Russia Special


Russia: Ruble free fall continues, Russian authorities will commit to 2015 budget

November 4, 2014

Pressure on the ruble has not subsided in past weeks due to a variety of domestic and international factors including a potential interest rate hike in the U.S., the ongoing conflict in Ukraine, Western sanctions and a sharp fall in oil prices. Despite the current backdrop of slowing economic growth and high inflation, Russian authorities have confirmed that they will not revise the budget for 2015, although they recognized that expenditure will have to be reduced in the two following years.

In an effort to support the currency, the Russian Central Bank temporarily resumed heavy currency interventions in October, spending nearly USD 24 billion over the course of the month, which has led to a further drop in foreign exchange reserves. In spite of the intervention, the ruble weakened 8.4% in October and fell to a multi-year low of 42.7 RUB per USD on 31 October. Compared to October last year, the ruble was down 34.1%.

A number of factors exerted pressure on the Russian currency. Expectations of an increase in U.S. interest rates in 2015 have prompted investors to withdraw capital from emerging markets. In Russia’s case, capital outflows have been aggravated by the conflict in Ukraine, which has severely eroded investors’ confidence. Capital outflows totaled USD 13 billion in the third quarter, extending the capital flight for the 17th consecutive quarter. Capital outflows have reached USD 85.3 billion so far this year, which has already exceeded the amount that left the country in 2013 (USD 61 billion). The Central Bank expects that capital outflows will range between USD 85 and 90 billion this year, while the IMF estimates that capital outflows will reach USD 100 billion.

Moreover, Western sanctions have restricted Russian firms’ access to global credit markets and thus limited debt inflows into the economy. Finally, a sharp fall in oil prices in October has exacerbated the ruble’s fall. Oil accounts for about half of the country’s revenue and reduced oil income is likely to pull back domestic demand through less government spending. The combination of slowing economic growth, a falling ruble leading to higher inflation, as well as decreasing foreign exchange reserves has put the Central Bank in a difficult position. In order to support the currency and stem the rise in inflation, monetary authorities decided to hike the policy rate at their 31 October meeting, even though the rate hike will further constrain economic growth (see monetary policy text).

Although the economic outlook is worsening, Russian authorities recently stated that they will not revise the 2015 budget. The budget was compiled on the basis of macroeconomic assumptions that have already proven to be too optimistic. The budget assumes GDP growth of 1.2% in 2015, 2.3% in 2016 and 3.0% in 2017. In addition, the oil price is projected to average USD 100 per barrel in 2015, while oil is currently trading at around USD 85 per barrel. Private sector analysts are much less optimistic. In fact, FocusEconomics panelists forecast that the economy will grow just 0.5% in 2015 and 1.5% in 2016, with several panelists predicting an outright recession next year. Anatoliy Shal, Chief Economist at J.P Morgan, comments:

We cut our 2015 growth forecast to -0.8% from 0.9% previously. The revision is driven mainly by the change in our oil price assumption to $85/bbl (Brent) from above $100/bbl previously. In addition, expectations that the CBR will tighten monetary policy—to stabilize RUB and rein in inflation expectations—pose a further headwind to growth. The oil shock comes at a time when domestic demand has already been stagnating in recent quarters, impacted by geopolitical uncertainty, sanctions and tightening financial conditions. Sharply reduced oil windfalls are set to pull domestic demand further down into next year, in our view, with both consumption and investment demand expected to contract significantly.

Finance Minister Anton Siluanov acknowledged that economic growth could be significantly lower than the assumptions that are underlying the budget and stated that the government will prepare alternative spending plans, should sanctions remain in place beyond 2015. The government’s commitment to the spending plans in the 2015 budget will likely result in a higher fiscal deficit for 2015 than the 0.6% of GDP it currently expects. This prompted Russian officials to explicitly recognize that they may have to tap into the country’s Reserve Fund. According to the 2015 budget, as much as RUB 500 billion (USD 12 billion) from the RUB 3.5 trillion (USD 92 billion) Federal Fund could be used to cover the shortfall in revenue.

Despite the Central Bank’s tightening measures, inflation is likely to rise further and harm consumers’ purchasing power, thus affecting the outlook for private consumption. At the same time, lower oil prices will limit the government’s ability to support the economy with fiscal stimulus measures.

Author:, Senior Economist

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