Journal Issue

2. Developments in Russia

Ara Stepanyan, Agustin Roitman, Gohar Minasyan, Dragana Ostojic, and Natan Epstein
Published Date:
November 2015
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In 2014 the Russian economy was hit by sanctions and rapidly falling oil prices. These shocks led to significant balance of payment pressures with a surge in capital outflows and depreciating exchange rate. Consequently, akin to a sudden stop, external financing conditions worsened substantially.

The economic outlook for 2015–16 is weak, as sanctions and oil price shocks are expected to persist.

  • Growth and inflation: Sanctions and a sharp drop in oil prices are expected to cause Russia’s GDP to contract by 3.4 percent in 2015. The fall in oil prices will significantly affect real incomes and investment prospects, hence taking a toll on domestic demand. Net capital outflows are likely to remain elevated in 2015 due to Russia’s limited access to international capital markets. This will add to pre-existing structural bottlenecks and sanctions imposed during 2014, resulting in a recession in 2015. Since December last year oil prices have recovered somewhat supporting the ruble, which has appreciated by about 4 percent against the dollar in first half of 2015. The Russian economy contracted by 1.9 percent (year-over-year) in the first quarter of 2015, mainly reflecting a decline of household real incomes. However, the decline in industrial production was smaller than expected partly supported by a weaker ruble. Inflation should decline rapidly over the next two years. While the oil price drop and sanctions impact potential output, the cyclical downturn will open a small output gap in 2015-16. This, together with the dissipating effect from the exchange rate pass-through, partial public wage indexation in the 2015 budget, and the recent ruble appreciation, will set the stage for inflation to fall to 12.5 percent at end-2015 and 7.8 percent in 2016. Given the long-lasting nature of these shocks and pre-existing structural challenges, Russia’s long-term growth projection was reduced by 2 percentage points in 2015 relative to the 2013 projections.

  • External adjustment: The external sector adjustment is underway. In the first quarter of 2015, imports’ compression reflects both weak domestic demand and expenditure switching due to the ruble depreciation. Exports values fell with global oil prices but volumes have remained broadly constant. External deleveraging continued in the face of limited market access, with external debt falling to USD560 billion at end-2015Q1 from USD730 billion at end-2013. These developments would have major adverse spillovers on economies with strong economic links with Russia.

The authorities’ macroeconomic policy response stabilized the economy. Monetary policy was tightened and exchange rate flexibility was brought forward amidst market turbulence. Measures to support financial stability were also introduced. All these policy steps helped contain the balance of payment and banking sector pressures.

  • Monetary tightening. The Central Bank of Russia (CBR) started increasing interest rates at a measured pace in early 2014, lifting the policy rate from 5.5 percent to 9.5 percent while relaxing the exchange rate band from the second half of the year. However, when market pressures intensified, the CBR floated the ruble in November to facilitate a more rapid adjustment to external shocks and curb reserve losses. Subsequently, the central bank raised the policy rate to 17 percent, including by 650 basis points on December 16th. The latter hike aimed at limiting financial stability risks following the large currency depreciation and volatility in December. In addition, the CBR expanded its FX liquidity provision and launched a package to support the banking system. The CBR started to withdraw the emergency policy rate increases in early 2015, as financial market conditions, the exchange rate, and bank deposits stabilized.

  • Stabilizing the banking sector. In December 2014, the CBR introduced temporary regulatory forbearance on loan classification, provisioning, and valuation accounting amid ruble depreciation and market volatility.2 The measures were appropriately combined with intensified supervision and their elimination will start in July 2015. To shore up banks, the government launched a Rub 1 trillion bank capital support program (1.5 percent of GDP) together with the use of up to Rub 400 billion from the National Wealth Fund (NWF).3 Twenty-seven large banks, selected sanctioned banks, and top regional lenders qualify for the support. In exchange for public funds, the banks must comply with CBR’s prudential requirements, raise their own funds equal to at least half of the government support (with an exception made for (partly) state-owned banks), increase lending by 1 percent per month for three years, and commit to not raising management salaries or the overall wage bill for three years. Finally, the authorities refrained from the use of capital controls.

  • Limited fiscal stimulus. The government introduced an anti-crisis plan, including a 2 percent of GDP bank capital support program, and revised its 2015 budget to reallocate spending to priority sectors. Spending was reallocated to priority areas such as support to the manufacturing sector, and social payments, while some programs were cut by 10 percent and public wages were partially indexed to inflation. The budget also includes limited tax cuts (about 0.2 percent of GDP). Additional measures include budget credit to regions, federal credit guarantees, and use of the NWF to support systemically important enterprises and banks.

Significant risks and uncertainty remain, but Russia has large buffers. A possible intensification of geopolitical tensions would further dampen the outlook and increase balance of payment pressures. Lower oil prices, higher uncertainty, and tighter financing conditions would further dampen activity. In addition, should the authorities pursue inward-looking policies or increase the role of the state in the economy, the positive effect from a more competitive exchange rate would likely be limited. Although most corporations have enough cash on hand to finance their external debt coming due and have natural hedges due to energy exports, deleveraging would entail reducing investment, which if sustained would further affect potential output. However, against the risks to the balance of payments, Russia has a net positive international investment position (18 percent of GDP), a sizable current account surplus of 4 percent of GDP, low public debt, and no need to access international markets for government financing due to the Reserve Fund (RF) buffer.4 Moreover, the CBR’s international reserves remain ample and balance sheet currency mismatches are low. Thus, existing buffers reduce the likelihood of a systemic event.

While regulatory forbearance could cushion the adverse impact of the shock on banks in the short run, it should be reversed once conditions normalized.

The federal government program has subsequently been reduced to Rub 830 billion, as estimates for capital support have been reduced. Recent CBR stress tests suggest that the government support for all the large eligible banks is sufficient to cover loan-loss provisioning and market losses under an adverse scenario.

The 2015 budget assumes gross financing from the RF, reducing considerably fiscal buffers for the future.

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