Russia: Stability has been maintained thanks to a strong macroeconomic policy framework, but growth prospects remain weak

A strong macroeconomic framework

Since 2014, the Russian authorities have put in place a strong macroeconomic framework in the form of inflation targeting, a flexible exchange rate and prudent fiscal policy (with the adoption of a fiscal rule). They have even implemented some unpopular reforms such as an increase in VAT in January 2019 and a pension reform in summer 2018. The sound macroeconomic policies have helped the country to weather the external shocks (lower oil prices and sanctions) relatively well. As a result, macroeconomic stability has been maintained. The current account balance remains in surplus, gross foreign exchange reserves are high, external debt is low and public finances are sound with general government debt below 20% of GDP and the fiscal balance back in surplus. Even taking into account the infrastructure spending announced in the May 2018 presidential decree, public debt is expected to remain low. The main risk for public finances remains the reliance on oil revenues. The rouble is stable and has even appreciated year-to-date. That being said, it remains vulnerable to external shocks. Inflation has increased slightly following the increase in VAT from 18% to 20% but is again on a downward trend, which has allowed the central bank to cut its benchmark interest rate (see graph 1). The average lending rate is therefore likely to follow the same path and decrease. Despite weaknesses in small banks, the banking sector is more stable, even if there are risks from expansion in household credit.

Sluggish economic growth prospects

Despite the strong macroeconomic policy framework, inflows of net foreign direct investment remain largely in negative territory. This is explained by various factors, including the continuous threat of further sanctions being imposed on the country, but also more domestic reasons related, among other things, to institutional quality and expropriation risk, as highlighted by Credendo’s category 5/7 for expropriation risk.

One key weakness of the Russian economy lies in its low economic growth prospect amid a lack of competition, negative population dynamics, low productivity growth and a weak institutional framework. To remediate this low-growth environment, President Putin announced ambitious reforms – in a presidential decree in May 2018 – aimed at boosting productivity and growth, reducing poverty and extending life expectancy. These objectives have been translated into national projects that envisage an increase in public spending on infrastructure, health and education (and are partly financed by the increase in VAT). Despite this ambitious plan, growth prospects have so far remained low. The IMF expects a real GDP growth rate of 1% this year (see graph 2) and a small rebound next year as the national projects are expected to be implemented.

Looking ahead, the main risks remain the same for this big commodity exporter: the imposition of additional sanctions and a sharp decrease in commodity prices. The global trade environment constitutes another risk as the country was indeed not immune to trade tensions, suffering from the US tariffs on steel and the fallout from low global growth. That being said, Russia has large external buffers and is in a better position than in 2014 thanks to its sound policy framework.

Analyst: Pascaline della Faille – P.dellaFaille@credendo.com