99230 Russia Monthly Economic Developments July 2015  In June, the European Council extended EU economic sanctions against Russia for another six months while Russia extended its food import ban against Western countries for a year.  A fluid situation on global financial markets and yet again lower growth prospects led to oil prices losing ground in early July.  Ruble depreciation pressure remained throughout June as demand for foreign currency increased while supply declined slightly due to lower oil prices.  Russia’s first quarter GDP growth was revised from -1.9 to -2.2 percent−still slightly less than projected earlier−while May high frequency statistics show a deepening recession.  On June 25, the government approved the main parameters for the 2016–2018 budgets, foreseeing persistent deficits and evaporating fiscal buffers despite significant expenditure cuts. In June, the European Council extended EU especially for countries with tight trade, economic sanctions against Russia for remittance, and bank links. A slowdown in the another six months while Russia extended its Euro area, which accounts for more than one- food import ban against Western countries sixth of global GDP, and in excess of one-quarter for a year. The EU measures were originally of global trade and cross-border banking system imposed in July 2014 and reinforced in assets, could raise sovereign and corporate risk September 2014. They target certain premia, as investors reassess growth prospects, exchanges with Russia in the financial, energy and defense and might force some countries to tighten fiscal policy. Global sectors and dual-use goods. The latest decision on June 22 growth is expected to average 2.8 percent in 2015, slightly follows an agreement at the European Council in March 2015, lower than the 3 percent anticipated in January. While China is when EU leaders linked the duration of these sanctions to the slowing as expected, and the recession in Russia appears complete implementation of the Minsk agreements, which is slightly less severe than initially predicted, deteriorating anticipated by 31 December 2015. A few days later, Canada prospects in Brazil and across major oil exporters are extended the list of sanction individuals and companies, contributing to the downward revision of developing country including Gazprom. On 24 June, President Putin announced growth to 4.4 percent (from 4.6 percent in 2014). that Russia is extending its ban on food imports from EU and A fluid situation on global financial markets and yet again other developed countries for another year, until August 6, lower growth prospects led to oil prices losing ground in early 2016. There was no significant impact on the markets, but July. During June, Brent prices averaged US$64 per barrel, major ratings agencies announced that, as a result, Russia’s slightly lower than in May. The global oil market is still sovereign rating is likely to remain below investment grade. oversupplied with OPEC’s oil output exceeding 31.3 million Risks to the global outlook remain tilted to the downside; in barrels per day (1.3 million barrels per day above its stated particular, tighter financial conditions could combine with quota, which is becoming increasingly obsolete). Iran has deteriorating growth prospects in commodity-exporting agreed on a deal to enable the lifting of sanctions, and if (or countries, to raise the possibility of greater financial stress. when) those sanctions are lifted, Iran could add some 0.6 Euro area growth has gained momentum and has been revised million barrels per day to the global market by the end of 2016. upwards to 1.5 percent for 2015, yet the recovery is still fragile U.S. oil production has been robust with oil output expected (World Bank Global Economic Prospects, June 2015). to average 12.3 million barrels per day next year, (U.S. Energy Additional easing by the European Central Bank in 2014-15, Information Agency). The U.S. oil rig count (indicating U.S. including the launch in March 2015 of a quantitative easing future oil supplies), reached a low of 628 at end-June but program, brought long-term interest rates to record lows in increased in early July for the first time since December, both core and periphery countries. However, an extended signaling a likely end to the downward adjustment. The World period of uncertainty and Euro area stagnation—perhaps Bank projects oil prices to average US$58 per barrel in 2015 triggered by spillovers from renewed economic and financial and US$64 per barrel in 2016. stress in its periphery—could have global repercussions, RUSSIAN FEDERATION Monthly Economic Developments – July 10, 2015 Figure 1: Oil prices fell again … Figure 2: … and depreciation pressure on the ruble is mounting USD/barrel count 120 1800 30 1600 40 100 1400 50 80 Brent 1200 60 WTI 60 US Oil Rig Count (right scale) 70 1000 40 80 800 90 20 600 Source: Bloomberg, Bakes Hughes, and World Bank Ruble/US$ Ruble/Euro Ruble/Dual cur. basket Source: CBR Ruble depreciation pressure remained throughout June as decision to cut key policy rates by 100 basis points, less than the demand for foreign currency increased while supply declined 150 basis points reduction in April. slightly due to lower oil prices. The average ruble exchange rate Russia’s first quarter GDP growth was revised from -1.9 to -2.2 depreciated by 7.3 percent in June relative to May levels, partly percent−still slightly less than projected earlier−while May due to lower foreign currency supply as the average Brent oil high frequency statistics show a deepening recession. The price fell by 2.9 percent. Depreciation pressure came mostly World Bank growth forecast for Russia in 2015 is -2.7 percent. from increased demand for foreign currency: first, external debt The first quarter contraction was mainly driven by depressed payments almost tripled in June to about US$9 billion compared domestic demand which continued to weaken in May. to US$3.5 billion in May (and US$17 billion in the second Household consumption plummeted by 9 percent in the first quarter). Second, additional demand for foreign exchange came quarter given negative real income growth and high consumer in June from the Central Bank of Russia (CBR) which purchased credit cost. In May, real incomes shrank by 6.4 percent, US$4.3 billion on the market to replenish its foreign currency contributing to the drop in retail trade by 9.2 percent, year-on- reserves. Lastly, with the start of the tourist season there has year, compared to -9.8 percent in April and the decline in been a seasonal increase in demand for foreign currency by the market services by 3.5 percent, compared to -2.6 percent in population. Unless oil prices adjust upward, pressure on the April (and growth of 1.5 percent in the first quarter). As ruble is likely to mount given high external debt payments of consumer demand weakened, the massive destocking of US$29 billion due in the third quarter. inventories continued in the first quarter and fixed investment In June inflation slowed, yet higher utility tariffs will likely declined by 8.8 percent, putting the contraction of gross capital push up inflation in July. The 12-month Consumer Price Index formation at 28.5 percent (from -4.5 percent in quarter four of decreased to 15.3 percent from 15.8 percent in May as food 2014). Only buoyant export growth (4.5 percent) and a sharp inflation continued to decline from its record level of 23.3 contraction in imports (-25.0 percent) limited the first quarter percent in February to 18.8 percent in June. The monthly GDP contraction. In May, economic activity deteriorated with deflation in food prices by 0.4 percent was largely due to the manufacturing posting an 8.3 percent contraction (compared to seasonal decline in fruit and vegetable prices. Continued -7.2 in April). Industries that produce investment goods weakness in consumer demand, which is constrained by the reported again the strongest declines: machine building (-24.9 recent sharp declines in real wages and incomes, helped non- percent); transportation vehicles (-17.8 percent); and food inflation to stabilize at 14.2 percent (compared to 14.3 production of electro-technical equipment (-12.4 percent). A percent in May). However, higher utility tariffs will likely push sharper decline in construction output in May (10.3 percent inflation up in July and keep core inflation (at 16.7 percent in compared to 5.7 percent in April) confirms fading investment June) above headline inflation. In its meeting on June 15 the demand with fixed investment contracting by 7.6 percent in CBR sited remaining inflation risk as the main reason for its May, year-on-year, compared to -4.8 percent in April. RUSSIAN FEDERATION Monthly Economic Developments – July 10, 2015 Figure 3: Inflation slowly subsides … (percent, y-o-y) Figure 4: … amid weak economic activity (percent change, y-o-y) 24 20 CPI food industrial production non-food services 15 manufacturing 19 retail trade core-CPI 10 fixed investment 14 5 9 0 4 -5 -10 -1 Jan-12 Jan-13 Jan-14 May- Source: Rosstat, Haver Analytics, WB team 15 Source: Rosstat, Haver Analytics, World Bank team In January-May, the federal budget primary deficit improved 2016, 18.3 percent in 2017 and 16.7 percent in 2018. To bring slightly from its 5 percent levels in previous months to 3.0 about the decrease in expenditure, government expects to percent of GDP. In the first five months, federal budget follow the principles of the 2015 budget: cutting non-wage revenue decreased to 19.0 percent of GDP from 21.2 percent spending by 10 percent and not indexing wages of civil of GDP over the same period a year ago (a nine percent servants and military personnel in 2016. Pensions would be decrease in nominal terms) due to a drop in oil revenues to 8.8 indexed, but less than inflation. Changes to the 2015 federal percent of GDP from 11.4 percent of GDP in January-May 2014. budget law would consist in 2016 of cuts to the military and Non-oil revenues ticked-up slightly to 10.3 percent of GDP national security (by 1 percent of GDP) and to the national (from 9.9 percent in May 2014). Federal budget expenditures economy (by 0.3 percent of GDP). In 2016 and 2017 the federal rose to 22.8 percent of GDP in January–May from 19.5 percent budget deficit is expected to be financed mainly by the Reserve of GDP over the same period a year ago, mainly due to Fund, which will shrink by 2018 to RUB500 billion from RUB4.9 increased military spending (6.5 percent of GDP compared to trillion in January 2015. In 2018 the deficit would be covered 4.7 percent of GDP in May 2014, a 42.3 percent increase in by internal borrowing. The draft budget will be considered by nominal terms) and somewhat higher spending for social the Duma in September. policy (5.9 percent of GDP compared to 4.8 percent of GDP in Continued monetary easing led to lower interest rates, but May 2014, a 23.5 percent increase in nominal terms). The non- had little impact on credit activity in May while credit risks oil deficit stood at end-May at 12.5 percent of GDP compared moderately rose. The stock of ruble credits to firms decreased to 9.6 percent of GDP in May 2014. by 0.4 percent in May, month-on-month, and to households by On June 25, the government approved the main parameters 0.5 percent. Credit growth further slowed to 14.4 percent in for the 2016–2018 budgets, foreseeing persistent deficits and May, year-on-year, compared to 14.9 percent in April and evaporating fiscal buffers despite significant expenditure almost 30 percent in January. A continued fall in real incomes cuts. The macroeconomic assumptions used for calculating the negatively affected the capacity of households to repay debt new budget parameters suggest a recovery of the economy to in May with the share of non-performing loans increasing to 2.5 percent growth in 2016, 2.3 in 2017 and 2.4 percent in 2018 7.4 percent from 7.1 percent in April. Banks increased while the Urals oil price is projected at US$60, US$65 and provisioning for bad loans by 3 percent in May, which further US$70 per barrel, respectively. Economic sanctions are lowered their profits. Thus the number of loss-making banks expected for the entire planning period. Within that increased to 264 in May from 245 in April, compared to 126 at framework, the federal budget deficit is projected to improve the end of 2014. In May, the CBR revoked licenses from five from 2.4 percent in 2016 to 1.9 percent in 2017 and 0.7 small banks mostly on grounds of low capital adequacy and percent in 2018. Federal budget expenditures would decrease risky and suspicious operations. (from 20.8 percent of GDP in 2015) to 19.2 percent of GDP in Please contact Birgit Hansl: bhansl@worldbank.org Prepared by a World Bank team under the guidance of Birgit Hansl, consisting of John Baffes, Olga Emelyanova, Sergei Ulatov and Eka Vashakmadze. RUSSIAN FEDERATION Monthly Economic Developments – July 10, 2015