Russian economy set to dive deep in 2015

• We cut our 2015 GDP forecast to -7.9% y/y, from -1.8% y/y previously.

• Fixed investments will be hit the most.

• We expect Russia’s economy to expand after 2016.

Assessment and outlook

We downgrade significantly our 2015 and 2016 GDP outlooks for the Russian economy as the oil price has been decreasing and Russia’s central bank (CBR) has caused considerable monetary contraction. We expect the Russian economy to shrink 7.9% y/y in 2015 and 0.8% y/y in 2016. We expect quarterly GDP growth to hit its bottom in Q2 15, falling 11.3% y/y.

Due to geopolitical woes, introduced western sanctions and Russia’s counter-measures both the cost of foreign capital and consumer prices have accelerated significantly. From 6.1% y/y in January 2014, CPI hit 9.4% y/y early in December 2014, while the CBR’s target for 2014 was 5.0% y/y. At the same time as the rouble weakened partly due to geopolitical woes and sovereign rate cuts but mostly because of the plunge in the oil price, the CBR hiked its key rate by 1,150bp to 17.0% during 2014 to support the currency. Capital outflows accelerated significantly as citizens and corporations ran from the rouble and entered FX, causing a significant supply-side shock. We expect capital outflows to rise to USD130bn in 2014 but moderate in 2015 due to the weaker oil price. At the same time, tight monetary policy and negative sentiment have caused outflows in portfolio investments.

We see that fixed investments will be hit the most, falling 12.0% in 2015 on a halt in loans and supply-side shock. The geopolitical environment is weighing on foreign direct investments. Thus, we expect major investments in 2015-16 to come from the Russian state. However, the lower oil price is limiting budget expenditure and the government is already planning to cut it by 10% in 2015. We expect private consumption to see a deeper fall than we previously expected – from -1.2% y/y to -5.5% y/y in 2015 – on weaker loan growth and surging non-performing loans, as high the CPI and weak rouble affect the purchasing power of Russian consumers. However, we do not see the unemployment rate rising significantly, due to weak demographic factors, which hark back to the 1990s.

We expect possible growth of the Russian economy after 2016 at the earliest, as domestic production gets stronger and substitutes falling imports. Thus, we expect the current account to see a surplus as imports continue to fall and the rouble floats freely. Upside risks for our new outlook are a surging oil price, easier monetary policy and the revoking of sanctions, which would improve sentiment. We estimate that if we see Brent staying at an average USD100/bl in 2015, the GDP contraction would be less than 2% y/y, getting support from a better performance for private consumption.