A recent trip to Moscow on the 100th anniversary of the 1917 revolution revealed not a whiff of revolutionary change in the economy, but rather stagnant growth mixed with structural stability. We could simply call it “stagnant stability.”
Despite the hit to real incomes, the country weathered the 2014–2015 double shock of collapsing oil prices and Western sanctions far better than anticipated. Yet the consequences of that crisis are still felt in the economy: Russia’s current account surplus is likely to settle around 2% (far lower than earlier in the decade, but still above that of most oil-exporting countries), and real GDP growth is predicted to eke out 1.5% or so in 2017.
On the bright side, despite the tepid rebound, Russia proved its resilience to shocks, in no small part thanks to orthodox policymaking by the Central Bank and Ministry of Finance. The latest examples of what we believe are prudent policies are the freeze on nominal expenditure and a fiscal rule designed to sterilize oil revenue above $40/barrel and replenish the Reserve Fund by purchasing U.S. dollars in the market (assuming no budgetary deficit). A strong signal that policymakers intend to prevent wasteful spending, the measure is even more impressive coming just a year ahead of presidential elections.
Sanctions: outlook and impact
While the likelihood of U.S. and European sanctions removal is difficult to estimate given the murky international political climate, we believe there are four key considerations on this front:
- Sanctions removal is far from assured given U.S. congressional hawkishness toward Russia and the dimming prospects of pro-Russia French presidential candidate François Fillon. Rather than a blanket lifting of sanctions, there may be piecemeal adjustments that alleviate the choke on individual industries.
- The impact is more likely to be felt via the capital account (additional foreign asset purchases) than in the real economy. Russia’s investment climate remains subpar given transparency issues, and restored trade ties with Europe, for example, may not translate into a wave of foreign direct investment. Banks report lukewarm demand for loans from Russian corporates as they see a dearth of investment opportunities in the local economy.
- With over 35% of budgetary receipts, 60% of exports and circa 10% of GDP, the oil and gas sector is and will remain the key driver of Russia’s prospects. Just as the introduction of sanctions proved less dire for the country’s GDP than feared, so will their removal be less of a boon than hoped.
- The surge in the ruble and rally in the country’s credit and CDS spreads (see chart) suggest markets have already priced in a favorable (for Russia) outcome with regards to sanctions. An actual removal may thus do little to further fuel asset prices.
For bond investors, however, Russia may appear to be a “safe(r)” haven in times of emerging market volatility than less stable emerging market countries. Despite its hawkishness and razor-sharp focus on achieving 4% inflation, the Central Bank is likely to cut rates later in 2017. And even if the ruble’s rally may be running out of steam, we believe it remains an attractive currency on a carry-to-volatility basis.
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Yacov Arnopolin is an emerging market portfolio manager and a contributor to the PIMCO Blog.