Baku, Azerbaijan, Dec. 12
Trend:
The rise in interest rate in Russia will constrain domestic demand and hasten the move into recession, Fitch Ratings said Dec. 12.
The Central Bank of Russia increased its main interest rate by 100bp to 10.5% on Thursday. It said that the rouble's fall in 2H14, together with trade restrictions, means year-end inflation will be around 10%. The rouble fell to a record low against the dollar immediately after the decision.
"Russia's latest interest rate increase highlights the challenges to policy makers from rising inflation and the falling rouble, Fitch Ratings says. "These are set to increase in 2015 as the economy deteriorates, downside risks accumulate, and inflation reaches double digits."
The combination of sanctions, lower oil prices and a falling exchange rate led us to cut our growth forecasts for Russia (BBB/Negative) in our December "Global Economic Outlook". We forecast real GDP to contract by 1.5% next year, with zero growth in 2016, the report says.
Exogenous downside risks include possible tightening of sanctions if the conflict in Ukraine escalates, and further oil price falls. Our simulations suggest a sustained fall 20% below our baseline (Brent to average USD83/b in 2015 and USD90/b in 2016) could cause an additional 1.3% decline in real GDP next year and a cumulative 2.3% reduction by 2016, accompanied by steep falls in the current account surplus and international reserves.
The CBR's readiness to raise rates supports our view that Russia's policy framework remains robust. President Putin acknowledged the CBR's independence in his annual address to the Federal Assembly last week. The Finance Minister has said capital and currency controls would be unacceptable, and the Ministry of Finance has yet to disburse large sums from the National Wealth Fund despite requests from companies and banks affected by sanctions.
"But the policy framework could come under growing pressure," the agency said. "The prospect of double-digit inflation points to additional rate rises at a further cost to growth. The size of the oil price fall implies large spending cuts if the MoF sticks to the fiscal rule, which is based on the average price for the last five years, in 2015-2017. This would be in contrast to the sharp spending increase when oil prices fell in 2008-2009, which was also facilitated by larger sovereign wealth funds (around 16% of GDP in 2008 versus 9% now)."
Pressure for capital controls could increase if the rouble continues to fall. President Putin talked about "harsh" measures against "speculators" in his annual address. He also offered a tax amnesty to attract back fled capital. But he offered little that could be interpreted as a prelude to broader structural reforms.
End-2014 forecasts suggest Russia's sovereign and external balance sheets, which are key ratings supports, are largely intact. Reserves have fallen by around USD100bn this year and the CBR has resumed currency market interventions, but they remain substantial at over USD410bn. The floating exchange rate has cushioned public finances. The federal budget was in surplus by 1.9% of GDP in January-October. Public debt is low, net external debt has remained virtually unchanged at around 16% of GDP and the sovereign net foreign asset position is still strong at 20% of GDP, the report.
But as the economy slows and sanctions remain (one reason net external debt held steady this year is that sanctions-affected borrowers cannot refinance external liabilities), the private sector will continue to make demands on the sovereign and external balance sheets. The deteriorating growth outlook, coupled with the magnitude of the external shocks and their impact on credit fundamentals, will be key drivers of Russia's rating in 2015, the report says.