Investors warned over threat of Russian recession

12th August 2014

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The Russian economy is in severe danger of falling into recession as the European Union sanctions against the nation are likely to hit hard.

The latest flash estimate suggests that economic growth slowed in Russia during the three months to the end of June, with GDP at 0.8% year-on-year for the period, down from 0.9% growth in the first quarter of 2014. As a result, it now appears that Russia has entered a technical recession given year-on-year growth numbers suggest a contraction of GDP for two consecutive quarters.

As part of the sanctions which were put in place to punish Russia’s support of separatists in eastern Ukraine, the EU banned Russian state-owned banks from access to European capital markets, a move that was supported by the US. In an act of retaliation, Russia’s president Vladimir Putin put a ban on the import of agricultural goods from countries that have imposed the sanctions, a move which will push up already elevated inflation.

Investors in Russian equities have felt the pain of the geopolitical problems as year-to-date the MSCI Russia index is down by 16%. In fact over the past month alone, Russian shares have plummeted by 10% as the situation in the region has escalated.

US restrictions on the export of equipment and technologies for the oil sector are negative for investment in future production, and hence state revenues noted Craig Botham, emerging market economist at Schroders. He pointed out that while more information on economic growth will arrive in September, he is however not optimistic and that “the outlook does not look good”.

He said: “But both industrial production and retail sales flagged in June, with real wage deceleration likely weighing on consumer demand. While the most recent manufacturing surveys showed some improvement, we are yet to see the impact of the latest round of sanctions. The financial sanctions are likely to prove the most significant of the EU’s measures, in terms of economic impact.”

For now however, the central bank will act to support Russian banks hit by the sanctions, and with reserves of around $480bn it is well placed to do so.

Botham said: “However, some $80bn in external debt is maturing this year, and the central bank is already using its reserves to defend the ruble. Clearly this is not something that can be managed indefinitely. Reflecting this, the central bank has already hiked rates to slow capital outflows, and further hikes may be coming if the situation is not resolved.”

“The cost of credit in Russia will increase sharply, particularly as state owned banks account for over half of banking system assets, hitting already poor investment.. At a time when sanctions from the West have already pushed up financing costs and forced banks to seek domestic financing, domestic interest rate hikes will have a greater impact than usual. Credit and economic growth will suffer, and it is difficult to see 2014 improving for Russia’s economy.”

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