Russia to fall deep in recession, drag region down: EBRD

Russia will fall into a deep recession following the ruble’s collapse and the sharp decline in the price of oil, and will drag down with it many other countries in the region this year, new forecasts from the European Bank for Reconstruction and Development (EBRD) show.

Growth in EBRD region

Russia has been hit by the price of oil, dragging the region down. Source: EBRD

The price of oil has more than halved since the first half of last year, compounding the effect of structural problems, increased uncertainty and low investor confidence in Russia.

Economic sanctions imposed after the Russian annexation of Ukraine’s Crimea in March 2014 have also hurt the Russian economy.

Investment continued to decline in the first three quarters of last year, when consumption growth slowed to below 1% and imports fell by 6% in real terms, the EBRD’s report for the region shows.

Capital flight has accelerated, with outflows almost doubling to $134 billion in 2014. The ruble lost almost half of its value against the dollar last year, when Russia spent around a quarter of its foreign exchange reserves defending the currency.

The central bank hiked interest rates to 17% to arrest the Russian currency’s fall, and the ruble stabilised towards the end of last year.

The central bank also provided aid to some of the country’s banks and the government said it would help some companies towards the payment of some of their dollar-denominated bonds.

The EBRD expects the Russian economy to contract by nearly 5% this year because of the effect of all these factors, with investment shrinking at a double-digit rate as local borrowing costs surge and external funding is constrained by sanctions.

The development bank itself was forced to stop any new investment in Russia last year, when Turkey became the top destination for EBRD investment.

Consumption will contract as real incomes are eroded, while fiscal transfers are constrained by lower oil revenues to the budget, the bank’s report predicts.

Inflation will continue to go up, bucking the trend in most of the world economy, because of the deep currency depreciation suffered by Russia.

The region suffers

The effect of the sharp slowdown will be felt in countries in the region with strong economic ties with Russia.

In Armenia and Belarus, for example, the currencies came under pressure last year in December when the ruble tumbled.

“These pressures have been contained so far, but may resume if low oil prices persist,” the EBRD’s report warned.

Belarus is forecast to enter recession, while economic growth in Armenia and Moldova is projected to come to a halt.

The fall in commodity prices will have a negative effect on the economies of Azerbaijan, Kazakhstan and Turkmenistan, while the rest of the region is expected to “decelerate significantly” because of its strong ties with Russia.

By contrast, Turkey will benefit strongly from the fall in commodity prices, especially oil. Its economy is expected to grow at a rate of 3% this year.

Central, Eastern, South Eastern Europe and the Baltic states will benefit from the sharp fall in the price of oil, but they will have to face other headwinds.

Some of the countries, such as the Baltic states, have trading ties with Russia and are likely to be hurt by its recession while others are strongly linked to the eurozone, which is not expected to recover as quickly as had been expected.

In addition to the global risks – geopolitics as well as elections in major countries, which could change the fate of the eurozone or the European Union – the region also has to deal with its own ills.

Credit growth remains subdued, because banks have continued to cut their exposure and credit standards were tightened.

Non-performing loans have been high for a long time, and have weighed on the countries’ economic recovery.

In most South-Eastern European countries, the level of non-performing loans is close to 20% of all loans, while they exceeded 30% in Kazakhstan. In Cyprus, they are around 50% of total loans.

The decision by the Swiss National Bank to scrap the currency’s peg with the euro last week could hurt some of the countries, as banks in Poland, Hungary and Romania extended some loans denominated in Swiss francs during the boom years before the financial crisis.

Hungary has passed legislation mandating the conversion of the loans into the Hungarian forint, at an exchange rate that helped borrowers, but other countries in the region have no measures in place to protect debtors.