29 October 2013

Danske Bank Markets Analyst: Sanna Kurronen +358 10 546 8369

Stagnation is starting to look like a policy goal in Russia

Important disclosures and certifications are contained from page 16 of this report.

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Russian economy is stagnating – is this planned?

Russian economic growth continues at a very low pace and the policy response has been muted.

To us, it appears that both the government and the central bank are contented with the slow growth and inflation targeting is really taken seriously. Stagnation is perhaps used to avoid stagflation, i.e. slow growth combined with higher inflation and rising unemployment.

Thus, we expect the slow growth rate of 2.0-2.5% to continue in Russia in 2014-15.

However, the policy has one major shortcoming, as

the need for significant growth in investments cannot be bypassed.

Source: Macrobond, Danske Bank estimates

3

Stagnation is used in Russia to buy time

Given several major bottlenecks in the Russian economy (labour force, logistics, production capacity, etc.), we believe Russian politicians are trying to buy time with stagnation to improve the investment environment in the economy.

Without significant investment, rapid growth is

likely to lead to higher inflation. However, as the investment environment

remains poor in Russia, time is needed to improve the environment to enhance investments.

Source: Macrobond, Danske Bank Markets

4

What is dragging investments in Russia?

Slowdown in fixed investments this year is due mostly to public investments and investments of state-owned companies.

Lower energy price expectations deter

investments in mineral extraction sector. The change of mayor in Moscow and St

Petersburg has caused significant delays in some of the investments in these areas.

Access to finance can be an obstacle as well

for private companies.

However, the most important obstacle for investments remains the poor overall investment environment.

Source: Rosstat Danske Bank Markets

0

10

20

30

40

50

60

70

80

90

2012

% o

f t

ota

l in

ve

st

me

nt

s

Fixed investments in Russia in most important

sectors of total fixed investments

Real estate

Transport and communication

Electricity, gas and water

Manufacturing

Mineral extraction

5

Putin’s 100 steps programme shows positive progress but it’s not enough We remain sceptical about Russia’s ability to

improve the investment environment. Putin’s 100 steps programme aims at

improving Russia’s rank in the Ease of doing business survey by 100 steps, ranking 20th as soon as 2018.

Progress has been apparent since the launch of the programme in 2012 and some red tape can still be removed relatively quickly (construction permits, trading across borders) but we are less convinced of improvements in investor protection and believe wide-ranging corruption will hamper progress towards the top ranks.

Source: World bank, Danske Bank Markets

0 50 100 150 200

Total rank

Starting a business

Dealing with construction permits

Getting electricity

Registering property

Getting credit

Protecting investors

Paying taxes

Trading across borders

Enforcing contracts

Resolving insolvency

Russia’s rank in Ease of doing business survey

2012 and 2014

2014 2012

6

Retail sales supported by benign labour market conditions, as low unemployment keeps wages on the up

Source: Macrobond, Danske Bank Markets

Although investment activity remains sluggish in Russia, the consumer sector continues to grow rapidly.

Unemployment is low and real wage growth remains impressive, which continues to support the retail sector.

Moreover, the declining labour force is likely to underpin wages for years to come.

Consumer loans continue to increase as well but the share of non-performing loans has started to increase this year.

7

Is the consumer sector threatened by overheating or cooling?

The Russian central bank is trying to curb excessive growth in consumer loans through stricter regulation to prevent growth in non-performing loans.

However, excessive curbing of the overheating

might lead to declining consumer demand, if unemployment increases and wage pressures moderate simultaneously.

Thus, policy is about balancing between supporting consumer sector and eliminating the symptoms of overheating.

Source: CBR, Danske Bank Markets

0

1

2

3

4

5

6

7

8

%

Non-performing loan share of total loans at

the beginning of the year in Russia

All loans

Households

Mortgage

8

Inflation continues on its downward trend

Source: Macrobond, Danske Bank Markets

Russian inflation has started to ease since the summer and we expect the good harvest and slow economic growth to push inflation down further over the coming year.

However, the weak rouble is adding some upside pressure to import prices.

The central bank’s inflation targets are 5.0% for 2014, 4.5% for 2015 and 4.0% for 2016.

All in all, the Russian central bank has shown commitment to its inflation target, which just might turn out to be a strategy worth sacrificing a couple of years growth for.

9

Rapid inflation impairs Russian competitiveness

Source: Macrobond, Danske Bank Markets

Despite the nominal weakening of the rouble, high inflation ensures real appreciation of the rouble as inflation in trade partner countries is lower on average.

Against a trade-weighted basket, the rouble has appreciated 50% in real terms over the past 10 years.

In practice, the real appreciation means that Russian companies lose their international competitiveness but Russian consumers are able to consume more and more foreign goods.

10

Oil price continues to be the main threat for the Russian economy The oil price still has a major effect on the

Russian economy: an oil price collapse would diminish the current account surplus, increase the budget deficit and reduce investments.

Such wide-ranging economic deterioration would spread to the whole economy.

We expect a moderate decline in the oil price in coming years, which should not have a dramatic effect on the Russian economy.

Source: Reuters EcoWin, Danske Bank Markets

Oil price and basket/RUB

09 10 11 12 13 14

32

33

34

35

36

37

38

39

40

60

80

100

120

140basket/RUB USD/barrel

<<Basket/RUB

Oil price and DB forecast >>

11

Russians are not concerned about rouble weakness anymore

Although the Russian central bank continues to limit rouble volatility, the rouble is almost free floating already. Thus, the current level of the rouble reflects its market valuation.

Moreover, the rouble will not be defended as strongly as it was in 2008-09 and, consequently, Russia will not drift to such a severe liquidity crisis in the case of a weakening rouble.

A weaker rouble is favourable for the government budget, as a big share of government income is USD-denominated from energy exports.

Source: Macrobond, Danske Bank Markets

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Macroeconomic forecasts for Russia

Source: Danske Bank Markets, Macrobond, Rosstat

Russian macro forecasts -Danske Bank

5,6 5,22014 2,6 3,9 3,6 -2,0 3,7 6,3 2,7 2,8

Infla-

tion1

Russia

2012 3,4 6,6 6,7

Year Gdp1

Private.

Cons1

Fixed Inv1

Export1, 4

Import1, 4

3,5 2,6 5,3

Trade

Balance2, 4

Current

acc.2, 4

Industrial

prod.1

Unem-

ploym3

3,4 5,7 2,3

5,1

2013 1,8 4,4 -0,6 -1,8 3,8 7,2 3,1 0,3

3,5 6,0 9,5

2015 2,3 3,4 3,8 -1,5 3,0 5,8 4,8

5,5 6,4

1) Average % y/y 2) % of GDP 3) % of total work force 4) export and import prices

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Disclosures

Lähde: Danske Bank Markets, Macrobond

This presentation has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The author of this presentation is Sanna Kurronen, Analyst.

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