Russia to face recession on geopolitical woes

• We cut our 2014 GDP forecast to -0.3% y/y from +1% y/y.

• We see a supply-side shock from extreme capital outflows.

• We see a demand-side shock from tightening monetary policy.

• Downside risks for the Russian economy remain on possible new sanctions by the west.

Assessment and outlook

We cut our GDP growth forecasts to -0.3% y/y for 2014, down from 1.0% y/y previously and -1.8% y/y for 2015, versus 2.2% y/y previously, as recent net outflow statistics show extreme acceleration in Q1 14 due to increased geopolitical risks and monetary policy having tightened. In Q1 14, the total amount, which includes banks’ FX operations, has exceeded total 2013 outflows. Net capital outflows by private sector with local banks’ FX operations reached USD63.7bn in Q1 14. Without banks’ FX operations, outflows were USD50.6bn. Banks started to secure their FX positions as capital control fears arose. We expect net capital outflows to hit USD120bn in 2014.

We see this as a significant supply-side shock, which will be seen in economic data with a lag but as early as H2 14. The shock will further curb fixed investments and have a significant impact on business sentiment and productivity growth – two crucial things needed for the Russian economy to expand.

As Bank Rossii has tightened its monetary policy in response to supporting the RUB’s rapid devaluation caused by geopolitical fears, we expect the demand-side shock to hit private consumption and investment by local corporations. Yet, we expect private consumption growth to slow down to 1.2% y/y in 2014 and fall 2.2% y/y in 2015.

Downside risks for our forecast include escalating geopolitical woes surrounding Ukraine, new economic sanctions by the EU and the US towards Russia and sudden rate hikes by Bank Rossii to support the RUB and curb accelerating inflation. Upside risks to our forecasts are permanent de-escalation of the situation regarding Ukraine, Bank Rossii’s significant rate cuts and clear investment plans by the Russian government. However, if realised, upside risks would affect the economy mostly in 2015 due to the lag effect.