27/4/17: Russian Economy Update, Part 3: Ruble and CBR Rates

The following is a transcript of my recent briefing on the Russian economy. 

This part (Part 3) covers outlook  for ruble and monetary policy for Russia over 2017-2019. Part 1 covered general growth outlook (link here) and part 2 covered two sectors of interest (link here).

Outlook for the ruble and CB rates

The ruble has appreciated this year about 6.6% against the US dollar, from 61.15 at the start of 2017 to just above 57.10 so far, and 3% against the euro from 64.0 to 62.06, compared to the start of 2016, ruble is up on the dollar ca 21.3% and on the euro some 22.4%

• The ruble has been supported by the strengthening in the trade surplus in late 2016 into early 2017, and by improved foreign investment inflows
• The ruble has been on an upward trend after hitting the bottom at the start of 2016
• However, rate of appreciation has fallen in recent months, while volatility has risen
• March real effective (trade-weighted) exchange rate (RER) was up nearly 30% y/y, as reported by BOFIT (see chart below)
• As noted by some researchers (e.g. BOFIT), “in Russia, exchange rate shifts tend to pass through relatively quickly and strongly to consumer prices, so ruble strengthening tends to curb inflation” which, in turn, increases private and fiscal purchasing power
• Another effect of the ruble appreciation is that it lowers government ruble-denominated tax revenue through direct link between energy exporting taxes (oil and gas) and oil prices, which are denominated in dollars 

For domestic businesses, a stronger ruble:

• Reduces their price competitiveness with respect to imports, but also 
• Lowers the cost of imported capital, technology and intermediates
• Majority of Russian manufacturers are relatively highly dependent on such imports and have very limited non-ruble exports

• Stronger ruble has very limited effect on the volume of Russian exports, primarily due to heavy bias in exports in favour of dollar-denominated energy and other primary materials
• Ruble appreciation reduces the costs of foreign debt service for firms (a positive for larger firms and banks) and can lead, over time, to lower borrowing costs within Russian credit markets (a positive for all firms)

In line with the export-import effects discussed above:

• Volume of Russian exports grew by over 2 % last year (primarily driven by oil and gas prices recovery and continued elevated volumes of Russian production of primary materials), plus by another (second consecutive) year of grain harvests 
• In 2017, export growth should slow as both harvest and energy prices effects dissipate
• Volume of exports of goods and services fell 1.87% in 2014, 0.41% in 2015 and 0.68% in 2016. Current forecasts suggest that the volume of exports will rise 4.5-4.6% in 2017
• Volume of imports was much harder hit by the crisis
• Volume of imports of goods and services fell 7.6% in 2014, followed by 25.0 drop in 2015 and 4.0% decline in 2016
• Current forecasts suggest strong, but only partial recovery in demand for imports, with volumes expected to rise 7.0-7.2% in 2017
• Key driver for imports growth will be the recovery in aggregate demand, plus appreciation of the ruble
• Key downward pressure on imports will continue to come (as in 2016) from trade sanctions and from ongoing reforms of public and SOEs procurement rules and systems (more on this later)
• Russia’s current account surplus contracted last year to less than 2% of GDP, printing at USD 22.2 billion, down from USD69 billion in 2015
• 2017 projections of the current account surplus range widely, although no analyst / forecaster projects a negative print, despite expected increase in imports
• IMF’s most current (April 2017) projection is for 2017 CA surplus of USD51.5 billion
• This level of CA surpluses would stand above the 2014-2016 average (USD 49.6 billion), but below 2010-2013 average (USD67.4 billion) and lower than 2000-2007 average (USD 55.7 billion)
• If IMF projection comes through, CA surplus will be supportive of significantly tighter fiscal deficit than currently projected by Moscow
• As a percentage of GDP, CA surplus is expected to come in at 3.30% in 2017, slightly above 2014-2016 average of 3.19% and slightly below the 2010-2013 average of 3.42% of GDP

Inflation

• With Russian inflation falling and current account surplus strengthening, 2017 will witness further pressures on the ruble to appreciate vis-à-vis the dollar and the euro
• Russia’s annual inflation fell below 5% in 1Q 2017
• The CB of Russia has kept a relatively tight monetary stance, holding the key rate at nearly 10% through most of 1Q, as consistent with the CBR strict targeting of the inflation rate (4% inflation target set by the end of 2017)
• CBR dropped rate to 9.75% at the end of March, noting a faster-than-expected drop in inflation and a slight decline in inflation expectations 
• Inflation fell from 4.6% in February to 4.5% in March and 4.1% as of mid-April
• 12-month forecast now at 4.3%
• CBR governor Nabiullina said the central bank does not share the finance ministry's view of a overvalued ruble, which is consistent with her projecting continued cautious stance on inflation
• Finance Minister, Anton Siluanov, recently stated that the ruble is overvalued by 10–12%
• Consistent with this, I expect a 25 bps cut at April 28th meeting of CBR Council and year-end (2017) rate target of around 8.25-8.5% if inflation remains on the path toward 4.3% annual rate, or 8.75-9% range if inflation stays around 4.6% annual rate