By Dieter Wermuth, Chief Economist, Wermuth Asset Management.
As Putin has assumed office once again, dark clouds in the form of plunging oil prices and a recession in Western Europe are hanging over him. His third term as president is unlikely to benefit from a benign external environment. Investors are reminded that Russia has a high-beta economy that is hostage to the oil price. Historically, revolutionary situations develop when a government is unable to meet the aspirations of its rising middle classes. Commodity prices are still very high and generate correspondingly high household incomes in Russia, but what matters most in terms of political stability is whether prices and thus living standards will keep rising.
Expectations will probably be disappointed. At an annualised rate of about 2¼ per cent, global real GDP at market exchange rates expands well below trend which suggests that inflation rates are on the way down. This includes commodity prices. Slow global GDP growth has in the past led to a decline or stagnation of energy consumption. There have been four years – 1981, 1982, 1993 and 2009 – when it actually fell in response to sub-par GDP growth. The risk, from a Russian point of view, is that it could happen again this year. This is the most fundamental reason why oil prices are on the way down. Only clear signs that global economic growth will accelerate again will stop the trend. They are still missing.
As long as the outlook for oil prices is negative, both the Russian stock market and the exchange rate will be under pressure. The government budget which had shown a small surplus last year will move into the red again, because revenues are largely a function of the oil price – by how much depends on the actual oil price. Since government financials remain extremely sound, there is actually room for manoeuvre on the expenditure side. Infrastructure stocks, including utility stocks, may become the next investment story.
Inflation will remain low (CPI in April was 3.6% y/y): the negative effects of the depreciating rouble and the coming increase of electricity prices will be compensated by weaker overall demand and falling food prices. The central bank keeps interest rates at elevated levels in both real and nominal terms and could cut them if necessary, in case the economy slows more than expected. Interest rate-sensitive stocks would benefit. A few names will also profit from the lower rouble.
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