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The sanctions imposed so far against Russia by the EU, the United States and other Western powers – and Russia’s counter-sanctions – will have rather little direct impact on their respective economies, write SEB’s economists in a new report.
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Economic Insights:"Sanctions war" will have little direct impact on growth
The sanctions imposed so far against Russia by the EU, the United States and other Western powers – and Russia’s counter-sanctions – will have rather little direct impact on their respective economies, write SEB’s economists in a new report.
The sanctions imposed so far against Russia by the EU, the United States and other Western powers – and Russia’s counter-sanctions – will have rather little direct impact on their respective economies, write SEB’s economists in a new report.
This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only.
Information and opinions contained within this document 1
are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice. Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of investment business in the UK. Sanctions war will have little direct impact on growth Tuesday August 12, 2014 The European Union has entered what it views as the toughest phase of its sanctions against Russia, but is reluctant to go too far, due to the self- interests of major EU countries. The sanctions imposed so far against Russia by the EU, the United States and other Western powers and Russias counter-sanctions will have rather little direct impact on their respective economies. Russias economy is moving towards stagnation, but this is only partly because of the sanctions. The economic recovery in the central and southern parts of Eastern Europe can continue, though at a somewhat slower pace due to Russias weaker outlook.
The downing of a Malaysian Airlines passenger plane in Ukraine on July 17 dramatically rekindled the Ukraine crisis, following a two-month trend towards easing of military and diplomatic tensions between Russia and Ukraine, as well as between Russia and Western powers. This event underscores our forecast in the May issue of Nordic Outlook that the geopolitical conflict in eastern Ukraine, including domestic discord, will last a long time. The US and the EU have responded by toughening their sanctions, which had previously encompassed only key individuals in the business community and politics in Russia and Ukraine. Today the EU sanctions list totals more than 100 individuals and companies and includes travel bans and freezing of bank assets. Their purpose is to put pressure mainly on Russia to work actively towards a demilitarisation of the conflict region. US ahead of EU The United States quickly seized the initiative, banning a number of major Russian companies and banks from taking out long-term dollar-denominated loans. One reason why the US was a step ahead of the EU is that in relative terms, the countrys trade with Russia is far smaller than that of the EU countries. Although only the three Baltic countries, Finland and Bulgaria have a high exposure, 30 per cent of Western Europes natural gas needs are covered by Russia. In addition, there have obviously been political divisions among the major EU countries for partly selfish national reasons. For example Germany imports large quantities of Russian natural gas and France is in the process of selling two warships to Russia. Italy is the only large EU country with more marginal direct links to Russia in its overall foreign trade. It took until late July before the EU reached agreement on an expanded three-part sanctions package: Russian state- owned banks and some large non-financial companies will be blocked from access to long-term financing in EU capital markets; there will be a partial embargo on arms trade with Russia (applicable to new contracts out of deference to France?); and exports of certain energy sector technology to Russia will be banned. The US immediately imposed a similar embargo on defence- and energy-related trade. Japan and Switzerland also followed up with financial sanctions against individuals and companies of both Russian and Ukrainian nationality connected to the Ukraine crisis. In Japans case this was an expansion of last springs list. It was aimed at blocking possible evasion of US and EU sanctions. Little direct impact With its expansion of sanctions after the Malaysian plane was shot down, the EU entered the toughest phase known as Phase 3 of the action plan it launched early last spring following Russias annexation of Crimea. This is aimed at hurting such sectors of the Russian economy as finance, energy and defence. However, the sanctions imposed so far have had a fairly small effect, at least viewed in the short term. Russian banks have a modest need for refinancing their foreign loans over the coming nine months, the central bank has a strong foreign currency reserve and the federal government is in a strong financial position if funding needs to be provided. Arms exports from Russia are small in relation to the countrys total arms production. The freeze on Western technology input in the energy sector will affect performance and production only in the long term. The escalated sanctions from the EU and other major Western powers are nevertheless expected, in themselves, to cause greater uncertainty about general developments in Russia as well as speculation that the Ecnomic Insights
2 sanctions will be further tightened or broadened. As a result, foreign companies will be more restrictive about investing in Russia, hampering growth short term growth as well. In August, Russia responded to Western sanctions by imposed various trade barriers in the aviation, agriculture and food sectors. About 10 per cent of Russias food imports are being suspended for one year. The effect of this ban is mostly symbolic. It will have very little economic impact on any of the affected countries, except Lithuania, which has relatively large food exports to Russia. Instead it threatens to push up Russian inflation. Further targeted sanction measures by the Russians are rather likely. But in that case they will be relatively cautious. Note the words of President Vladimir Putin in his decree to Russian authorities concerning agricultural and food products: with the goal of guaranteeing the security of the Russian Federation." We are sticking to the fundamental economic assumptions we have maintained since the Russia-Ukraine conflict broke out in February-March: There will be no large-scale trade sanctions and no serious disruptions in Russian energy deliveries to Europe. Both Western powers and Russia are highly reluctant to start a full-scale trade war, since the early recovery of the euro zone is fragile and Russias economy is both cyclically and structurally weak. There is also sizeable mutual dependence on Russian natural gas. The repercussions of the geopolitical conflict especially via accentuated weakness in the data and outlook for Russian and Ukrainian growth resulted in modest downward adjustments in our general growth forecasts for Eastern (including Central) Europe last spring, but relatively large such adjustments for Estonia and Latvia. Yet our latest downward adjustment of the 2015 growth outlook for Russia (see below), as well as any new sanctions, only justify a marginal new lowering of GDP forecasts for the region. Continued recovery in Central Europe Given the limited impact of sanctions, we are sticking to our forecast that the gradual recovery which began in the second half of 2013, mainly in the central portion of Eastern Europe but also further south in the region, will continue over the next couple of years. The recovery will be modest. Growing private consumption and cyclical upturns in Germany/Western Europe will offset lost exports to Russia and at least short-term investment downturns, especially in countries near the conflict area. It is worth noting that the larger countries of Central Europe send a relatively small share of their exports to Russia. During the second quarter, fairly strong GDP growth in a number of central and southern countries in the region probably gained further strength. Retail sales remained good. Although manufacturing indicators have lost some ground almost everywhere in the region, a similar pattern is also apparent in Western Europe. We believe this is a temporary correction. Both in Eastern and Western Europe, in part this probably was due to uncertainty created by the Ukraine crisis, especially in its initial stage. Private consumption will remain a key driver of economic growth in many Eastern European countries. Households are benefiting from good real income increases due to labour market stabilisation, but especially via low inflation. Purchasing power has further strengthened just in the past few months, since weak price pressures in such countries as Hungary and Slovakia have morphed into deflation. In Poland, inflation is now only a few tenths of a per cent above zero. We expect continued strong downward pressure on inflation in Central Europe and further south during the coming year, since there are sizeable idle resources in these economies. In the near future, inflation will remain low in the wake of declining global food prices late in the spring; food is a major component of the Consumer Price Index in many countries of Eastern Europe. In Poland, for example, this may open the way for further cuts in key interest rates, which are already very low, boosting household demand for loans and contributing to higher consumption. Russian stagnation, but no collapse Russia is not on its way towards economic collapse over the next couple of years far from it. The economy will be sustained by continued stable energy prices, a strong labour market and underlying government financial strength in the form of low sovereign debt (11 per cent of GDP), a balanced budget and a strong currency reserve. Note that extra expenditures for Crimea/Sevastopol this year are being paid for out of funds, not the federal government budget. In addition, the governments forecast that its 2014 budget surplus will total 0.5 per cent of GDP (compared to a final 2013 figure of -0.5 per cent) is based on a realistic +0.5 per cent growth assumption. But there are many years of anaemic growth ahead, in addition to the difficult short-term challenge of ending high inflation. This is not, however, only a consequence of the Russia-Ukraine conflict but largely a result of structural problems. Russias GDP will increase by 0.5 per cent this year. The economy will stagnate in 2015 and then expand by 1.5 per cent in 2016. This is well below its potential growth rate of 2-3 per cent. We have adjusted our 2014 forecast upward from zero in the May issue of Nordic Outlook, following unexpectedly good growth in the second quarter (according to official figures 1.2 per cent year-on-year, after +0.9 per cent in the first quarter). This was after industrial production provided something of a surprise and short-term manufacturing sector indicators showed a weak but consistent improvement. The purchasing managers index gradually rose from around 48 in March to 51 in July, in other words above the expansion threshold of 50. Assuming largely unchanged oil prices of USD 105-110/barrel for the rest of 2014 and decent net exports, Russia can avoid recession despite a rapid decline in domestic demand. Ecnomic Insights
3 We have lowered our 2015 GDP growth forecast from 1.2 per cent to zero due to lower household purchasing power (via higher-than-expected inflation), recently approved extra sales taxes of up to 3 per cent in various regions (to maintain a balanced budget when large sums are being allocated for developing Crimea), even weaker capital spending in the wake of the conflict with Ukraine and the impact of new sanctions. A sharp upturn in long-term bond yields will contribute to lower capital spending, but this summer the government has provided some support for infrastructure investments. There will probably also be increases in Russian wages and pensions next year to combat economic weakness. Supply-side restrictions The Russian economy is being squeezed on several fronts. There are supply-side restrictions in the labour market, despite clearly slower economic growth in recent years. Unemployment has fallen further, from 5.5 per cent early in 2014 to just below 5 per cent (the lowest level since the mid-1990s) and has been somewhat below its equilibrium level of 6-7 per cent since mid-2011. Because of negative demographics, it will take time to strengthen labour supply. Furthermore, capital spending has lagged for many years; Russias investment ratio is low compared to other emerging market economies.
Inflation above target Inflation has surged from 6 per cent at the beginning of 2014 to 7.5 per cent, well above the central banks target of 6.0-6.5 per cent by the end of the year (raised since last spring) and its medium-term target of 4 per cent. The upturn is being driven by waves of decline in the rouble exchange rate connected to last springs Crimea conflict and a powerful new downswing after the exchange rate had almost completely recovered in May-June. But inflation is also fundamentally high due to the tight labour market. The central bank unexpectedly raised its key interest rate in late July to slow inflation and try to halt new capital outflows (a weak effect is expected there). We expect new interest rate hikes, but inflation will lose its momentum only slowly during the coming year despite weaker demand. This is partly because we foresee a further weakening of the rouble (to 38.5 per USD, compared to 36 today), driven by geopolitical turmoil and economic weakness. The ban on certain food imports will also lead to some price increases, despite a government directive ordering a price freeze. The broad extra sales tax will also have an impact, leading to somewhat higher consumer prices next year. We expect inflation to average 6.5 per cent in 2015.
Mikael Johansson, Head of CEE Research, SEB Economic Research + 46 8 763 80 93