Russia: Weathering a U.S. storm

Russia: Weathering a U.S. storm

  • 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