Comment

Why we should look forward to a resurgent Russia

Moscow skyline

Low oil prices and economic sanctions are the two major challenges facing Russia today. But they are also key factors driving reforms from which the Russian economy will emerge greatly strengthened.

This may sound paradoxical, but the fall in the price of crude, taken together with the need to reduce external debt as a result of sanctions, have combined to give powerful momentum to reform.

That Russia is already adjusting to this radically changed landscape is an early sign of the gains to be had from seizing the new opportunities. The year-on year change in gross domestic product (GDP) is estimated at -3.7pc in 2015, but it is not inconceivable, under certain assumptions, that this could turn positive this year and next, by around 0.4pc and 1.9pc respectively. The response of the Russian authorities to what could have turned into a grave crisis has shown that the lessons of the past may have been learned.

Perhaps most important in terms of the official response was the decision in November 2014 to float the rouble, which has allowed the currency to “take the hit” in terms of absorbing much of the market response to the crisis. It has fallen from an average 31.9 to the US dollar in 2013 to an average 61 to the dollar in 2015. This is set to bolster Russia’s trade balance, from $143.9bn in 2015 to a forecast $148bn in 2016 and $173.1bn in 2017.

But it is not a cost-free option and has resulted in higher price rises and a consequent reduction in living standards. Inflation ran at 12.9pc in 2015, up from 11.4pc the previous year. But it is forecast to decline to 7pc this year and 6.1pc next year, while the official target is more ambitious still.

The Russian political model, whether you agree with it or not, has proven to be more stable than, let’s say, the Brazilian. For investors this stability and predictability has costs but also some benefits. In part, it can be credited to low and falling unemployment; according to the Federal State Statistics Service, the jobless total declined steadily from 5.5m in 2010 to 4.1m in 2013 and 3.9m in 2014.

If floating the rouble was one key element of reform in Russia, another occurred in the capital markets. Under the auspices of the Central Bank of Russia, the Moscow Exchange was strengthened to give the country its own, world-class financial-system capability. The fruits of this reform can be seen in the net profits of the finance sector, which having registered at 1.6pc below their 2008 level in 2014, bounced back strongly to record an estimated 660.6pc in 2015. But more needs to be done. A top priority must be the control of inflation. This was running at 9.8pc in the year to January 2016, and the CBR has a target for 2017 of 4pc. Were it to go in the other direction and reach 20pc or more, this would cause enormous damage to the banking sector.

Alongside inflation there is the need to tackle reform to social benefits such as pensions. In a number of occupations, from school-teaching to the police, people are retiring ten to 15 years below the official pensionable age. This will prove an unpopular reform and may be postponed until after parliamentary elections in September.

Finally, the privatisation of public sector monopolies has a vital role to play. We expect to see the first wave of privatization to come to the market in the later part of this year. We also expect the government to continue pressuring companies they control to disburse more of their profits through higher dividends.

Until now, reform has been forced on the government. It did not go down a populist route but acted responsibly. And we believe Russian policy makers will remain responsible. Demands to support growth through aggressive placement of new debt, spending of reserves or through overly expansive monetary policy by the Central Bank of Russia will be shot down by the Kremlin. 

The only real alternative to create sustainable growth in Russia is through proper, market-oriented reforms. So far the Kremlin has been reactive and it now needs to be pro-active.

We need always to remember that, even when oil was trading at $100 a barrel, Russia had problems in terms of slowing growth, and President Putin was speaking of the need for a more balanced economy with greater private-sector activity. Now, lower oil prices have helped to drive reform; even sanctions have had beneficial macro-economic and financial effects – they have meant cuts in Russia’s external debt of 30pc in the last year and a half – it has fallen from a peak of $733bn in mid-2014 to $515bn in early 2016 - and have forced the clean-up of the banking sector, with stricter regulations.

We have seen oil prices steadily rise in recent months due to a mixture of sustainable demand growth and a series or supply disruptions. We expect the oil market to continue to rebalance and see prices at $60 per barrel by year end. 

Investors have expressed their approval of the reform process to date. Capital outflows have declined significantly, the equity market is among the top performers among emerging-market economies and the levels of credit default swaps show risk in Russia in decline.

External pressures forced the first wave of reform in Russia. The next wave will come from the determination of Russians themselves.

Yossi Dayan is the head of markets for BCS Global Markets

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