After a Long Russian Winter, A Rate Cut Will Come

Summary

• RUB is benefitting from the EM rally and the OPEC+ agreement to delay increases in oil output.
• But Russia is in the middle of a second COVID wave and activity is slowing again.
• Fiscal stimulus has been modest, with the CBR instead providing much of the support.

Market Implications

• Medium term – Positive FX and rates. We expect further rouble appreciation and see OFZs rallying in anticipation of further rate cuts.

The Fourth-Highest COVID Count Globally

Russia is in the middle of a second COVID-19 wave. As of 3 December, it had 2.35 million confirmed cases, the fourth-largest number globally. The official mortality count is 28 per 100,000 people, more than twice as high as in India but much lower than in the US, UK and the most-affected EU economies. Without action, however, the situation worsens: the daily number of new COVID cases in Russia has exceeded 28,000 and is still rising.

But vaccination has started. On 2 December, President Vladimir Putin declared the beginning of mass vaccination with Sputnik V, the first of the domestically developed vaccines to pass clinical trials. According to Russia’s Direct Investment Fund, which has sponsored the vaccine’s development by the Gamaleya institute, it is 95% effective. Medical workers and teachers will receive inoculation first, starting from next week – the government has reassured the population that vaccination will be voluntary and free of charge.

Seeking to save the economy, the government has eschewed a blanket lockdown this time. The approach differs markedly from its first-wave tactic in Q2, when lockdowns in Moscow and other badly affected areas contributed to a 7% contraction in GDP vs Q2 2019. Avoiding another plunge in economic activity is now considered paramount. This time around, restaurants and non-essential shops have remained open, though hours have been curtailed. The government has also asked citizens aged 65 and above to stay at home, but there are no explicit restrictions on travel for other age groups. The success of this approach is mixed: economic activity has slowed down again, albeit not as much as in Q2.

Modest Fiscal Support, But Substantial Monetary Stimulus

The government’s fiscal stimulus has been relatively modest at around 2.5% of GDP. Its household income support primarily aims to protect families with children from sliding into poverty, and it authorised three one-off payments to such households in 2020. Other fiscal measures include 0% loans and subsidies to SMEs and tax holidays for the sectors thought to be hit particularly hard by the epidemic. But the government has stopped short of shielding workers from unemployment via furlough schemes.

The official unemployment rate seems to have stabilised at above 6%. However, the official labour statistics fail to capture the reduction in hours worked, particularly in services sectors, which have suffered most during the pandemic. Even then, official data reflect an almost 5%yoy drop in real incomes in Q3. This underemployment and weak job security translate into low consumer confidence.

The Central Bank of Russia (CBR) has been pulling its weight: since January, it has cut its policy rate by 200bps, to 4.25%. The IMF has praised the regulator for the adequate policy response to the crisis in its latest country review. On 18 December, the CBR is holding a policy meeting. Following a dovish statement released in October, will it decide to ease policy again?

Another rate cut might be poor timing. The rouble has been among the worst-performing EM currencies this year. Although USD/RUB is off its peaks, the pass-through from the weaker rouble into the FX rate is going to take a few months to manifest fully. Despite the demand weakness, consumer price growth picked up in recent weeks. Headline inflation, which hit the target of 4% in October, is likely to rise to 4.5-4.6%yoy in November and may approach 5%yoy in the winter months.

While a December rate cut is unlikely, the CBR should stick to its dovish rhetoric. Like elsewhere, the vaccination process should take at least a few months, with a risk of delays due to complex logistics. We may have to wait until 2Q 2021 to see the vaccine’s beneficial impact on economic activity. There are no signs that the government is planning further social spending hikes to stimulate household consumption. In the absence of new stimulus, consumer demand should remain subdued, and the inflationary impact of the autumn rouble rout on prices is likely to be short-lived. By the end of next spring, headline inflation could drop to 3%.

The CBR acknowledges that, despite the current spike in headline inflation, the economic environment should become disinflationary next year. Thankfully, the current level of its nominal policy rate (4.25%) still leaves room for further rate cuts.

OPEC+ Agreement Adds to Our Bullish Stance

The OPEC+ decision to gradually ease output cuts should support the oil prices during the bleak winter months. Meanwhile, lockdowns and other restrictions continues to affect oil demand. The rouble has already benefitted from the recent EM rally; in the coming months, the previously unloved currency should continue appreciating. Investors who slushed their Russian local debt holdings earlier this year should consider re-stocking their portfolios with OFZs. At ~5.3%, the yield on the 5y benchmark is juicy. Also, OFZ prices are likely to increase in the coming months in anticipation of further policy easing. It is worth looking at other RUB-denominated assets too, for example Russian stocks, with the RTX index still way below its pre-COVID level.