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Russia Country Risk Report Q2 2016

Russia Country Risk Report Q2 2016

Core Views

President Vladimir Putin's popularity remains near record-highs,although we expect this to moderate as economic hardship continuesto be realised by the general public. Despite the deterioration inliving standards, we do not expect any mass uprising in responseto the deteriorating economy.

Persistently low oil prices, fiscal austerity, weak investment growthand declining real incomes will lead to a second consecutive realGDP contraction of 0.7% in 2016, followed by only a modest recoveryto 1.5% growth in 2017.

Russia's long-term growth potential is subdued, closer to that ofmature developed economies rather than a higher growth emergingmarket. This is due to the highly centralised nature of the economicmodel and large government footprint in key sectors, reliance onenergy exports, poor business environment, weak investment growthand lack of structural reform momentum.

Russia's external position will remain a bright spot for the economydespite a fall in the price of its main commodity exports, with thecurrent account surplus remaining in relatively robust surplus in thecoming years as imports remain subdued. Over the coming quarterswe expect little financing pressure to emerge in the economy as itslarge international reserves position remains sufficient to entirelycover maturing external obligations during 2016-2017.

While Russia's fiscal position is bolstered by very low public debt ratiosand fiscal reserves at its disposal, the sovereign profile will deterioratein the coming years and major fiscal reforms – such as an overhaul ofthe pension system – will be necessary to ensure long-term sustainabilityof the public finances in light of lower commodity prices.

Major Forecast Changes

We maintain our real GDP growth forecast for 2016 at -0.7%, althoughwe have downgraded our forecast for 2017 from 2.3% to 1.5% y-o-yas lower oil prices will prolong a recovery in the Russian economy.

With inflation proving sticky and oil price declines keeping depreciatorypressure on the rouble, we now expect monetary easing toproceed at a slower pace. We have revised up our end-2016 forecastto 9.00%, from 7.00% previously.

With oil price declines at the start of 2016 rendering the government'sbudget assumptions unrealistic, we have increased our budget deficitforecast from 2.8% to 4.0% of GDP in 2016.


Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Recovery Delayed Amid Slumping Oil Prices
Oil price declines have put a Russian economic recovery out of reach in 2016, when we forecast real GDP to contract by 0.7%.
Households will continue to bear the brunt of the recession, as rouble depreciation, elevated inflation and government budget cuts drive
further declines in purchasing power and real incomes. A rebound in oil prices and easing of Western sanctions will facilitate a recovery
to 1.5% growth in 2017.
GDP By Expenditure Outlook
TABLE: GDP GROWTH FORECASTS
TABLE: PRIVATE CONSUMPTION FORECASTS
TABLE: GOVERNMENT CONSUMPTION FORECASTS
TABLE: FIXED INVESTMENT FORECASTS
TABLE: NET EXPORTS FORECASTS
External Trade And Investment Outlook
External Position Remains Bright Spot
Russia will maintain a relatively large current account surplus position in the coming years in spite of the terms of trade shock from lower
oil prices, as weak domestic demand keeps import growth at bay.
Outlook On External Position
TABLE: CAPITAL & FINANCIAL ACCOUNT BALANCE
TABLE: TOP FIVE IMPORTS SOURCES AND PRODUCTS IN 2014
TABLE: TOP FIVE EXPORT DESTINATIONS AND PRODUCTS IN 2014
Fiscal Policy And Public Debt Outlook
Sovereign Profile Deteriorating Further In 2016
With recent oil price declines rendering the Russian government's already austere 2016 budget untenable, additional spending cuts will
be necessary to keep the fiscal deficit in check. We forecast the deficit to rise to 4.0% of GDP in 2016, and expect the Reserve Fund to
be depleted by 2017. With public debt ratios also creeping higher, albeit from low levels, Russia's sovereign profile will continue to suffer
amid lower oil prices and a weak growth outlook.
TABLE: BUDGET EXPENDITURES BY FUNCTION, % OF TOTAL
Structural Fiscal Position
TABLE: MAIN REVENUE & EXPENDITURE CATEGORIES
Monetary Policy
Monetary Easing Delayed Until H216
Oil price declines and rouble depreciation at the start of 2016 have delayed the potential restarting of monetary easing from the Central
Bank of Russia, although we continue to expect 200bps worth of interest rate cuts in H216 as FX base effects and depressed domestic
demand ease inflation.
TABLE: MONETARY POLICY FORECASTS
Monetary Policy Framework
Currency Forecast
RUB: Rallying With Oil In H216
The Russian rouble will remain tightly correlated to oil in 2016, keeping volatility elevated in H116 as commodity prices find a base.
We expect a supply correction in the oil market to take shape in H216, driving a rally in energy prices and the rouble. However, after
outperforming Brent as prices fell, we expect the rouble to underperform during the rebound.
TABLE: BMI CURRENCY FORECAST
Chapter 2: 10-Year Forecast
The Russian Economy To 2025
Structural Deficiencies Weighing On Growth Potential
We forecast Russian growth to slow markedly over our 10-year forecast horizon, with average real GDP growth of just 1.6% between
2018 and 2025. Russia's convergence towards developed standards of wealth will slow considerably over this time due to structural
factors weighing on growth potential including a weak business environment, poor institutional capacity and a declining population.
TABLE: LONG-TERM MACROECONOMIC FORECAST
Chapter 3: Political Outlook
SWOT Analysis
BMI Political Risk Index
Domestic Politics
Economic Woes Sapping Government Support In 2016
Falling living standards in Russia are eroding the ability of nationalist sentiment and aggressive foreign policy to prop up the
government's approval ratings. The potential for social unrest is gradually building, as the economy enters its second year of recession
and the September 2016 parliamentary election approaches.
TABLE: POLITICAL OVERVIEW
Regional Politics
The Syrian Conflict In A Global Context
The Syrian civil war must be viewed as part of a wider proxy conflict encompassing a vast swathe of South Western Eurasia. At the
same time, there is an intensifying geopolitical struggle taking place in East and South East Asia. These two struggles will redefine the
world order for decades to come.
Long-Term Political Outlook
Putin Facing Far Greater Challenges Over 2016-2025
President Vladimir Putin will face tougher political challenges over the coming decade, as a result of a deterioration in relations with the
West, a weaker economy, ongoing demographic decline, and the Islamist insurgency in the North Caucasus. Although Putin's popularity
stood at near record-highs through much of 2015, economic disruption means his support will fall, and that he will face increased
opposition later this decade.
Chapter 4: Operational Risk
SWOT Analysis
Operational Risk Index
Operational Risk
Trade Procedures And Governance
TABLE: OPERATIONAL RISK
TABLE: EMERGING EUROPE – TRADE PROCEDURES AND GOVERNANCE RISK
Vulnerability To Crime
TABLE: EXPORT AND IMPORT DOCUMENTS
TABLE: TRADE PROCEDURES BREAKDOWN
Chapter 5: BMI Global Macro Outlook
Global Macro Outlook
Downside Risks Gather Momentum
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %
TABLE: MACROECONOMIC DATA & FORECASTS

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