The bottom line:
- The business cycle: The latest round of sanctions announced by the US surprised us in terms of intensity leading us to modestly reduce our projections for this year and mildly increase the outlook for inflation. That being said, in our view none of the key parties involved: Russia/US/Europe have an interest in fully escalating the situation, so we may have hit the “worst spot”. As a result, whilst in the eurozone we are confident that we have passed the peak of the business cycle, in Russia the best may be ahead.
- Monetary policy: The pace of the interest rate easing ahead is likely to be slower given the recent RUB and market weakness but we think there is ample scope for reducing the policy rate and thus retail borrowing costs in Russia in coming years.
- Exchange rate: We have lifted our expectation for RUB from 60/USD to 65/USD as a result of the sanctions announcement. Even if the geopolitical tensions were to subside, we think a meaningful recovery of the RUB appears highly unlikely in the coming year.
- Long-term considerations: Fundamentally the economy is going through a multi-year period of balance sheet restructuring of the non-financial corporate sector. International experience shows this is a process that lasts around 5 years (in which case Russia has 1-2 more years to go) that depresses the labour market but in the end delivers significant improvement in competitiveness. This process is what allows the CBR to gradually cut interest rates – more than what analysts expect in our view – going forward.
Ongoing reduction in the CBR’s policy rate will be a catalyst for improving housing market affordability, this in our view is a structural improvement for Russia.
Global rankings on some competitiveness measures show that Russia is falling behind on education.
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