HSBC GLOBAL RESEARCH RUSSIA TRIP NOTES. Struggles with growth 1

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1 HSBC GLOBAL RESEARCH RUSSIA TRIP NOTES Struggles with growth 1 Russian economy is macroeconomically stable backed by broadly prudent fiscal and monetary policies yet with weak growth, structurally constrained In Russia we believe that risks to economic growth are skewed to the downside, reflecting a combination of weaker potential economic growth and some cyclical weakness in the economy. Authorities are running broadly prudent fiscal and monetary policies, avoiding taking large-scale stimulus. While the macroeconomic stance of Russia remains stable, some in the expert community doubt the adequacy of policy decisions to address the structural challenges in the economy. An apparent preference for quick-fix solutions over systemic policy measures undermines the efficiency of government s policies and contributes to the increased unpredictability of regulations despite the progress achieved in some structural areas. This adds to commercial risks and may further hamper economic growth in Russia in the medium term. 1 HSBC Global Research, Economics CEEMEA, Russia trip notes, Struggles with growth, 7 November PUBLIC

2 Macro is OK, structural policies lag behind Prudent fiscal, monetary policies weigh on growth in the short run Despite a moderation of economic growth to below 2% this year, the government did not rush to employ expansionary fiscal or monetary policy. Understanding that is it mostly structural factors behind growth moderation, the government has used fiscal and monetary policy only selectively, seeking to prevent macroeconomic imbalances from developing. This is a good thing from a macroeconomic stability perspective. However, for markets looking for stronger growth now, this might be disappointing news for now. PUBLIC - 2

3 The Central Bank (CBR) remains fully committed to disinflation policy objectives, which translates into a more hawkish policy stance, a necessary requirement for building up credibility and reduction of inflationary expectations. With a target inflation range of 5-6% in 2013 and 5% in 2014, it can hardly risk missing these targets, with annual inflation still staying above the target as of end- October. This translates into the need to keep policy rate positive 50bp against forward-looking inflation target at the moment. At the same time, the CBR is focused on improving the monetary transmission mechanism and bank refinancing system (for instance, holding 3M and 12M MTRO refinancing auctions), which has already helped in reducing 1-3M money market rates and in stabilising corporate lending growth at just below 13% y-o-y in nominal terms. The CBR confirmed its commitment to abandon the RUB band by 2015, which should allow managing interest rates more efficiently. At the same time, the CBR stipulates that it may continue buying and selling FX on the market after 2014 for two purposes: performing FX operations for the needs of the government s Reserve Fund and for the sake of liquidity injections into the banking system. Federal budget expenditures remained unchanged from plan for this year, although the government had to soften the interpretation of the fiscal rule allowing extra oil & gas revenues to substitute a shortfall in non-oil & gas revenues this year. President Putin authorised spending of RUB450bn (USD14bn) from the National Wealth Fund for infrastructure projects, yet actual disbursement of these funds will be likely spread over next few years and has not started yet. Local experts believe that the government will have to increase regular taxes in the coming years (eg VAT rate) in order to offset a decline in oil & gas revenues in percentage of GDP, while planned expenditure growth is modest even in nominal terms. The Ministry of Finance is hoping pension reform will reduce the transfer from the federal budget to the Pension Fund as a solution for the fall in oil & gas revenues in the medium term. Hence fiscal PUBLIC - 3

4 stability will likely be preserved in the medium term while higher regular taxes (or lower pension income) would hinder economic growth. Although the authorities expect stronger economic growth in 2014, they appeared having doubts about it. The Ministry of Economic Development (MOED) expects economic growth to pick up in 2014, reaching 3.0% (the Central Bank expects 2.0%), but says that are a few downside risks to its expectations and no upside risks. Foreseeing lower growth of private consumption (4.0% growth of real wages in 2014 vs. expected 6.2% this year), the MOED believes fixed investment will recover benefiting from base effect (domestic investment) and better investment climate (foreign direct investment). Besides, the MOED expects that re-stocking of inventories will also help to boost growth in That said, the Ministry admits the presence of the strongest downside risks to its fixed investment forecast. In the view of the MOED, the privatisation program in Russia will be activated only after 2016, which is another sign that at least some fixed investment that may come with privatisation will likely be delayed.. while erratic structural policies hinder growth in the longer-term The decision-making process on complex structural issues has been oversimplified and accelerated, with decisions often made without proper discussion with the general public, the legislative and the government. In some instances, this has led to the emergence of conflicts between these decisions and existing legislation, lack of the strategic vision in the decisions made and the increased unpredictability of the legal and regulatory framework in Russia. Changes in the pension system, the temporary freeze of natural monopolies tariffs, a planned merger of the Supreme Court and the Higher Arbitration Court are examples of such decisions which have raised a lot of criticism from local business and the investment community. PUBLIC - 4

5 This effectively offsets the improvements that Russia has made recently in some structural areas that are captured in results of the Doing Business Survey, in which Russia moved to 92nd place globally in the 2014 Survey from 111th place in the 2013 Survey. The key improvements occurred in access to electricity, getting construction permits, and property registration. That said, for businesses on the ground a lot depends on the subnational governments policies, with success in attracting investment achieved in those regions that run pro-investor policies. In this respect, the experience with industrial parks in some regions that enjoy preferential tax and regulatory treatment was quoted as successful. Market implications Investors looking for GDP growth are unlikely to find positive growth surprises in Russia as a whole. Neither macroeconomic nor structural policies sufficiently target economic growth issues. Yet, broadly prudent macroeconomic policies ensure the preservation of macroeconomic stability in the medium term, which is good from a sovereign credit risks perspective, we think. In this respect, the monetary authorities commitment to reducing inflation to below 5% after 2014 should be supporting the RUB bond market, provided UST yields do not increase significantly. The forthcoming gradual removal of the RUB band along with the CBR s plans on FX interventions after 2014 is negative news for the RUB, we think. However, we have already priced in these news in our current RUB forecasts. PUBLIC - 5

6 HSBC Holdings plc HSBC Holdings plc, the parent company of the HSBC Group, is headquartered in London. The Group serves customers worldwide from around 6,600 offices in 80 countries and territories in Europe, Hong Kong, Rest of Asia-Pacific, North and Latin America, and the Middle East and North Africa. With assets of US$2,723bn at 30 September 2013, HSBC is one of the world s largest banking and financial services organisations. HSBC Russia HSBC Group operates in Russia through OOO HSBC Bank (RR). HSBC Russia provides a wide range of corporate banking, investment banking and financial markets products and services to corporate and institutional customers. The HSBC Group, HSBC, we, mean HSBC Holdings plc, the company established in accordance with and regulated by the laws of England and Wales, and/or HSBC Bank plc, the Bank established in accordance with and regulated by the laws of England and Wales, and every company that is a member of the group, controlled by this Bank. ООО «HSBC Bank» (RR) («Bank HSBC»). General license 3290 issued by the Bank of Russia. 2 Paveletskaya square, bld. 2, , Moscow, Russian Federation. This Document does not constitute investment, financial, legal or tax advice, it should not be construed as a recommendation or an offer and/or basis for making any deals with HSBC or third parties, or legal actions of any nature, or making investment, financial or business decisions. This Document is based upon information obtained from sources HSBC believes to be reliable but which it has not been independently verified by HSBC. HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to the accuracy of the contents of this Document. HSBC is not liable to maintain the relevance of the information contained in the Document. Neither HSBC nor any of its affiliates shall not undertake to provide consultations on legal, tax, investment or any other issues. HSBC disclaims any liability whatsoever for any direct or indirect loss or loss of opportunity howsoever arising from making any deals or any actions of legal nature based upon the contents of this Document. Opinions, data and other information expressed in this Document are based upon publicly available information at the moment of publication and/or distribution of this Document and may be amended without notice. PUBLIC - 6