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Russia's economy off the floor, just

The country seems to have seen off the worst. But the recovery will be weak and come from a low base

RUSSIA'S economy has been wounded and looks anaemic after the triple hit of the collapse in oil prices, international sanctions and the subsequent ruble devaluation. But the Kremlin has nursed the decline with sound macro management, tapping its large currency reserves. The patient may emerge from a two-year recession next year.

Russia’s ability to survive the pain of sanctions, which has severely limited its access to international capital markets, has been boosted this year by the better-than-expected oil price. The country, which generates about a third of its budget revenue from oil and natural gas exports, is expected to post a 0.6% contraction in GDP this year, compared with a 3.7% contraction in 2015.

Most forecasters think Russia will return to growth next year, although the rebound is expected to be in a modest range of 0.5-1%.

The ruble, which plunged to a record low in January, has firmed along with oil prices: it has gained more than 13% against the dollar, the best performance globally this year. The dollar-denominated RTS benchmark stock index has jumped 40% from its January lows.

Most forecasters think Russia will return to growth next year, although the rebound is expected to be in a modest range of 0.5-1%

Russia budgeted its 2016 economy with a 3% deficit based on $50-a-barrel oil prices, down from an $80/b budgeted oil price in 2015. That assumption looked wildly optimistic but looks a lot rosier now oil has risen by 80% to $49 from its yearly lows.

Forced hands

Hopes that sanctions may be eased this year have been dashed with tough rhetoric from senior politicians in the EU, despite opposition from some politicians in France, Italy and Greece.

Sanctions have not severely impacted the government although the US Treasury did successfully scupper a planned Russian government $3bn Eurobond sale in April by scaring away Western banks and potential investors. Russia’s external debt amounts to $30bn, which is just 16% of GDP.

The prohibitions, which were introduced over Russia’s interference in the Ukraine conflict, have wreaked more havoc on the private sector, as well as state-controlled companies such as Rosneft and Gazprom.

Rosneft had to repay or refinance $26.2bn between mid-2014 and the end of 2015 after splashing out $55bn to buy rival oil producer TNK-BP in 2013. The company, which had relied on western capital markets to finance its expansion, turned to Russia’s Central Bank for help refinancing in a move that spooked the markets and triggered a ruble collapse.

Gazprom has had limited access to Western credit markets but successfully raised $1bn in October in a three-year bond deal at 4.625%. The gas monopoly, which wasn’t directly sanctioned like Rosneft, still has over $22bn in outstanding bonds denominated in foreign currency, primarily in dollars and euros.

Strong market plans

That window for issuance by Gazprom, miner Norilsk Nickel and steelmaker Evraz seems, however, to have been slammed shut – American and European regulators have warned investors against participating in the Kremlin’s rebooted privatisation programme. A limited state sell-off now seems likely, with most interest emanating from strategic buyers in India and China.

With the opposition in disarray and media repression growing, opinion polls show little change in popular support for the government or Putin

That’s part of a raft of new initiatives the Kremlin hopes will spur the economic-growth outlook.

The Presidential Economic Council met for the first time in three years on May 25 and according to Andrei Belousov, economic adviser to President Vladimir Putin, the Kremlin is setting a goal of 4% annual GDP growth by 2019.

This, he says, would add more than RUB3 trillion ($45.8bn) to GDP and inject another RUB300m-400m into the budget – more than the government’s entire anti-crisis plan for 2016.

But a 4% GDP-growth target is unrealistic without revolutionary overhaul – especially when you consider Russian growth was trundling along at 1% in early 2014, when oil exceeded $100/b.

All hands are on deck, though, as evidenced by the recent appointment of former economy minister Aleksei Kudrin as a deputy chairman of the council, ending his five-year break from state office following a row with then-president Dmitry Medvedev over defence spending.

Hanging over all of the economic planning are forthcoming parliamentary elections in September, and a presidential election in 2018 that is likely to keep Putin in power for another term.

With the opposition in disarray and media repression growing, opinion polls show little change in popular support for the government or Putin. Neither rising inflation nor a slide in wages has led to significant street protests, with many Russians apparently content to accept patriotic point-scoring over Ukraine, Turkey and Syria in exchange for economic sacrifices.

Structural reforms, such as a hike in income tax and value-added tax, have been mooted – but it is unlikely the Kremlin has the appetite to inflict more pain on a country in an election cycle.

“Russian reform will not happen as long as Putin’s power vertical remains paramount, and Putin will not threaten radical reform which could unleash unpredictable and unmanageable social and political forces,” says Tim Ash, head of emerging-market strategy at Nomura International, an investment bank. “So the Russia growth story will remain one of stagnation, with growth plus 1% or minus 1%, which still might suggest a penchant from Putin for foreign adventures and gunboat diplomacy.”

 

Tax avoiders

Russian oil producers have escaped the threat of an onerous hike in taxation

IN THE nick of time, oil prices are coming to the rescue of Russia’s oil producers. Benchmark Brent, closing in on $50 a barrel, has risen by more than 70% since February. The Kremlin will breathe with relief too – Russia’s 2016 budget, fixed in October, needs oil to be at $50 to run a 3% deficit within “acceptable” ruble-rate limits.

For oil producers, the good news is twofold. Cash flow is higher, that’s the first positive. Second: higher oil prices have changed the calculus for the Ministry of Finance, which alongside cuts in budget expenditure and more raids on the sovereign reserves, had been planning to squeeze more tax from the energy sector.

Progressive taxation and a weak ruble have largely shielded Russia’s oil producers since oil prices started tumbling almost two years ago. While the rest of Russia has struggled, they’ve done quite well.

The tax system introduced in 2002-03 is based on export duties – the crude-export duty (CED) and a range of product-export duties (PED) – and the mineral-extraction tax (MET) on crude oil. It has survived many changes and tweaks, including a large number of special CED and MET rates and a rebalancing known as the major tax maneuver, effective from the beginning of 2015. It is progressive in the sense that the government’s share of revenue per barrel increases with the oil price. Conversely, the oil producers’ netback, expressed as a percentage of Brent or Urals, increases as the oil price drops.

Finance minister Anton Siluanov proposed in February that the formula for the base rate of the MET be revised, with the cut-off level halved from the current $15/b. But the hike is to be deferred. In late May, Siluanov said the tax change would not happen this year, or before the 2017-19 budget is ready.

It is a relief for producers. The proposed tax changes had been hanging over the sector for months.

The idea behind the proposal had been that the oil industry was gaining so much from the ruble’s depreciation that some of the windfall should be taxed away. VTB Capital analysts said the move would have cost the industry about $11bn of earnings in 2017.

But lobbying from the industry has prevailed. As in 1999, when operating costs denominated in rubles were slashed to a quarter of their pre-1998 crisis levels, while revenues remained in dollars, most of Russia’s commodity producers have seen profits surge in the past year.

The notion of higher taxes hasn’t been totally abandoned – but their spectre is now distant. An oil-price recovery may be underway by the time the government decides to exact more tribute.

This article is part of an in-depth series on Russia. Next article: Yamal LNG's slow sailing.

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