bbl in 2019. And in June 2018, OPEC member states and a number of non-OPEC allies (including Russia) agreed to increase oil supply.
In Russia, the move led to an estimated increase in average oil output per day by 0.3 barrels in Q3 (to 10.65 barrels) as compared to H1 2018. Although OPEC led by Saudi Arabia is in the meantime considering to cut oil supply again in response to the recent fall in oil prices, there is no indication yet of Russia following such a reversal. Moreover, we believe that prudent economic policies and robust economic fundamentals – as outlined in the following chapter – provide some cushion against new sanctions in the near term. All in all, we have revised down our full-year GDP growth forecasts only slightly to +1.6% in 2018 and +1.5% in 2019.
Figure 1 Exchange rate and Brent oil price
After the implementation of Western sanctions against Russia (and Russian counter-sanctions) in 2014, falling Russian trade with sanction-imposing countries was to a significant extent substituted by rising trade with non-sanction-imposing countries. From end-2013 to mid-2018, the EU’s share in Russian total merchandise exports fell from 54% to 45%. During the same period, China’s share increased from 7% to 12% and the Middle East’s share from 1.6% to nearly 4% (see Figure 3).
The share of the U.S. in Russia’s exports is relatively small, however, it surprisingly increased over the same period from around 2.1% to 2.8% (in value terms it accounted for about USD11bn at end-2013 as well as in mid-2018).
This diversification of export destinations has mitigated the impact of the 2014 sanctions and supported the recovery of exports since mid-2016. In the 12 months up to July 2018, the value of Russian total exports to the world amounted to USD411bn, equivalent to 78% of the value reached in 2013. This means that in real (or volume) terms, exports are today roughly back to the level pre-imposition of sanctions, because the average oil price was about -40% lower in the 12 months up to July 2018 compared to 2013 and oil products account for 48% of Russian exports (and gas products for 12%).
Against the background of deteriorated inter-bank lending conditions in the context of tightening global liquidity and the intensified U.S. sanctions against Russia, the Russian government is reportedly working on measures to reduce the economy’s dependence on the USD. The plans include encouraging and facilitating the usage of alternative currencies in international trade. For example, transactions with the EU and China, Russia’s main trading partners accounting for nearly 60% of its foreign trade, could be shifted into EUR and CHY while trade with CIS countries could be done in RUB. However, previous efforts to do so have had little success, highlighting that close cooperation with other countries is needed. But this may be easier now in a world of rising U.S. protectionism.
Other measures could be delisting of major Russian companies from foreign stock exchanges and increasing gold and EUR reserves. Russia has already reduced its holdings of U.S. government debt by around USD80bn this year. And the CBR’s gold reserves stood at USD81bn at end-October 2018, +10% higher than a year earlier.
Still, large-scale de-dollarization will take time – estimates range between 1.5 and five years.
FX reserves are adequate over a two-year horizon
Official foreign exchange (FX) reserves dropped from USD470bn at end-2013 to a low of USD308bn in April 2015 as a result of large capital outflows and large-scale FX interventions by the CBR in an attempt to fight the RUB depreciation at the time. Then the CBR discontinued those FX interventions in order to halt the decline in its FX reserves while at the same time capital outflows faded away.
Thereafter, FX reserves stabilized and began to increase again in 2017. At end-October 2018, reserves stood at USD379bn, a comfortable level in terms of import cover (13 months). In other terms, reserves cover thrice the external debt maturing in the next 12 months, well above an adequate level of 125%. Also when compared with peer countries, Russia does well on these indicators (see Figure 4). All in all, current FX reserves provide a cushion against a liquidity crisis on a macro level for the next two years or so. Yet, the future development needs to be monitored closely and is not fail safe.
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The View November-December 2018