Country Raport

2015IHS. 2015 IHS.. No portion of this report may be reproduced, reused, or otherwise distributed in any form without prior written consent, with the exception of any internal client distribution as may bepermitted in the license agreement between client and IHS. Content reproduced or redistributed with IHS permission must display IHS legal notices and attributions of authorship. The informationcontained herein is from sources considered reliable but its accuracy and completeness are not warranted, nor are the opinions and analyses which are based upon it, and to the extent permitted bylaw, IHS shall not be liable for any errors or omissions or any loss,damage or expense incurred by reliance on information or any statement contained herein.

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Country Reports - Russian Federation

27 Jan 2015 IHS Economics and Country Risk

Our take

Key pointsEconomic sanctions prompted by the annexation of Crimea and continued fighting in Ukraine are negatively affecting growth and investment.Stance towards Ukraine has damaged Russia's international standing and carries moderate interstate war risks.Russian president Vladimir Putin is maintaining a crackdown on the opposition.The high-profile anti-corruption campaign remains selective and largely ineffective.

AnalysisSix-Factor Country Risk - Russia

Risk Score Description

Political 3.00 SIGNIFICANT

Economic 3.25 SIGNIFICANT

Legal 2.75 MEDIUM

Tax 2.50 MEDIUM

Operational 3.75 HIGH

Security 3.25 SIGNIFICANT

Overall 3.07 SIGNIFICANT

12-Month Rating Trend Negative Trend

Note: 1 = minimum risk, 5 = maximum risk. Ratings form part of enhanced Country Analysis & Forecast suite of services.

Sovereign Risk Ratings - Russia

Medium-Term 40(BBB-) Supportive Credit Fundamentals

Sovereign Risk Outlook Negative

Note: 0 = minimum risk, 100 = maximum risk. Ratings form part of enhanced Economic and Sovereign Risk services.

Economic sanctions prompted by the annexation of Crimea and continued fighting in Ukraine are negatively affecting growth and investment. TheUnited States and the European Union have adopted a series of sanctions against Russia as a result of its annexation of Crimea and support for rebels insoutheast Ukraine. While the effectiveness of the sanctions will depend on a solid multilateral approach, the uncertainty created for the Russian economy willaffect business and consumer confidence and worsen the investment environment. The rouble has depreciated significantly since the beginning of the year asa result of the slowing economy and accelerating capital flight, and is likely to remain weak in the year ahead. The house arrest of Vladimir Evtushenkov,chairman of AFK Sistema, will raise concerns that private business will again be under attack from the Kremlin.

Stance towards Ukraine has damaged Russia's international standing and carries moderate interstate war risks. The annexation of Ukraine's Crimearegion in March 2014 and the maintenance of a large military presence close to the Ukrainian border have led to widespread Western condemnation. Theyhave also raised the prospect of Russia intervening militarily in eastern Ukraine if violence there between pro-Russian separatists and the security forcesescalates. Such a development would probably entail expansion of the US- and EU-imposed sanctions. However, if the conflict in Ukraine eases and the Minskagreement is upheld, there is likely to be some amendment of the sanctions.

Russian president Vladimir Putin is maintaining a crackdown on the opposition. This has included the launching of investigations against leadingopposition activists and the implementation of restrictive measures on civil-society organisations. The crackdown also indicates the rising influence of thesiloviki faction (comprising current and former members of the security services) within government. In the event of a significant economic downturn, thesuppression of opposition protests by state security forces could result in a popular (and potentially violent) backlash across the country and especially inMoscow.

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The high-profile anti-corruption campaign remains selective and largely ineffective. The government has launched a series of corruption investigationsagainst senior officials, and moved to tighten anti-corruption laws. The implementation of similar measures and dismissals of senior officials are likely tocontinue over the coming year. However, this initiative is unlikely to affect the still overall high levels of corruption in the bureaucracy, as anti-corruption casesare likely to remain selective and be politically motivated.

Forecast summaryThe Russian economy is faltering amid slack investment activity, falling oil prices, and the threat of further and broader economic sanctions. Theofficial estimate of GDP for the third quarter put year-on-year (y/y) growth at just 0.7% and growth in cumulative GDP in the first three quarters at 0.8%. Mosthigh-frequency indicators suggest an even less promising result in the fourth quarter,. A number of factors were already aligned, even before the threat ofeconomic sanctions on Russia arose, to ensure that Russian economic growth will disappoint in the near term. The Russian economy remains overlydependent on energy export revenues (fully 70.6% of total export earnings in 2013) to drive domestic growth. Energy priceswhich have declined sharply inthe most recent period on slowing global economic growth and abundant oil suppliesare expected to remain far below recent peak levels in the near tomedium term, while physical exports will stagnate at best. In addition, the policy interest rate has been boosted dramatically to dampen inflationary pressures,help stem the flow of capital from the country, and relieve some of the downward pressure on the rouble. Strong inflation, propelled by a weakening rouble, iscutting into household purchasing power. With the rouble and equity prices already losing ground in early 2014 as investors looked for safer havens, theimposition of economic sanctions due to Russia's annexation of the Crimean region of Ukraine as well as perceived Russian intervention in Ukrainian affairshas only worsened the Russian business and investment environment. The ongoing erosion of business confidence has caused investment activity to contract.Estimates are that net capital outflow in 2014 exceeded USD150 billion, compared with USD61.0 billion in full-year 2013. Accordingly, we have cut ourestimate for 2014 GDP growth to only 0.4%. We now have GDP contracting by 4.0% in 2015 and declining a further 0.3% in 2016. A modest recovery is seento take hold in 2017 with growth at 1.5%.

The currency, which suffered in early 2014 from sell-offs of rouble assets, has come under further pressure from accelerated capital flight in thewake of the tensions over the annexation of Crimea and pro-Russian unrest in eastern Ukraine, the economic sanctions imposed by the UnitedStates and the European Union, and a dramatic slide of world-market oil prices. The rouble has suffered periodically in the last two years as turmoil hitinternational capital markets. Further concerns were raised in early 2014 by disappointing growth in several of the BRIC countries and by tapering ofquantitative easing by the US Federal Reserve. As Russia sent forces into Crimea in early March 2014 and the West subsequently levied economic sanctionsagainst Russia, the rouble dived once again. Concerned about financial stability and the impact on inflation, the Central Bank of Russia (CBR) has intervenedheavily in the local foreign currency market and hiked its key policy interest rate by 1,150 basis points total in March and in mid-December 2014, yet roubleexchange rates against the dollar and the euro have descended to new historical lows. Plunging oil prices in the fourth quarter added new downward pressureon the currency and prompted the further increase of 250 basis points in the key interest rate, followed by an unprecedented midnight decision on 15December for a new increase of 650 basis points in an effort to put a floor under the plummeting rouble. The perception of Russia as a risky environment forinvestment will continue to provide for large-scale net capital outflow at least through 2016.

Fiscal revenues are slipping, owing to slowing economic growth and reduced receipts from the energy sector, and will not cover mountingexpenditure commitments for 201517. In the face of expansive social spending and public-sector investment programs, the Russian fiscal position isparticularly vulnerable to a protracted downward movement in world-market commodity prices as well as the impact on tax revenues of a slowing economy.The recently approved three-year fiscal framework assumes average oil prices at around USD100 per barrel in 201517, with an average fiscal deficit over theperiod of 0.6% of GDP and thus will necessarily be revised. While the new plan is to cut expenditures across the board by 10%, large-scale investment inexpanded military capabilities are not to be touched.

Changes since last forecastJanuary interim forecast versus December interim forecast

GDP DOWN We have decreased projected GDP in 2015, with the decline now at 4.0%, thanks to our more downbeat forecast for

world-market oil prices.

Consumer price

index

UP We have raised our projection for end-December year-on-year inflation to 17.0% in 2015. This revision is due to the

impact of a dramatically weaker rouble on import prices.

Gross fixed capital

formation

DOWN We have cut our projection of the change in gross fixed capital formation in 2015 by 3.0 percentage points to -7.2%

given the ongoing credit crunch and plummeting oil prices.

Selected data and charts: Data (forecasts)


Political summary

Presidential elections Next contest: 2018 March; Last contest: 4 March 2012.

Legislative elections (Lower chamber) Next contest: 2016 December; Last contest: 4 December 2011.

President: Vladimir Putin (since 7 May 2012)

Chair of the Council of Ministers: Dmitry Medvedev (since 7 May 2012)

First Deputy Chair: Igor Shuvalov (since 12 May 2008)

Source: IHS and CIRCA People in Power

Key Macro-Economic Indicators

2011 2012 2013 2014 2015 2016 2017 2018 2019

Real GDP (% change) 4.3 3.4 1.3 0.6 -5.0 -0.5 1.5 2.7 3.0

Nominal GDP (US$ bil.) 1,903.7 1,999.4 2,078.2 1,875.2 1,042.5 1,088.0 1,171.2 1,267.9 1,358.5

Nominal GDP Per Capita (US$) 13,272 13,965 14,550 13,162 7,336 7,677 8,286 8,996 9,669

Consumer Price Index (% change) 8.4 5.1 6.8 7.8 19.0 11.5 8.7 7.1 6.6

Exchange Rate (LCU/US$, end of period) 32.20 30.37 32.73 56.24 71.00 68.00 69.00 70.22 71.80

Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the 15th ofSource:each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release of the GIIF bank.

Country risk - overall statement

OverallRussia continues to be a relatively risky destination for foreign investment, ranking as Significant Risk overall in IHS's country risk rankings and languishingmore than half-way down the global list of countries. Its scores are worst on security and operational risks and better on legal and tax risks. The scores forpolitical and economic risks place it well below most Western European countries, as well as some of its BRIC competitors. Nevertheless, Russia has emergedfrom its turbulent post-Soviet period with confidence and strong economic potential, as well as aspirations to restore its prominence as one of the world's majorpower centres. As expected, Vladimir Putin returned to presidential office for a third term after he won March 2012's election. Despite the unprecedented streetprotests leading up to the election, Putin remains the most popular politician in Russia. That said, the strengthening of the opposition, especially those whorepresent the young professional middle class, is likely to influence Putin's domestic policies in the medium term. Russia's economy has been growing at itsslowest pace since 2009 due to subdued consumer demand and lower levels of investment in the wake of the 2014 crisis in Ukraine, and the subsequentimposition of Western sanctions. Economic growth is also being negatively affected by falling oil prices. Prior to the sanctions, the government was keen tomake the country more attractive for foreign investors by promises of new privatisation schemes, creating the world's best tax code, and fighting corruption.However, the September 2014 arrest of billionaire Vladimir Evtushenkov has sparked fears that private business will again be under attack and it will probablyscare away foreign investors from Russia in the medium term. The operational and security environment varies from region to region, but continued terroristacts committed by Islamist militants based in the North Caucasus are likely. Internationally, the annexation of Crimea in March 2014 and ongoing maintenanceof political and military pressure on Ukraine, including the threat of further military intervention into eastern Ukraine, has led to vociferous international criticismand the imposition of global sanctions, damaging its international standing.

Economic: Country risk statementRussia's economy slowed further in the first quarter of 2014 in the face of moderating private consumption and slack investment activity. The Russianinvestment environment remains highly unsatisfactory and massive net capital outflows have continued, taking a toll on the rouble and Russian asset markets.The business and investment environmentalready judged unattractive by many foreign and domestic investors, due to a far-reaching and corruptbureaucracy, weak standards of transparency and corporate governance, and the lack of an independent judiciaryhas been exacerbated by the threat ofeconomic sanctions against Russia and retaliation against US and European interests in return. In an effort to soften the impact on the rouble and impetus toinflation, the Central Bank of Russia found it necessary to hike its key interest rate by 200 basis points at a time when the government and business leadershad been pressing for lower commercial interest rates to restore momentum to the economy. Meaningful sanctions on selected Russian sectors in response toRussian moves in Ukraine could push the economy into recession for the full year. We suspect the economy was already in a technical recession in the secondquarter of 2014. While the government may be tempted to engage in stimulative spending, it would necessarily violate the recently adopted fiscal rule that capsexpenditures based on the historical path of world-market oil prices.


Short-term outlook

Key points

The Russian economy is faltering amid slack investment activity, falling oil prices, and the threat of further and broader economic sanctions.The currency, which suffered in early 2014 from sell-offs of rouble assets, has come under further pressure from accelerated capital flight in the wake ofthe tensions over the annexation of Crimea and pro-Russian unrest in eastern Ukraine, the economic sanctions imposed by the United States and theEuropean Union, and a dramatic slide of world-market oil prices.Fiscal revenues are slipping, owing to slowing economic growth and reduced receipts from the energy sector, and will not cover mounting expenditurecommitments for 201517.

Analysis

The Russian economy is faltering amid slack investment activity, falling oil prices, and the threat of further and broader economic sanctions. Theofficial estimate of GDP for the third quarter put year-on-year (y/y) growth at just 0.7% and growth in cumulative GDP in the first three quarters at 0.8%. Mosthigh-frequency indicators suggest an even less promising result in the fourth quarter,. A number of factors were already aligned, even before the threat ofeconomic sanctions on Russia arose, to ensure that Russian economic growth will disappoint in the near term. The Russian economy remains overlydependent on energy export revenues (fully 70.6% of total export earnings in 2013) to drive domestic growth. Energy priceswhich have declined sharply inthe most recent period on slowing global economic growth and abundant oil suppliesare expected to remain far below recent peak levels in the near tomedium term, while physical exports will stagnate at best. In addition, the policy interest rate has been boosted dramatically to dampen inflationary pressures,help stem the flow of capital from the country, and relieve some of the downward pressure on the rouble. Strong inflation, propelled by a weakening rouble, iscutting into household purchasing power. With the rouble and equity prices already losing ground in early 2014 as investors looked for safer havens, theimposition of economic sanctions due to Russia's annexation of the Crimean region of Ukraine as well as perceived Russian intervention in Ukrainian affairshas only worsened the Russian business and investment environment. The ongoing erosion of business confidence has caused investment activity to contract.Estimates are that net capital outflow in 2014 exceeded USD150 billion, compared with USD61.0 billion in full-year 2013. Accordingly, we have cut ourestimate for 2014 GDP growth to only 0.4%. We now have GDP contracting by 4.0% in 2015 and declining a further 0.3% in 2016. A modest recovery is seento take hold in 2017 with growth at 1.5%.

The currency, which suffered in early 2014 from sell-offs of rouble assets, has come under further pressure from accelerated capital flight in thewake of the tensions over the annexation of Crimea and pro-Russian unrest in eastern Ukraine, the economic sanctions imposed by the UnitedStates and the European Union, and a dramatic slide of world-market oil prices. The rouble has suffered periodically in the last two years as turmoil hitinternational capital markets. Further concerns were raised in early 2014 by disappointing growth in several of the BRIC countries and by tapering ofquantitative easing by the US Federal Reserve. As Russia sent forces into Crimea in early March 2014 and the West subsequently levied economic sanctionsagainst Russia, the rouble dived once again. Concerned about financial stability and the impact on inflation, the Central Bank of Russia (CBR) has intervenedheavily in the local foreign currency market and hiked its key policy interest rate by 1,150 basis points total in March and in mid-December 2014, yet roubleexchange rates against the dollar and the euro have descended to new historical lows. Plunging oil prices in the fourth quarter added new downward pressureon the currency and prompted the further increase of 250 basis points in the key interest rate, followed by an unprecedented midnight decision on 15December for a new increase of 650 basis points in an effort to put a floor under the plummeting rouble. The perception of Russia as a risky environment forinvestment will continue to provide for large-scale net capital outflow at least through 2016.

Fiscal revenues are slipping, owing to slowing economic growth and reduced receipts from the energy sector, and will not cover mountingexpenditure commitments for 201517. In the face of expansive social spending and public-sector investment programs, the Russian fiscal position isparticularly vulnerable to a protracted downward movement in world-market commodity prices as well as the impact on tax revenues of a slowing economy.The recently approved three-year fiscal framework assumes average oil prices at around USD100 per barrel in 201517, with an average fiscal deficit over theperiod of 0.6% of GDP and thus will necessarily be revised. While the new plan is to cut expenditures across the board by 10%, large-scale investment inexpanded military capabilities are not to be touched.

Assumptions

Oil prices will remain far below the historical peak reached in 2012 through the end of the decade.We anticipate only halting progress at best on market-oriented institutional and structural reform under President Vladimir Putin.Required adjustment of administered prices and the continued loose fiscal stance in the next several years will limit progress on disinflation. Currentofficial targets for bringing down inflation rates to the neighborhood of 4% in the medium term strike us as very optimistic.The state will continue to play an active role in the economy by means of controlling stakes in large enterprises in "strategic sectors and naturalmonopolies." The scope, schedule, and, most critically, the transparency of a proposed new wave of privatization remain in question.The central bank will attempt to limit its intervention to support the rouble to periods in which it deems financial stability is threatened.

Changes since last forecast


January interim forecast versus December interim forecast

GDP DOWN We have decreased projected GDP in 2015, with the decline now at 4.0%, thanks to our more downbeat forecast for

world-market oil prices.

Consumer price

index

UP We have raised our projection for end-December year-on-year inflation to 17.0% in 2015. This revision is due to the

impact of a dramatically weaker rouble on import prices.

Gross fixed capital

formation

DOWN We have cut our projection of the change in gross fixed capital formation in 2015 by 3.0 percentage points to -7.2%

given the ongoing credit crunch and plummeting oil prices.

Alternative scenarios

Effective trade and financial sanctions: Further Russian incursions into Ukraine to support militant separatists trigger ever more severe and coordinatedsanctions directed against Russia by the United States and the European Union. Incoming foreign direct investment and external borrowing are blocked,export earnings are reduced substantially, and the rouble and asset values continue to tumble, pushing the Russian economy further into recession froman already disappointing near-term trajectory.Higher oil prices: Because of regional military conflict, action by terrorists or insurgents, or a natural disaster, global oil-production capacity could besubstantially diminished. World-market oil prices could rebound and even surpass peak levels seen in early 2012 as a result, buoying the rouble andproviding additional revenues for the state and private sectors but further delaying efforts at economic and institutional reform.Accelerated reform: An increased push for reform and restructuring in the Russian economy, in an effort to entice investors back and spur productivitygrowth, results in improved competitiveness of the manufacturing sector. At the same time, the maintenance of cautious monetary policy and a tightenedfiscal stance help to stabilize the currency and reduce inflationary pressures, reinvigorating domestic and foreign investment and boosting growthprospects in the medium and long term.

Data



2011 2012 2013 2014 2015 2016 2017 2018 2019

Real GDP (% change) 4.3 3.4 1.3 0.6 -5.0 -0.5 1.5 2.7 3.0




Policy Interest Rate (%) 8.00 8.25 5.50 17.00 10.50 7.50 6.25 7.00 7.00

Fiscal Balance (% of GDP) 1.5 0.4 -0.2 -0.8 -3.0 -2.9 -1.5 -1.7 -0.9

Population (mil.) 143.44 143.17 142.83 142.47 142.10 141.73 141.35 140.94 140.50

Unemployment Rate (%) 6.6 5.5 5.5 5.2 6.6 6.7 5.8 5.3 5.3

Current Account Balance (% of GDP) 5.1 3.6 1.6 3.1 0.5 0.0 -0.2 -0.4 -0.5

BOP Exports of Goods US$bn 515.4 527.4 523.3 496.7 356.4 367.1 381.7 397.0 412.9

BOP Imports of Goods US$bn 318.6 335.8 341.3 308.0 270.3 281.9 292.7 303.8 315.3



Medium- and long-term outlook

Key points

Through the medium term, Russian economic growth will continue to depend on developments in world-market prices for fuels and other basiccommodities.Providing investment capital for the medium and long terms will be critical for propping up economic growth, yet the investment environment hasbecome increasingly unattractive while foreign policy goals have overridden efforts to become more integrated with the developed economies.Russia needs to achieve sustainable, diversified growth decoupled from developments in world-market prices of key export commodities.Russian policymakers will have to give greater priority in the future to lowering inflation rates, acknowledging that this is a critical factor in improving theenvironment for investment.

Analysis

Through the medium term, Russian economic growth will continue to depend on developments in world-market prices for fuels and other basiccommodities. Growth rates will remain well below earlier peaks since external economic and financial conditions are less favorable than prior to the greatrecession of 200809. Beyond the near-term recession, brakes on a robust recovery will include the underdeveloped domestic banking sector and heightenedinvestor aversion to risk in Russia. President Vladimir Putin, who has been blaming the recent notable economic slowdown on actions by the United States andEuropean Union, admitted that there is a home-grown dimension reflecting a poor investment environment and slow growth of labor productivity. Domestic andexport demand will continue losing momentum in the near term; aggregate output is estimated to have nearly stagnated in 2014, thanks largely to the effects ofheightened geopolitical tensions over the annexation of Crimea and support of pro-Russian separatists in eastern Ukraine as well as a depressed global oilprice. In the following year, GDP is projected to contract a hefty 4.0%, with a further 0.3% decline in 2016. A modest recovery at best is projected for 2017 withgrowth of 1.5%, as business and consumer confidence remains shaky. Should the tensions with Western powers over Ukraine escalate or the trajectory of oilprices become even more unfavorable, recession could extend beyond 2015. Through the medium term, however, growth can be expected to return to the justunder the 3% range, settling below that range after 2020. In the remainder of the forecast period, Russia will face shortages of labor due to its shrinking andaging population as well as increasingly capital-intensive nature of development of energy resources, which will constrain the pace of economic growth,keeping annual GDP growth rates in the neighborhood of 2%.

Providing investment capital for the medium and long terms will be critical for propping up economic growth, yet the investment environment hasbecome increasingly unattractive while foreign policy goals have overridden efforts to become more integrated with the developed economies.Injections of both foreign and domestic capital into the Russian economy will be critical for sustainable growth. Some of the most important industrial branchesin both manufacturing and the natural-resource-extraction sector are facing effective capacity constraints. In natural-resource extraction in particular, realgrowth has slowed markedly and exploitation is increasingly capital intensive. After a continued net outflow of capital from Russia in 201013, the central bank


looked forward to slowing outflow going forward and reversal in the next several years. Capital flight in 201415 looks to overmatch that of the global crisis yearof 2009, and it is now doubtful that a complete reversal of the situation could take place within the medium term because the political and international financialsituations will remain unsettled, the Russian environment for investment will remain relatively unattractive, and the perception of risk in Russia will remainacute.

Russia needs to achieve sustainable, diversified growth decoupled from developments in world-market prices of key export commodities. To becompetitive, productive capacity needs to be modernized and infrastructure expanded and rehabilitated. Some of the additional fiscal expenditure in the nextfive years is aimed at increasing the competitiveness of the Russian manufacturing sector and relieving anticipated bottlenecks represented by infrastructure.Should structural and institutional reform proceed more rapidly than we currently expect, Russia could enjoy more robust growth than we have projected in ourbaseline. On the other hand, should the environment for investors worsen as the government retains or even enhances its dominance in major sectors of theeconomy, Russia will have to continue to rely on energy and other key export commodities to drive growth. In either case, we do not see any reduction inreliance on fuels and metals to sustain exports and growth any earlier than 2020.

Russian policymakers will have to give greater priority in the future to lowering inflation rates, acknowledging that this is a critical factor inimproving the environment for investment. While increases in regulated tariffs have been limited for 201415 in an effort to rein in inflation, further upwardadjustment of regulated prices will be necessary in the future in an effort to reduce the burden of subsidies on the state budget. Indeed, the process ofdisinflation will only be more complicated because the government now plans to channel some of the earlier accumulated oil and gas tax revenue windfallthrough to the domestic economy, depleting fiscal reserves. Given an already tight labor market despite the considerable output gap in the economy, resultingupward pressure on wages will feed inflationary pressure. Thus, despite a greater focus on macroeconomic stability on the part of the monetary authorities,progress in reining in inflation will be very gradual, continuing to negatively impact the investment climate.

Data (forecasts)


2007 2008 2009 2010 2011 2012 2013 2014 2015

Real GDP (% change) 8.5 5.2 -7.8 4.5 4.3 3.4 1.3 0.6 -5.0





Fiscal Balance (% of GDP) 6.0 4.9 -6.3 -3.4 1.5 0.4 -0.2 -0.8 -3.0

Population (mil.) 141.94 141.39 140.87 140.37 143.44 143.17 142.83 142.47 142.10


Current Account Balance (% of GDP) 5.6 6.3 4.1 4.4 5.1 3.6 1.6 3.1 0.5





Growth

GDP

Key points

Russian domestic consumption will be the only mainstay of domestic demand while investment activity is slack, but strong inflationary pressures arenevertheless pinching household budgets.The central bank cannot address slower growth with monetary easing as long as the rouble is weakening and inflation is stubbornly strong.The Russian economy remains overly dependent on movements in world-market commodity prices and the extraction and export of natural resources todrive growth.


Analysis

Russian domestic consumption will be the only mainstay of domestic demand while investment activity is slack, but strong inflationary pressuresare nevertheless pinching household budgets. A slump in both investment activity and industrial production is continuing. Growth in the first quarter of 2014came in at just 0.9% while GDP grew just 0.1% quarter on quarter (q/q). Growth in GDP for the second quarter came in at 0.8% y/y and seasonally adjustedq/q data put the increase in the second quarter at 0.2%. The official estimate of third-quarter growth came in at 0.7% year on year, while GDP was stagnantaccording to seasonally adjusted q/q data. The addition of broader economic sanctions following the downing of Malaysian Airlines flight MH-17 over easternUkraine, together with falling global oil prices, is sending the economy toward recession in 2015, with a decline of 4% projected for the year as a whole. Wehave cut our projection for 2016 as well, from 0.7% growth to a decline of 0.3%. A recovery should begin to take hold in 2017 at 1.5%, with growth ratesprojected to recover thereafter to near the 3.0% level through the medium term. The investment climate remains highly unsatisfactory. Capital continued toleave the Russian private sector on a net basis through 2013, to the tune of USD61.0 billion, according to the Central Bank of Russia. Sell-offs of Russianassets in 2014 led to the net outflow of an additional USD150 billion. A minimum of USD100 billion is projected for 2016. This is taking a heavy toll on therouble, in turn contributing to higher inflationfurther dampening private consumptionand to strong inflationary expectations.

The central bank cannot address slower growth with monetary easing as long as the rouble is weakening and inflation is stubbornly strong. TheCentral Bank of Russia (CBR) had been anxious to build its inflation-fighting credibility with an eye to floating the rouble in 2015, and resisted monetaryloosening while inflation was above target, despite considerable pressure from the government and business elite to cut rates. Bank rhetoric late in 2013, undernew bank chairman Elvira Nabiullina, had suggested less complacency about risks to economic growth and seemed to leave open the possibility of a rate cutin the coming months, but continued to emphasize the importance of managing inflationary expectations. Unfortunately, inflation in early 2014 remained farabove the new 5% target, with the prospect of a more extended period of high inflation due to a weaker rouble causing the bank to hike its key interest rate by150 basis points in March, and by another 50 points each in April and July. New economic sanctions in September and falling world-market oil pricesrepeatedly pushed the exchange rate beyond the intervention trigger against the basket of dollars and euros in succeeding weeks. After a further150-basis-point hike in the banks key rate, the rouble was set afloat in November, ahead of the planned date of 1 January 2015. The bank has reserved theright to intervene to support the currency if financial stability is threatened and intervened heavily in succeeding weeks to no avail. In a desperate move inmid-December, the CBR raised its key interest rate a further 650 basis points to an eye-popping 17.0%.

The Russian economy remains overly dependent on movements in world-market commodity prices and the extraction and export of naturalresources to drive growth. Exports of fuels and metals now account for nearly four-fifths of total Russian exports, and the gas and oil sector is responsible forslightly more than 50% of federal budget receipts. Yet the natural-resource extraction sector, which currently represents 25% of the entire Russian economy,faces significant capacity constraints because of an extended period of insufficient investment. Moreover, capacity needed to replace depleted older deposits istypically associated with more difficult geologic, logistic, and climatic conditions, and hence is far more capital intensive to develop and expensive to exploit.Moreover, the technology required to tackle many of these problems remains concentrated in the hands of the multinational energy companies that arecurrently prohibited from cooperating in Russia on high-tech energy projects by economic sanctions.

Data


Economic Growth Indicators

2012 2013 2014 2015 2016 2017 2018 2019

Real GDP (% change) 3.4 1.3 0.6 -5.0 -0.5 1.5 2.7 3.0

Real Consumer Spending (% change) 7.8 5.0 1.9 -4.7 -1.8 1.0 1.5 1.6

Real Government Consumption (% change) 2.6 1.1 0.5 -5.0 0.5 2.5 2.2 2.3

Real Fixed Capital Formation (% change) 6.6 1.4 -2.5 -15.0 -5.0 3.0 3.0 3.0

Real Exports of Goods and Services (% change) 1.4 4.2 -2.0 -4.0 4.0 3.0 2.9 -1.5

Real Imports of Goods and Services (% change) 8.8 3.6 -6.8 -1.5 -1.0 2.5 1.5 -1.7

Nominal GDP (US$ bil.) 1,999.4 2,078.2 1,875.2 1,042.5 1,088.0 1,171.2 1,267.9 1,358.5

Nominal GDP Per Capita (US$) 13,965 14,550 13,162 7,336 7,677 8,286 8,996 9,669


Consumer demand

Key points

Russian consumer demand is driven by gains in domestic purchasing power and stubborn inflation is dampening it.Consumer demand is expected to grow at a more moderate pace than in the pre-recession period through the medium term.

Analysis

Russian consumer demand is driven by gains in domestic purchasing power and stubborn inflation is dampening it. Russian workers had beencatching up rapidly after the hit on real wages that they took following the financial crisis of 1998. More recently, real incomes have benefited from stronggrowth in nominal wages due to a relatively tight labor market, while affordable consumer credit from domestic banks is expanding again. The latter had beeninstrumental in revitalizing domestic passenger automobile production after a severe slump following the global recession. While consumers benefited in thefirst half of 2012 from post-Soviet record-low inflation rates, the delayed adjustment of regulated prices in July 2012, higher global and domestic food prices,and new rounds of administered price increases in January and July 2013 eroded some of that advantage. Inflation received new impetus in 2014 as aweakening rouble increased the domestic cost of imported goods. This took a bite out of households purchasing power. In the first 10 months of 2014, theaverage monthly wage was up only 0.3% year on year in real terms after an extended period of robust growth in real incomes. Stubbornly high inflation,buoyed by food prices as Russia bans imports from the United States, Canada, Australia, Norway, and the European Union, will continue to pinch householdbudgets in 2015. This has convinced us to downgrade the projected growth of private consumption in each of the two years in our latest forecast.

Consumer demand is expected to grow at a more moderate pace than in the pre-recession period through the medium term. After recovering from themost recent economic downturn with very strong growth in consumption fed by improved household finances, renewed consumer lending, and pent-updemand, slower growth in real wages due to lagging productivity, reduced profitability of enterprises, and stubborn inflation is slated to continue to take some ofthe wind out of the sails of Russian consumers beyond the near term. The strongest increase in consumer demand over the medium term will be for services,as that area remains underdeveloped, having been given the lowest priority under the old Soviet development model as well as having taken the most severebeating during the steep recession in 2009.

Capital investment

Key points

Investment in fixed capital in Russia will rise at a much more moderate pace than in the pre-recession period through the medium term. The Central Bank of Russia (CBR) projects net capital outflow will moderate beyond 2013 and will be reversed thereafter, but this would depend ondevelopments in the investment environment.Investment in modernization is much-needed as natural resource extraction becomes more capital-intensive.

Analysis


Investment in fixed capital in Russia will rise at a much more moderate pace than in the pre-recession period through the medium term. Fixedinvestment must be driven by ongoing improvements in the financial situation of Russian enterprises, as well as by recovering business confidence, affordablecredit terms, and much-needed enhancement of the Russian investment environment. Financial-market turmoil has also dampened the flow of capital into thecountry, and capital continued to leave Russia on a net basis through mid-2014 at an estimated USD61 billion in 2013, and this even accelerated in the firstthree quarters of 2014, to USD85.2 billion. Moreover, expenditure on fixed capital investment has been moderately lower year on year (y/y) to date in 2014, asit was the preceding year. This reflects, in part, reduced profitability of domestic enterprises and, more recently, heightened geopolitical tensions, includingsome that have limited access to external financing.

The Central Bank of Russia (CBR) projects net capital outflow will moderate beyond 2014 and will be reversed thereafter, but this would depend ondevelopments in the investment environment. In reality, this will also depend on the overall appetite for risk on the part of investors, and prospects indeveloped countries and other emerging markets. Uncertainty has been heightened by the threat of increasingly harsh sanctions on Russia from the UnitedStates and European Union in reaction to Russian support of militant separatists in Ukraine and retaliation by Russia. High commercial lending rates andfragile business confidence at home are also helping to restrain the pace of investment activity, exacerbated by the domination of credit markets by largestate-controlled banks and perceived risk due to the lack of transparency and poor governance typical of Russian enterprises.

Investment in modernization is much-needed as natural resource extraction becomes more capital-intensive. Over-burdened infrastructure, andoutmoded plant and equipment constrain diversification of the economy away from the energy sector, moreover. Strong growth in investment prior to therecession had been from a very low base. The level of fixed investment in 2003 by our estimates was only slightly more than one-third of that in 1991. Theextended period of insufficient investment that accompanied a transition to the market has resulted in capacity constraints in a number of key sectors.

Labor markets

Key points

After reaching a record low in May 2014, little further progress in reducing unemployment going forward can be expected; the labor market looks actuallyto be a constraint on potential output.Public-sector employment should be reduced in the medium term.Amid demographic challenges and public-sector layoffs, total employment will grow slowly in the medium term.

Analysis

After reaching a record low in May 2014, little further progress in reducing unemployment going forward can be expected; the labor market looksactually to be a constraint on potential output. From a low 5.2% of the economically active population, the jobless rate by International Labour Organization(ILO) standards sank to a historic low of 4.9% in the third quarter of 2014, despite the considerable output gap in the Russian economy. While the rateincreased to 5.2% by November, this was strictly a seasonal development. The labor market situation points to a structural problem that, along with slowgrowth of labor productivity and investment, helps to explain the sharp deceleration of GDP growth. We do not expect the rate of unemployment to movesubstantially lower in the near term, apart from seasonal fluctuation. In fact, the manufacturing and service sectors report in recent surveys that they have beenshedding labor as new business has slowed. The recent tight labor market had provided for robust increases in real wages, although strong inflation has noweroded them. We could see substantial restructuring in the next several years given a drive to diversify the economy that would provide for redundancies,particularly if much-delayed privatization plans eventually proceed.

Public-sector employment should be reduced in the medium term. Any reform of the so-called "natural monopolies" could be expected to boost joblessnumbers. There is also a need to trim the bloated public administrative bureaucracy. The plan under former president Medvedev had been for a slimmed-downand more qualified bureaucracy, but administrative reform is apparently on the back burner for now.

Amid demographic challenges and public-sector layoffs, total employment will grow slowly in the medium term. The overall population will beshrinking as mortality rates exceed birth rates. It will also be aging and the burden on workers of support for pensioners will be growing. The United Nationsestimates that the population aged 1559 will decline by an alarming 27.4% between 2015 and 2050, while the 60+ age cohort will be growing. Thegovernment has expressed concerns about looming labor shortages and is striving to provide incentives to increase the birth rate. It is also likely thatretirement ages will have to be increased. Labor shortages may force the government to more actively discourage discrimination against foreign guest workersand relax the waiting period for resident aliens to become Russian citizens.

Inflation

Key points

The Russian authorities have set unrealistic near- to medium-term targets for bringing down the rate of inflation.The central bank has struggled to stem inflation as the currency has weakened.

Analysis

The Russian authorities have set unrealistic near- to medium-term targets for bringing down the rate of inflation. Inflation headed higher in 2014 dueto the weakening of the rouble exchange rate. By the end of December 2014, year-on-year (y/y) consumer price inflation stood at11.4%. Together with the


effects of a much weaker rouble on the cost of imported goods, the ban on food imports from many Western countries, instituted to retaliate for sanctionsimposed on Russia, will send food prices surging even higher in the near term. To help stem inflationary pressures, the government will limit the indexation ofregulated utilities prices in 2015, despite concerns raised by utilities. It is also threatening to impose price controls on some food items, although this actionwould likely affect only the course of official indices while prices would surge in the informal economy. The Central Bank of Russia (CBR) earlier set inflationtargets at 5% y/y for 2014, 4.5% for 2015, and 4.0% for 2016. As a result of the new surge in inflationary pressures, these targets are well out of reach; thebank still hopes to eventually put the economy on a trajectory to hit 4% annual inflation within the medium term, but even this could still be wishful thinking.Recent inflationary pressures will have a longer-lasting impact, as they have also boosted inflationary expectations.

The central bank has struggled to stem inflation as the currency has weakened. As of its regularly scheduled February 2014 policy meeting, the CBR hadheld rates steady for 17 months. In early March 2014, the bank was forced to hike its key rate by 150 basis points to retain capital and slow the rouble sell-offand resulting inflationary pressure. Further 50-point increases came at the April and July meetings. The weakening rouble and its impact on domestic priceselicited yet another 150-basis-point increase in the key rate in early November, a 100-basis-point increase in early December, and another startling650-basis-point hike in mid-December as the plunging exchange rate put the CBR in panic mode.

Data

Inflation Indicators

2012 2013 2014 2015 2016 2017 2018 2019

Consumer Price Index (% change) 5.1 6.8 7.8 19.0 11.5 8.7 7.1 6.6

Wholesale-Producer Price Index (% change) 6.9 3.2 6.7 6.5 6.6 7.1 7.0 5.6


Exchange rates

Key points

The rouble lost 40.6% of its value against the dollar in the course of 2014, and 34.1% of its value against the euro in 2014.There will be less support for the exchange rate from foreign-exchange earnings.All remaining restrictions on capital account transactions have now been removed, but there is a chance they will be renewed in some form if theexchange rate does not respond to intervention or monetary policy tightening.

Analysis

The rouble lost 40.6% of its value against the dollar in the course of 2014, and 34.1% of its value against the euro in 2014. According to the CentralBank, in real effective terms, the rouble slumped 27.2%.In the near term, financial market volatility, falling oil prices, and an increasingly negative perception ofRussian risk (including the likely downgrade of sovereign obligations to junk status by at least one international ratings agency) will continue to affect therouble, despite still-substantial foreign-exchange earnings. Sell-offs of rouble-denominated assets caused 10% depreciation against the dollar between


October 2013 and April 2014. A new round of Western sanctions in September sent the exchange rate to new record lows. In mid-November, the Central Bankof Russia moved forward its planned float of the rouble, reserving the right to intervene if financial stability were threatened. This was an attempt to increasethe risk for speculators. The move helped temporarily stabilize the rouble. The bank announced a further massive interest-rate hike in December, to little avail.The slide is seen continuing into 2015 so long as there is downward pressure on world oil prices, while capital flight continues on a massive scale. Evenbeyond the turning point for oil prices, the relatively high rate of domestic price inflation will drive the nominal course of the rouble down against majorcurrencies.

There will be less support for the exchange rate from foreign-exchange earnings. We believe world-market oil prices will remain far below 2012 peaklevels in the medium term. This will reflect slowing global energy demand and rising output from new sources of supply, including unconventional. Russianphysical export volumes will grow slowly at best, given an anticipated slump in investment activity. Periods of greater weakness can also be expected becauseof scheduled large-scale redemptions of Russia's considerable private-sector external debt.

All remaining restrictions on capital-account transactions have now been removed, but there is a chance they will be renewed in some form if theexchange rate does not respond to intervention or monetary policy tightening. Full convertibility of the rouble was established in July 2006. Despiteseveral years of net capital outflow, the commitment to full convertibility continues to be enunciated at the highest political levels. Yet, if monetary policy andmarket intervention fail to stabilize the currency, capital controls could prove the only answer to the crisis.

Data

Exchange Rate Indicators

2012 2013 2014 2015 2016 2017 2018 2019

Exchange Rate (LCU/US$, end of period) 30.37 32.73 56.24 71.00 68.00 69.00 70.22 71.80

Exchange Rate (LCU/US$, period avg) 31.08 31.85 38.46 69.36 69.50 68.50 69.61 71.23

Exchange Rate (LCU/Euro, end of period) 40.07 45.14 68.27 75.26 76.84 86.25 92.69 96.07

Exchange Rate (LCU/Euro, period avg) 39.94 42.29 51.02 74.77 75.90 81.33 89.72 94.82


Policy

Monetary policy

Key points


Amid a severe economic recession, there will be increasing pressure on the Central Bank of Russia (CBR) to cut interest rates, but the rouble andinflation remain overarching concerns.The CBR had announced a free float of the rouble ahead of schedule, aimed at fending off speculative attacks on the currency, but continuedintervention in the market will be required when financial stability is threatened.

Analysis

Amid a severe economic recession, there will be increasing pressure on the Central Bank of Russia (CBR) to cut interest rates, but the rouble andinflation remain overarching concerns. The bank had kept the refinancing rate unchanged for 17 months as of February 2014. The bank, however, has nowtaken the one-week minimum repo auction rate as its new key policy lever in an effort to make its actions more transparent. The refinancing rate, currently at8.25%, is now largely symbolic, as the Lombard rate is no longer tied to it. The need to staunch the export of capital and support the rouble caused the bank toraise its new key rate by 150 basis points in March to 7.00% and further to 7.50% in April, despite the expected negative impact on the domestic economy.With inflation hitting 7.8%, a further 50 basis-point increase to 8.00% was instituted in July. As the weakening exchange rate lent further support to risingconsumer prices, the CBR announced a further hike in the key rate by 150 basis points to 9.50% at its November 2014 meeting. A 100-basis-point increase atthe December meeting was followed shortly by an extraordinary hike of a further 650 basis points, bringing the key rate to a startling 17.0%. The bankmaintains that if risks to the rouble and inflation strengthen further, it will not hesitate to increase rates again.

The CBR had announced a free float of the rouble ahead of schedule, aimed at fending off speculative attacks on the currency, but continuedintervention in the market will be required when financial stability is threatened. The heretofore dual focus of monetary policy had made achieving theaims vis--vis the exchange rate and inflation more difficult. To limit intervention in the foreign-currency market and move toward the float of the currency, thebank created a moving rouble trading band. The bank planned to no longer engage in targeted intervention and to move the trading corridor more often as itapproached a float of the rouble at the outset of 2015. When a further rate hike did little to stabilize the rouble, however, the bank moved up the float tomid-November. The CBR has continued to intervene in the foreign currency market, though, in an effort to punish speculation and preserve financial stability,but as of yet, with limited success.

Data

Monetary Policy Indicators

2012 2013 2014 2015 2016 2017 2018 2019

Policy Interest Rate (%, end of period) 8.25 5.50 17.00 10.50 7.50 6.25 7.00 7.00

Short-term Interest Rate (%, end of period) 9.10 9.47 10.85 22.32 18.13 14.22 8.10 7.40

Long-term Interest Rate (%, end of period) 6.12 6.14 6.15 5.83 5.78 5.72 6.60 6.40


Fiscal policy

Key points


Key points

Government spending on social programs and public-sector investment will be aimed at bolstering the popularity of the Putin regime, countering theeffect of Western economic sanctions, and kick-starting more robust, diversified growth.The downward correction in world-market oil prices in the face of populist spending programs will boost the deficit above current projections in the nextseveral budget years.

Analysis

Government spending on social programs and public-sector investment will be aimed at bolstering the popularity of the Putin regime, counteringthe effect of Western economic sanctions, and kick-starting more robust, diversified growth. While the Ministry of Finance saw a cash deficit of just0.5% of GDP in 2013, we estimate the non-oil deficit that year at 10.3% of GDP. This underlines the fiscal vulnerability of Russia to any protracted declines inworld market oil prices. The 2013 budget had a breakeven point of USD105 per barrel average for Urals crude, but the deficit excluding revenues from oil andgas remains wide and we see oil prices sliding modestly through 2015.The international financial institutions have recommended that by 2015 this non-oil gapshould be trimmed to no more than 4.7% of GDP. A new fiscal rule has been adopted that limits borrowing by the federal government to 1% of GDP annually.Nevertheless, there remains the possibility of funding additional spending by drawing down the governments massive fiscal reserves. Given the poorperformance of the economy in the first half of 2014 and blows to business confidence from economic sanctions, the government will engage in additionaldeficit spending in an effort to stimulate growth. Financing expenditures from fiscal reserves would be viewed as an alternative to borrowing, but these havebeen targeted at filling the gap in the pension fund, which will widen through the medium term.

The downward correction in world-market oil prices in the face of populist spending programs will boost the deficit above current projections in thenext several budget years. World-market oil prices have been exhibiting a significant downward correction as the global oil demand/supply situation is seenby markets to be easing even further. Together with additional spending programs aimed at fulfilling the pledges made by Vladimir Putin during his presidentialcampaign, the fiscal deficit could easily go higher than the Finance Ministry currently foresees, although it can be readily financed from fiscal reserves. Therecently promulgated fiscal framework calls for an average federal budget deficit of 0.6% of GDP during 201517, but assumes an average price of a barrel ofUrals crude oil of USD100. Given slowing global growth and rapidly rising supplies of unconventional oil, this is clearly overoptimistic.

Data

External sector

Key points

Russian trade surpluses will decrease as Russias energy export earnings decline, although the weakening rouble has also put a dent in imports.Russia's external payments surpluses will no longer approach the peak reached in 2008.

Analysis

Russian trade surpluses will decrease as Russias energy export earnings decline, although the weakening rouble has also put a dent in imports.Energy and metals dominate Russian exports, typically accounting for around three-fourths of their total value (the share hit 78.4% in full-year 2013). Ournear-term baseline forecast is for oil prices to remain far below the peak reached in early 2012, while energy exports in physical terms will stagnate, at best. In2013, the Central Bank of Russia estimates cumulative export earnings dipped 0.8% year on year, while imports continued to expand at 2.1%. Exportsdeclined in 2014. Imports, although from a lower statistical base, were cut back even more sharply in 2014, because of slack aggregate demand and aweakened exchange rate. We expect the trade surplus came in very near its 2013 level of USD181.9 billion in 2014, but will drop substantially in 2015 as theprice of Brent oil is expected to average just USD66 per barrel.

Russia's external payments surpluses will no longer approach the peak reached in 2008. In addition to the stabilization of the merchandise trade surplus,deficits on other subcomponents of the current account, such as non-factor services and income items, will widen further, helping to erode the current-accountsurplus substantially. The downwardly revised most recent estimate of the 2012 surplus came in at USD72.0 billion. The revised estimate of thecurrent-account surplus in 2013 came in at just USD34.1 billion, down approximately USD37 billion from a year earlier. Although the Central Bank estimatesthe surplus in 2014 rebounded to USD56.7 billion on improvements in subaccounts other than merchandise trade, we see the current-account surplus slippingsubstantially in 2015 and beyond. Current accounts will be much nearer balance.

Data


Trade and External Accounts Indicators

2012 2013 2014 2015 2016 2017 2018 2019

Exports of Goods (US$ bil.) 527.4 523.3 496.7 356.4 367.1 381.7 397.0 412.9

Imports of Goods (US$ bil.) 335.8 341.3 308.0 270.3 281.9 292.7 303.8 315.3

Trade Balance (US$ bil.) 191.7 181.9 188.7 86.0 85.1 89.1 93.2 97.6

Trade Balance (% of GDP) 9.6 8.8 10.1 8.3 7.8 7.6 7.4 7.2

Current Account Balance (US$ bil.) 71.4 33.0 58.0 5.0 0.0 -2.0 -5.1 -6.2

Current Account Balance (% of GDP) 3.6 1.6 3.1 0.5 0.0 -0.2 -0.4 -0.5


Key indicators and forecasts

Data (forecasts)


Detailed Macro-Economic Indicators

2011 2012 2013 2014 2015 2016 2017 2018 2019

Real GDP (% change) 4.3 3.4 1.3 0.6 -5.0 -0.5 1.5 2.7 3.0



Nominal GDP Per Capita (PPP$) 22,494 23,724 24,437 25,002 24,157 24,539 25,439 26,740 28,208

Real Consumer Spending (% change) 6.8 7.8 5.0 1.9 -4.7 -1.8 1.0 1.5 1.6

Real Fixed Capital Formation (% change) 9.1 6.6 1.4 -2.5 -15.0 -5.0 3.0 3.0 3.0

Real Government Consumption (% change) 1.4 2.6 1.1 0.5 -5.0 0.5 2.5 2.2 2.3

Real Imports of Goods and Services (% change) 19.9 8.8 3.6 -6.8 -1.5 -1.0 2.5 1.5 -1.7

Real Exports of Goods and Services (% change) 0.4 1.4 4.2 -2.0 -4.0 4.0 3.0 2.9 -1.5

Industrial Production Index (% change) 5.0 3.4 0.4 1.7 -7.0 -1.3 1.7 2.4 2.5


Wholesale-Producer Price Index (% change) 17.7 6.9 3.2 6.7 6.5 6.6 7.1 7.0 5.6


Short-term Interest Rate (%) 8.45 9.10 9.47 10.85 22.32 18.13 14.22 8.10 7.40

Long-term Interest Rate (%) 6.74 6.12 6.14 6.15 5.83 5.78 5.72 6.60 6.40

Fiscal Balance (% of GDP) 1.5 0.4 -0.2 -0.8 -3.0 -2.9 -1.5 -1.7 -0.9

Population (mil.) 143.44 143.17 142.83 142.47 142.10 141.73 141.35 140.94 140.50

Population (% change) 2.2 -0.2 -0.2 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3


Current Account Balance (US$ bil.) 97.3 71.4 33.0 58.0 5.0 0.0 -2.0 -5.1 -6.2

Current Account Balance (% of GDP) 5.1 3.6 1.6 3.1 0.5 0.0 -0.2 -0.4 -0.5

Trade Balance (US$ bil.) 196.9 191.7 181.9 188.7 86.0 85.1 89.1 93.2 97.6

Trade Balance (% of GDP) 10.3 9.6 8.8 10.1 8.3 7.8 7.6 7.4 7.2




Exchange Rate (LCU/Yen, end of period) 0.41 0.35 0.31 0.47 0.58 0.54 0.54 0.56 0.57

Exchange Rate (LCU/Euro, end of period) 41.66 40.07 45.14 68.27 75.26 76.84 86.25 92.69 96.07


Debt Indicators

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Foreign Exchange Earnings (US$ bil.) 442.6 574.2 590.6 593.9 632.7 660.2 685.8 716.2 748.0 ..

Portfolio Investment, Net (US$ bil.) -5.4 -4.4 -21.6 -12.3 -13.3 -14.4 -15.7 -17.0 -18.4 ..

Portfolio Investment, Net (% of GDP) -0.4 -0.2 -1.1 -0.6 -0.7 -0.7 -0.7 -0.7 -0.7 ..


Foreign Direct Investment, Net (US$ bil.) -9.4 -11.8 1.8 -15.6 0.0 18.0 11.9 11.3 10.8 ..

Foreign Direct Investment, Net (% of GDP) -0.6 -0.6 0.1 -0.7 0.0 0.9 0.5 0.4 0.4 ..

Foreign Exchange Reserves, Excl. Gold (US$ bil.) 443.6 454.0 486.6 469.6 420.6 437.5 455.0 468.6 466.3 ..

Import Cover (Months) 16.6 13.3 13.1 12.0 10.9 10.7 10.4 10.2 9.6 ..

Total External Debt (US$ bil.) 488.9 541.9 636.4 728.9 688.5 711.7 771.8 834.6 873.0 ..

Total External Debt (% of GDP) 32.1 28.5 31.8 34.8 34.3 34.0 33.7 33.0 32.3 ..

Total External Debt (% of forex earnings) 110.5 94.4 107.8 122.7 108.8 107.8 112.5 116.5 116.7 ..

Short Term External Debt (US$ bil.) 60.2 68.2 81.5 85.3 79.0 80.0 85.0 90.1 92.3 ..

Short Term External Debt (% of total external debt) 12.3 12.6 12.8 11.7 11.5 11.2 11.0 10.8 10.6 ..

Short Term External Debt (% of international reserves) 13.6 15.0 16.7 18.2 18.8 18.3 18.7 19.2 19.8 ..

Total External Debt Service (US$ bil.) 56.6 64.3 98.2 77.6 82.1 55.1 50.8 45.3 42.7 ..

Interest Payment Arrears (US$ bil.) 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 ..

External Liquidity Gap (% of forex earnings) 3.5 -0.8 10.4 13.8 6.6 3.3 4.6 3.9 2.8 ..

Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated live from quarterlySource:Sovereign Risk forecast bank (SRS).

Key facts and demographicsArea: 17,075,000 sq km (6,592,664 sq miles)

Population: 143,300,000 (Federal State Statistics Service, 2013)

Language: Russian (official). Many other languages are spoken throughout the federation.

Religion: Russian Orthodox, Islam, Judaism and others

Time Zone: The country covers 11 time zones. Moscow time is GMT +3, Vladivostok is GMT +10.

Neighbours: Azerbaijan, Belarus, China, Estonia, Finland, Georgia, Kazakhstan, Latvia, Lithuania, Mongolia, North Korea, Norway, Poland and

Ukraine

Capital City: Moscow

Primary Ports: St Petersburg, Novorossiysk, Murmansk, Vladivostok, Primorsk (oil terminal)

Primary

Airport:

Moscow Domodedovo Airport

Currency: Rouble (RUB)

External trade

OverviewRussian exports overwhelmingly consist of fuels and metals, accounting for more than three-fourths of total annual export revenue, while machinery andequipment, food and agricultural products, and chemicals dominate imports. After the collapse of the special trade relationships within the old Comecon (ormore properly, CMEA) and the disintegration of the Soviet Union, the locus of Russian external trade has shifted dramatically toward the West, the EU inparticular. Nevertheless, Russian import demand is still crucial for most of the other CIS economies. Russia is seeking to diversify its exports in terms ofcommodities and, in an effort to open markets abroad and spur competitiveness at home, it has sought membership in the World Trade Organisation (WTO),acceding in December 2012. Temporarily, Russia had linked its bid for the WTO to those of Belarus and Kazakhstan, as the three countries prepared to form acustoms union, but the joint approach was unacceptable to the WTO. The "troika" customs union of Russia, Belarus, and Kazakhstan, however, has goneforward and is intended to be the first step in promoting economic integration among the members of the CIS.

Data


DataRussia: Major Trading Partners, 2013

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

Netherlands 53.6 10.7 China 54.9 16.5

Germany 41.0 8.2 Germany 41.6 12.5

China 34.1 6.8 Ukraine 17.3 5.2

Italy 27.4 5.5 Belarus 16.4 4.9

Ukraine 24.8 5.0 Italy 14.6 4.4

Turkey 24.3 4.9 United States 14.2 4.3

Belarus 20.4 4.1 Japan 12.5 3.8

Japan 20.0 4.0 Kazakhstan 11.6 3.5

Poland 18.9 3.8 France 11.4 3.4

United States 17.2 3.4 South Korea 11.2 3.4

Source: IMF, Direction of Trade

Russia: Major Trading Partners, 2000

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

Germany 9.2 9.0 Germany 3.9 11.5

United States 8.0 7.7 Belarus 3.8 11.1

Italy 7.3 7.0 Ukraine 3.6 10.8

Belarus 5.5 5.4 United States 2.7 8.0

China 5.2 5.1 Kazakhstan 2.2 6.5

Ukraine 5.0 4.9 Italy 1.2 3.6

United Kingdom 4.7 4.5 France 1.2 3.5

Poland 4.5 4.3 Finland 1.0 2.8

Netherlands 4.3 4.2 China 0.9 2.8

Switzerland 4.0 3.9 United Kingdom 0.9 2.5

Source: IMF, Direction of Trade

Economic development

OverviewCompared with most other Soviet-era transition economies, the collapse in Russia's official output due to the transition to a market-orientedeconomy was the most dramatic. Under the leadership of President Boris Yeltsin and Prime Minister Yegor Gaydar, Russia undertook liberalization of pricesand trade, macroeconomic stabilization, privatization, and structural change early in the post-Soviet period. Due to a huge budgetary deficit directly financed bythe Central Bank of Russia (CBR), however, the country approached hyperinflation in 1992. The first wave of privatization proceeded quickly. Some 65% offirms ended up controlled by insiders, who proved reluctant to restructure them, and many remained inefficient. Yeltsin's strengthened political position and anew CBR chairman made stricter monetary and fiscal policies possible by 1995. By the end of 1996, the exchange rate was stabilized and set on a predictabledepreciation path. No equivalent progress was made with reforming the tax system. The fiscal gap was financed by short-term bonds. Increasing debt-servicingcosts and dwindling tax revenues proved disastrous, and in September 1998, the Russian sovereign defaulted on its debt and the exchange rate collapsed.


The rouble's massive devaluation provided a competitive advantage, and from 1999 through 2008, GDP growth was robust and stable, aided byrising oil prices. Output also received a boost from domestic demand as growing real wages led to higher levels of private consumption. Investment growthsurged as the financial situation of firms improved. In addition, foreign-exchange reserves soared and the debt burden has fallen so that the sovereign is now anet creditor vis--vis the rest of the world. Inflation had been reined in to single digits by the end of 2006, although subsequent monetary growth andmuch-needed upward adjustment of regulated tariffs and prices provided for moderate setbacks on the inflation front in the following years. As thestrengthening currency presented a major challenge to the competitiveness of Russian manufacturing enterprises, the dual focus of the CBR on both inflationand the exchange rate caused the bank to consistently miss its end-year inflation targets. The burden of macro stabilization fell on fiscal policy. Russia ranlarge fiscal surpluses in the years prior to the 2009 recession and accumulated windfall oil-based revenues in a stabilization fund. Until 2009, these fiscalreserves were tapped primarily to retire ahead of schedule nearly the entire debt to the Paris Club of official creditors inherited from the Soviet Union. Theeconomic dynamism that was spurred by high energy prices has, however, helped to stave off structural reform so that the economy remains overly dependenton the energy sector to drive growth. The plunge in world-market energy prices in the fourth quarter of 2008 and the credit crunch that accompanied turmoil inglobal financial markets subsequently resulted in a very sharp contraction of aggregate economic activity in Russia. This caused federal budget revenues todwindle while the government instituted major fiscal stimulus initiatives and fortified social spending. The resulting huge federal budget deficit was funded fromthe Reserve Fund and the National Wealth Fund, which are the successors to the oil stabilization fund accumulated during the period of record-highworld-market energy prices. Going forward, while fiscal reserves are being replenished as oil prices remain above the fiscal break-even point, the governmentplans to continue to run a substantial non-oil deficit aimed at raising living standards and modernizing and diversifying the economy through public-sector andpublic-private programs.

In contrast to the ambitious market-oriented reform agenda presented at the outset of Putin's first term in 2000, the government now seeks to"control the commanding heights" of the economy by building dominant state-controlled enterprises in strategic sectors. These include gas, oil,automotive machine-building, aviation, and metallurgy Rather than break up giant Gazprom as laid out in the original agenda, the company has been.strengthened by acquisition of assets at bargain prices through state manipulation, has spread into non-core activities, and has been given statutory monopolyover gas exports and control over the gas pipeline network. Picking up the assets of the defunct YUKOS integrated oil company, Rosneft grew from a smallstate-owned oil producer to the largest oil company in Russia, the state champion in the upstream oil sector. While former President Medvedev had espousedlimiting the influence of the state in the economy, all indications are that President Putin will not pursue that course. Although progress has been made incleaning up the banking sector, which could shore up its role in financial intermediation, and steps have been taken to create a market for electric power,liberalization of the gas market has not proceeded. Russia nevertheless has pledged to the World Trade Organization that the gas market in Russia would beliberalized in order to accede to the organization, meaning that domestic enterprises would have to pay market prices for their natural gas inputs, although notimetable was put forward for restructuring the sector. WTO accession was approved by the Duma in July 2012 by a relatively narrow margin and a number ofindustrial interests pressured deputies in light of their concern over the resulting increase in competition. Russia acceded to the WTO in December 2012. ThePutin regime is counting on WTO accession to open markets for Russian exporters as well as to spur Russian producers to greater efficiency, but Russia hasnegotiated exemptions to some WTO rules and rather lengthy adjustment periods to protect certain vulnerable sectors, agriculture in particular. Moreover, thecountry has adopted legislation that erects new, non-tariff barriers to imports, including a hefty recycling fee for imported automobiles and bans on someimports of livestock products, purportedly over hygienic and health concerns.

DataHuman Development Index (HDI)*

0.755 (rank 66th out of 187)

Inequality Adjusted (HDI)** 0.670 (rank 66th out of 187)

GDP Per Capita (2005 PPP USD) 13,611

Poverty gap at < USD2 (PPP) (%) 0

Income share held by highest 10% 32

Labour Force, total 75.6 million

Labour Participation rate (% of total unemployed) 63

Long term Unemployment (% of total unemployment) 35

Development strategyIn contrast to the ambitious market-oriented reform agenda presented at the outset of Putin's first term in 2000, the government now seeks to"control the commanding heights" of the economy by building dominant state-controlled enterprises in strategic sectors. These include gas, oil,automotive machine-building, aviation, and metallurgy. Rather than break up giant Gazprom as laid out in the original agenda, the company has beenstrengthened by acquisition of assets at bargain prices through state manipulation, has spread into non-core activities, and has been given statutory monopolyover gas exports and control over the gas pipeline network. While former president Medvedev had espoused limiting the influence of the state in the economy,all indications are that President Putin will not pursue that course vigorously. Although progress has been made in cleaning up the banking sector, which couldshore up its role in financial intermediation, and steps have been taken to create a market for electric power, liberalization of the gas market has notproceeded. Russia pledged to liberalize its gas market in order to accede to the WTO, although no timetable was put forward. WTO accession was approvedby the Duma in July 2012 by a relatively narrow margin, and a number of industrial interests pressured deputies in light of their concern over the resultingincrease in competition. The Putin regime is, however, counting on WTO accession to open markets for Russian exporters as well as to spur Russianproducers to greater efficiency.


Labor marketsThe Russian population is rapidly aging and shrinking. Like most of Central and Eastern Europe, the Russian population is dwindling and aging due to lowbirth rates and high infant mortality in the late-Soviet and transition eras. According to the 2010 revision of demographic projections by the UN, the Russianpopulation aged 1559 will decline 31.7% between 2011 and 2050. Russian policymakers are concerned that labor shortages will handicap the economybeyond the medium term and have struggled to formulate policies to encourage a higher birth rate, particularly among the Great Russian population, includingmaternity payments and investment in expanded and improved child-care facilities. While substantial numbers of migrant workers from other Commonwealth ofIndependent States countries supplement the native labor force, many of these are involved in retail trade and have been negatively received by ethnicRussians. At the same time, the ranks of pensioners will swell, placing a heavier burden of social taxation on workers and employers. A reform of the pensionsystem, a very politically sensitive issue, will certainly be necessary within the medium term.

Soviet-style trade unions survived the collapse of the USSR, and even though some reorganization has followed, the unions remain relativelypowerful. Important new unions include the air-traffic controllers, airline pilots, railroad engineers, and dockworkers. Some two-thirds of the workforce isestimated to belong to either an old or new union.

The Russian unemployment insurance system is complex and the level of benefits is modest. Thus, there is not much incentive to register asunemployed. In the Soviet system, the workplace acted as provider of many social benefits, such as housing, medical insurance, and child care. Firms havebeen slow to give up this role, and, as a result, workers have remained on the payroll even when not paid. This also contributed to a surprisingly lowunemployment rate, which persisted for a long time in independent Russia. Unemployment according to International Labour Organization standards began torise again at the end of 2008, as enterprises cut payrolls in an effort to preserve profit margins in the worsening economic environment. Unemployment hassince fallen well below the peak reached in early 2010 and stabilized in 2012 at a fairly low level, indicating a relatively tight labor market.

Monetary systemIn light of movement toward macroeconomic stability and rapid and sustained economic expansion since an external liquidity crisis developed in 1998,confidence in the Russian currency has grown, allowing the gradual introduction of complete convertibility in July 2006. Foreign currency is no longer used aslegal tender, as established by federal regulations. The exchange-rate structure is unified. The exchange-rate regime is a managed float within a movingtrading band with no pre-announced path for the rate. The band is moved if the level of intervention required to maintain its bounds exceeds a threshold. TheCentral Bank of Russia (CBR) announces daily an official exchange rate, determined on the basis of the interbank exchange rates. The official rate is used foraccounting and taxation purposes. To manage the rate, the CBR operates in both the interbank currency exchanges and the over-the-counter interbankmarket. There are no exchange subsidies. There is a forward market, with participation allowed for authorized banks. The rouble was made convertible on thecurrent account in mid-1992. Until July 2006, some restrictions remained on capital account transactions. A law that came into force in June 2004 on currencyregulation and currency control was a major step in liberalizing currency movement on the capital account. Under that law, all foreign currency paymentsbetween Russian residents and non-residents that were not specified as regulated operations could be made freely. (Regulated operations consisted of: 1)settlements in connection with the use of commercial credits in foreign trade over a specified period; 2) acquisition of equity participations by residents fromnon-residents and residents' contributions to foreign simple partnerships; and 3) payments to be regulated exclusively by the Central Bank: debt financing,securities, and banking operations between Russian residents and non-residents.) That law also specifically prohibited the introduction of an individualcurrency permit requirement. In July 2006, virtually all restrictions on convertibility of the rouble on the capital account were lifted in hopes of attracting aninflow of capital, both from non-residents and by means of residents repatriating capital that had earlier fled Russia at a time when holding rouble assets wasunattractive. While net capital flowed into Russia in 200607, increased aversion to risk and turmoil in international capital markets and the perception ofpotential investors that the environment in Russia was unattractive for investment resulted in a resumption of net outflow on a large scale in 2008 through thefirst quarter of 2013.

Financial systemAlthough there have been significant improvements in the supervision of the banking sector in recent years and the introduction of widespread depositinsurance has been a positive step, the Russian banking sector still is inadequate for the task of financial intermediation. The Russian banking sector remainsrelatively small, weak, and segmented. Given continued scarcity of skilled bank personnel and substantial non-transparency with respect to the operation andownership of domestic corporations, there is inadequate means to assess the creditworthiness of clients, which increases the likelihood of bad loans. In thewake of a worldwide credit crunch in 200809 and contracting domestic economic activity, the share of non-performing loans rose steadily and could havethreatened the banking system as a whole if the central bank and the government had not stepped in to support major institutions.

Prior to the introduction of the new deposit insurance system, state banks, such as leader Sberbank, which alone had offered deposit insurance previously,strengthened their dominant role in the economy, while the commercial banking sector hardly existed as a functioning system. In the absence of sophisticatedcapital markets and a basic banking system for channeling savings into investments and loans and with a growing, but still very limited, presence of foreignbanks, Russian corporations relied on retained profits from cash flow for their investment needs as well as borrowing abroad in foreign currencies. Banking-and financial-sector reform is lagging, but progress has been made. The regulatory framework has been tightened, but structural weaknesses remain.Vneshekonombank (VEB), which acts as both a bank and as the state's foreign debt-servicing agent, will have these functions split into two separate entities(Vneshekonombank Russia and Vneshekonombank USSR), and the Central Bank of Russia (CBR) is expected to eventually pare its 75.5% ownership ofRussia's second-largest bank, Vneshtorgbank (VTB) to 50% plus one share. The banking sector needs greater consolidation, as the market is currentlypopulated by more than 1,000 banks, a number of which serve one company alone and some of which are little more than money-laundering fronts. A numberof banks, particularly small and medium-sized institutions, also face problems because of troubled loan portfolios. The market for domestic government


securities remains small and relatively weak. The stock market has been developing rapidly in recent years, and its capitalization surged and then fell alongwith the aggregate economy and oil major earnings in early 2009. Equities have regained a good deal of ground since then. Nevertheless, trends are largelydriven by the large energy companies. There are securities exchanges in Moscow, Saint Petersburg, and Novosibirsk.

Natural resourcesExploitation of Russia's vast natural resource deposits was largely responsible for jump-starting the recovery of the economy following the 1998 financialcollapse, but it ushered in a second deep recession as energy prices plummeted in the final quarter of 2008. World market oil prices recovered along withglobal economic growth in the course of 2010 and rose further through 2011 and the first half of 2012, given only a very slight buffer of excess productioncapacity on a global scale. Russia is the world's largest country by area, stretching over 11 time zones. The southern part of European Russia holds rich soilsand supports most of the region's agriculture. The Ural Mountains contain important mineral deposits: mineral fuels, iron ore, nonferrous metals, andnonmetallic minerals. Also, the southern mountain systems, notably, the Caucasus Mountains, contain valuable mineral deposits. The northern and centralparts of the West Siberian Plain hold important oil and natural gas deposits. The Central Siberian Plateau is believed to contain important deposits of hard coal.Over two-fifths of the country's area is covered by forestsaccounting for nearly one-quarter of the world's forested areas. Unfortunately, the natural resourceextraction sector is suffering from an extended period of insufficient investment during the country's economic transition. Moreover, new resource depositsrequired to replace the dwindling capacity of older, depleted deposits are generally associated with more difficult geologic and climatic conditions andcomplicated logistics, making them even more capital intensive to develop and exploit. Along with necessary infrastructure to access newer natural resourcedeposits, this will mean that huge investment resources will be required to continue to benefit from Russias bountiful endowment.

Key sectorsManufacturing remains a significant sector in the Russian economy. The most important branches of manufacturing include machine building(locomotives, automobiles, agricultural machinery, space vehicles, military weapons, and computers); metallurgy (specialty steels and nonferrousmetals); and chemicals (chemical fertilizers and industrial chemicals). Manufacturing capacity is located mainly in western parts of the country and in theUral Mountains region.Mining and energy production are the most crucial export sectors. Russia is among the world's most important nickel and aluminum producers. It isalso an important producer of gold, silver, and diamonds as well as lead, copper, uranium ores, iron, and zinc ores. Russia is the world's most importantproducer of

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