Uralsib - Economy, 2012, BASE CASE SCENARIO - Nov 24, 2011.
Europe has little room to maneuver. The crisis of 2008-09 has clearly demonstrated that Russia is part of the global economy linked to the rest of the world through trade (three quarters of Russian exports are commodities) and capital flows (which may reach hundreds of billions of dollars). Because of its ties to the global economy, Russian economic performance critically depends on growth in the global economy. The situation in Europe is particularly important because the European Union is Russia's largest trading partner. However, European economy is deteriorating and is likely to slide into recession. The economic situation in Europe is aggravated by the sheer scale of the debt crisis, which is forcing the governments of many EU countries to implement tough austerity measures that further undermine economic growth. The situation seems particularly difficult because this time the policymakers cannot resort to their primary policy tools: monetary policy can no longer stimulate the real sector because developed countries are in a liquidity trap and fiscal expansion is practically impossible because of exorbitant sovereign debts.
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Europe will finally stand, but political risks remain high. We believe that in spite of existing political and economic problems European countries will consolidate their efforts and find a way to resolve the crisis, which, in our view, requires a reasonable compromise between cooperation on a unified economic policy and the fiscal independence of member states. However, political risks remain high, which creates substantial indeterminacy about the future of global economy. We believe that today it is impossible to judge the exact course Europe will finally take, so that one can only develop a set of scenarios and attach certain degree of likelihood to each of these possible outcomes.
Long-term growth will be low because of prolonged austerity. Our base case scenario assumes that economic deceleration in Europe is unlikely to develop into a new waive of global crisis. Even though the fundamental solution to the debt crisis may take time, Europe has sufficient resources to stabilize government finances in the problem countries. However, we expect that European problems will cause a deceleration to about 2% growth in the global economy in 2012 followed by a gradual recovery to long-term growth of 2.5% per annum from 2014. A slowdown in the global economy will put pressure on commodity prices. Even though oil prices remain surprisingly resilient in spite of the deteriorating global economy, we expect that oil will moderately decrease in 2012. Over the longer term, we see the repayment of European debt requiring many years of austerity, high taxes, low social spending and, as a consequence, sluggish economic growth. The same logic, to a large extent, applies to the United States. Although the US economy is currently in better shape than most European economies, American government runs huge
budget deficits, which will inevitably force it to adopt more conservative fiscal policy in the medium term. This prompts us take a conservative stance on long-term global growth; we believe that it will stay around 2.5% per annum over the next decade.
SOCIAL SECURITY TAX AND REGULATED TARIFF CUTS ARE THE MAIN MEDIUM-TERM DRIVERS
Russia will suffer from global deceleration and benefit from domestic policy. Over the medium term, the Russian economy
will be affected by external factors (the most crucial being the situation in Europe) and by internal policy changes, including a decrease in the social security tax rate from 34% to 30% of gross wage fund and general reduction in regulated tariff growth. In addition, Russia will join WTO in the summer of 2012. While reductions in social security tax and regulated tariff growth will benefit the economy, we believe that WTO accession will produce very limited economic effect.
Global deceleration will affect Russia via exports and credits
Exports will be stagnant in 2012. Global deceleration, stemming from European problems, will affect the Russian economy mainly through exports, out of which three quarters are commodities. We believe that commodity prices will come under pressure in 2012: we project the average Urals oil price to decline to $98.5/bbl in 2012, from $108.5/bbl in 2011. A decrease in commodity prices and weaker global demand for commodities in 2012 will lead to only 0.5% YoY
growth in export revenue to $522.3 bln in 2012. Imports will outpace exports due to real ruble appreciation: we expect that imports will grow by 9.9% YoY to $342.7 bln in 2012. Thus, the trade balance will decrease to $179.6 bln in 2012 from $201.0 bln in 2011. Compared with a hypothetical situation of no global economic deceleration and stable commodity prices in 2012, this means a loss of $20-25 bln in net exports or roughly 1-1.2% of GDP. Even though next year the Russian economy will be supported by a reduction in social security tax and regulated tariff growth, we have downgraded our real GDP growth forecast to 2.8% in 2012.
Lower 2012 Urals on global deceleration. We expect Urals to average $98.5/bbl in 2012, down 9% from our previous
forecast of $108.5/bbl. In particular, we expect Urals to decline in 1H12 to an average of $96/bbl, down 13% from the current price of about $110/bbl. Further during 2012, we see Urals firming up to $101/bbl in 2H11. The reason for the 1H12 weakness is global economic slowdown: we expect global deceleration to be most pronounced in 4Q11-1Q12. Our relative pessimistic scenario contrasts with both the consensus view ($109/bbl for Brent, implying $106-108/bbl for Urals) and the current 2012 Brent forward (also at $109/bbl).
Long-term oil scenario little changed. Following the 9% reduction in the 2012 average Urals price, our 2013 Urals forecast is only 2% below our previous estimate, and further out, we see Urals at 2-3% above our earlier projections. We have made no substantial changes to our global macro assumptions from 2014. Our 2013-15 forecast is close to the consensus, which is $115/bbl of Brent in each year. However, it is more optimistic than the forward curve would indicate, by 6%-25% in 2013-15. Starting in 2016, we assume that Urals is stable in real terms and nominally grows by about 2%, in line with US dollar inflation.
Deceleration in credit growth threatens domestic demand. We believe that Russia will also be significantly affected through deceleration in credit growth both to industry and private individuals. According to our estimates, credit growth to industry may decelerate to 10% (in nominal terms) in 2012 from 17% in 2011 and retail credit growth may decelerate to 15% (in nominal terms) in 2012 from 25% in 2011. We should mention that private consumption growth in 2011 was largely supported by retail credit expansion - in real terms private consumption grew 6.6% YoY in 2Q11 vis-A -vis 11.7% YoY retail credit growth and a 2% YoY contraction in real disposable incomes. Given our 2012 inflation forecast of 7.2%, deceleration of retail credit growth to 15% in nominal terms means deceleration to 7.3% in real terms. Even though we expect real disposable incomes to accelerate to 4.7% growth in 2012 due to a reduction in social security tax, this will not be enough to overcome the negative effect on consumer demand from a deceleration in credits. In addition, during periods of economic uncertainty people tend to increase savings in the event of a rainy day. Thus, consumer demand will be weaker in 2012, which will lead to a deceleration in private consumption.
Social security tax cut and regulated tariff growth reduction will benefit Russian economy
Social security tax cut will benefit larger part of the economy ... A decrease in the social security tax will benefit the Russian economy via capital investment and real incomes. Capital investment and incomes were strongly hit in 2011 following the social security tax increase from 26% to 34% of the gross wage fund (a total tax increase of RUB800-900 bln, or 2% of GDP): in 1H11 capital investment decelerated to 2.7% YoY growth (vs. 6.0% in 2010) and real incomes contracted 1.2% YoY (vs. 4.3% growth in 2010). In response to the negative tax shock, the government decided to
reduce the primary social security tax from 34% to 30% in 2012-13 and use that period to find a fundamental solution to the rapidly growing pension fund deficit problem.
a[bar] but will hit sectors which use high skilled labor. However, the government introduced a 10% social security tax surcharge for high wages: all amounts in excess of RUB512,000 per annum are now subject to 10% tax instead of 0% before. This means that employers pay more for employees who earn RUB59,700/month or more. According to Rosstat, in April 2011, 6.5% of employees earned RUB50,000 or more and the share of their salaries in total wage fund was 26.7%. Thus, at least 20% of the wages will be subject to higher social security tax in 2012. The introduction of a social security tax surcharge most of all affects the financial and natural resource sectors. To a smaller extent the surcharge affects research and development, trade, and transport and communications. Nevertheless, we expect that the social security tax reform will boost capital investment and real incomes in 2012 and to a smaller extent in 2013.
Reduction in regulated tariffs will help to combat inflation a[bar] After several years of debate, the government decided to substantially reduce growth rates of key regulated tariffs. Instead of the average 10-15% tariff growth in recent years, average tariff growth for 2012 will be 6.5-7.5% for electricity, 7.5% for gas, 6% for rail freight, 10% for passenger rail transportation, and 4.9% for household utilities. Unlike the previous years, most of the tariffs will be raised in July rather than on January 1, which will mean a sharp change in the seasonal pattern of consumer inflation. The deep reduction in regulated tariff growth will be one of the main restraints to 2012 inflation, which we expect to be 7.2%. Still, as regards inflation, we emphasize that contrary to its numerous promises, the Central Bank has not changed its approach to monetary policy, which is still centered at exchange rate management. Although the ruble depreciated substantially in the autumn as a result of global market volatility, we expect markets to calm down over the next few months. Based on this scenario, the ruble has some appreciation potential, which, given the current approach to monetary policy, creates upside risk for inflation.
... but will put at risk capital investment by key natural monopolies. A reduction in regulated tariff growth is likely to boost capital investment in 2012 because it reduces energy and transportation cost growth for most of the economy, however, it creates downside risks to capital investment by key natural monopolies, which have to adjust their capex plans in light of shrinking revenues. Whereas the government promised to compensate some of the most affected companies for the loss in revenue, a reduction in regulated tariff growth creates downside risks to capital investment partly because the government will have to find other tax sources to finance its capex compensations to natural monopolies.
Global volatility fuels capital outflows and drags the ruble down
Global volatility makes Russia a risky play a[bar] European problems have reinforced investor concerns about the prospects of the Russian economy. To a large extent, these concerns are fueled by still fresh memories of the Russian economy's hard landing in 2008-09. Many people continue to view Russia as a pure commodity play, and thus they see increased commodity risks as an increase in Russia's country risks. We should note that the situation in 2009 was due more to a liquidity crisis, a rapid deceleration in credit growth and the inability to refinance large amounts of corporate debt; as opposed to a commodity price slump per se.
a[bar] which encourages capital flight and drags the ruble down. This time Russia is better insulated from potential problems in the real economy because of better liquidity provisions by the CBR and a healthier corporate debt structure. However, now Russia has much thinner reserves: the reserve fund has contracted from $142.6 bln in September 2008 to $26.4 bln in November 2011. Thus, in the event of an adverse commodity price shock, substantial risks could come from the fiscal side: if in 2012 the Urals oil price drops to the average of $60/bbl instead of the $100/bbl currently planned in the budget, the budget deficit will reach 6% of GDP instead of 1.6% of GDP, which we currently forecast using our expected 2012 Urals price of $98.5/bbl. The increased risks will drive money out of the country, which will weaken the ruble vis-A -vis resilient oil prices. We believe that in spite of global deceleration, the Russian economy will remain in pretty good shape in the medium term, so that anxiety will gradually decrease and capital flight will ameliorate. The latter implies that the ruble has some potential for appreciation from current levels: we expect an average rate of RUB29.75/$ in 2012 and RUB29.61/$ in 2013.
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|Publication:||Russian Banks and Brokers Reports|
|Date:||Nov 27, 2011|
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