What next for Russia as Ukraine “unsettles the bear”?

12th June 2014

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Craig Botham, emerging markets economist at fund management house Schroders looks at developing economy of Russia and what investors can expect going forward…

Our growth forecast for Russia has seen a significant downgrade following events in Ukraine. Though sanctions have not been broad based as yet, there is already evidence of an economic impact; Russian GDP grew by 0.9% year on year in the first quarter. This marked a sharp fall from the 2.0% growth recorded in the fourth quarter of 2013.

Higher frequency data suggests the slowdown has been driven by lower investment spending. Consumer spending has slowed too, but has held up reasonably well in comparison. Meanwhile, PMI data points to ongoing contraction in manufacturing and services. It is not much of a stretch to argue that uncertainty arising from escalating tensions in Ukraine contributed to reluctance to invest. If the situation in Ukraine is not resolved, we would expect Russia’s GDP numbers to continue to worsen throughout the year. Further sanctions are being discussed and the economic damage from extant sanctions and general uncertainty will build over time. As it stands the second quarter already looks likely to disappoint, and will probably put Russia into recession.

Although it is not our base case, particularly as tensions seem to be easing, we should also consider the possibility of Iranian style sanctions. The scope for economic damage then becomes far greater. The withdrawal of finance equivalent to 12.5% of GDP would be difficult to brush off.

The slowdown will worsen policymaker headaches – presumably already throbbing from sanctions and political pressure – as inflation remains high. Rates have already been hiked in response to this and currency weakness, but there will be increasing policy conflict if the political situation does not improve. The easing of tensions though has seen the ruble strengthen, for now, so the inflation spike could prove temporary.

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