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Our base case outlook for the global economy in 2021 remains constructive on the back of vaccine optimism and substantial monetary and fiscal stimulus. We envisage that this will lead to a structural break lower in the US dollar, as outlined in our USD Outlook, as risk appetite recovers with the global economic upswing. In the environment of improved global growth, supported risk appetite, a weaker dollar, and favourable base effects, we believe 2021 is the year for EM outperformance.

While differences in economic fundamentals will drive divergence in FX returns within the EM space, we believe the asset class as a whole will recover to pre-pandemic levels after failing to do so in 2020. Vaccine availability is the obvious catalyst for EM FX divergence as the extent to which economies can re-open is likely to differ, but the recovery in the EM space as a whole is likely to be kickstarted by the reopening of major DM economies and the spill-over effects this has for the global growth outlook. Thereon in, the strength of the global economic recovery, US economic recovery and future path of Fed/DM monetary policy will be key for the EM FX outlook as a whole. However, we believe that 2021 is too premature to witness monetary policy normalisation, with quantitative easing programmes unlikely to be wound down completely over the next 12-months. In this light, suppressed DM yields, an improved global growth environment and the support of QE programmes will result in markets returning to hunt for yield, leading to the recovery in EM portfolio flows after the 2020Q2 hit.

Within the EM space, the ruble stands out as one of the main beneficiaries of the recovery in risk appetite.

Improved global growth conditions will result in a positive demand outlook for oil and gas exports, while elevated real yields in Russia will result in positive carry conditions for the ruble. Domestically, a substantial vaccine programme will allow the domestic economy to reopen at a similar rate to most DM economies, while monetary stimulus is likely to continue to be flushed through the economic system to support growth as we expect further cuts from the Central Bank of Russia next year. Our base case assumption of a robust recovery in the eurozone will also benefit Russia’s current account as external demand rises. We believe this confluence of factors will result in a substantial rally in the ruble, prompting a recovery to pre-pandemic levels by year-end. The risks posed to our outlook are substantial, however, and are tilted towards a weaker RUB than we anticipate. A subdued recovery in household demand and fiscal consolidation pose risks to the domestic economic recovery, while a more prolonged rollout in vaccinations and a slower global economic recovery pose risks to the assumption that carry conditions will recover. Additionally, the prospect of an escalation in geopolitical risks remains a primary concern for any ruble outlook, while a quicker than expected loosening of production cuts by OPEC+ could weigh on the oil rebound.

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The Central Bank of Russia has been instrumental in supporting the economy through the effects of the pandemic. Since March, the central bank has cut its Key rate by 175bps, eased liquidity regulations for important credit institutions, allocated a new RUB500bn facility for SME lending – which compounds RUB150bn already allocated – while also setting aside RUB50bn for lending to businesses that don’t have SME status, and has offset some RUB weakness by selling FX reserves in the market.

While this has sheltered the economy somewhat from the negative economic effects, the CBR’s job is far from done with regards to promoting economic growth and lifting underlying inflation forces. While headline CPI has printed above the CBR’s 4% target since October, much of the inflationary boost is due to transitory effects influencing food price inflation and the pass through of RUB weakness. Despite the CBR showing some willingness to look through the transitory rise in inflation, however, with these forces set to continue dominating the headline inflation print until at least 21Q1, we don’t expect the central bank to cut rates further.

In combination with this, recent commentary by Governor Elvira Nabiullina suggests that the CBR will hold rates until financial markets become more stable, which is unlikely to occur on a more prolonged basis until 2021. Nabiullina recent stated:

In an unstable situation in financial markets with elevated risks, a key rate cut could lead to an increase in interest rates on long-term financial instruments and a more pronounced reaction of the exchange rate than in steady conditions. As a result, monetary conditions could even tighten.

While the ruble has recovered some 4% since the October meeting where Governor Nabiullina looked to volatile financial conditions to hold rates at 4.25%, financial markets still remain tentative to an uncertain outlook at present. Additionally, the risk of US sanctions (discussed below) could reinforce the central bank’s decision to maintain a cautious stance.

Taken together, the transitory spike in inflation and unstable financial conditions are likely to leave the CBR on hold until year-end.

In 2021, however, we expect the central bank to continue cutting rates to support the domestic economic rebound as macro conditions face substantial headwinds and demand-pull inflation forces remain weak. While the central bank measures the real neutral rate of interest to be around 100-200bps, thus placing the key rate at 4.25% in accommodative territory with inflation above 4%, any substantial decline in inflation will quickly tighten monetary policy in real terms and thus pave the way for additional rate cuts. Our view on Russia’s macroeconomic developments outlined below suggest that growth and consumption are likely to face substantial pressure in the coming year, especially as fiscal support measures wane. This places the impetus on monetary policy to fill the void.

While our expectation of lower interest rates in Russia in 2021 is a high conviction call, the timing of their delivery depends on persistence of transitory inflation dynamics. One barometer of inflation that highlights the subdued level of inflation pressures once the effects of Covid-19 supply disruptions and RUB depreciation are removed is service sector inflation.  Inflation in the service sector sits substantially below headline CPI at 2.5%. Given this measure of underlying inflation, once the transitory effects fade and headline CPI starts to exhibit a disinflationary trend, we expect to see the CBR come back into action and continue to cut rates. However, the persistence of headline CPI is not the only risk to this view. Heightened geopolitical risks that will result in sanctions and, therefore, substantial RUB weakness could result in the CBR holding rates or potentially even tightening monetary policy depending on the extent of RUB depreciation in the coming year.


Uptick in inflation driven by food prices and RUB depreciation, but weakness in services CPI highlights weakness in underlying inflation forces



Our base case for the EM space heading into 2021 is that the hunt for yield will return in markets as risk appetite recovers due to the global economic upswing, yields in the DM space remain supressed at effective lower bounds and quantitative easing programmes remain expansive in most advanced economies. Russia’s positive real yield profile makes the RUB a prime candidate to benefit from this dynamic within the global economic recovery, even with our expectation of CBR rate cuts in the coming 12-months.

Portfolio inflows to Russia have struggled to recover since the pandemic despite the decline in sovereign default risk. While non-resident holdings of OFZ’s (Russian Federal bonds) has risen, this has coincided with increased debt issuance due to Russia’s fiscal stimulus efforts. In fact, the share of foreign ownership of OFZ’s has plummeted since the pandemic and has failed to recover. This is similar to the dynamics seen in other major EM’s, with domestic markets picking up the slack left by foreign players after massive capital outflows back in Q2. Should the risk climate in global markets be supported in 2021 by vaccine distribution and a more robust global economic recovery, while the geopolitical risk profile of Russian assets improves, we envisage foreign investors to return to Russian assets due to their higher yielding nature.


Declining share of foreign ownership of OFZ’s suggests substantial room for recovery in 2021 as hunt for yield returns



While Russia’s monetary stance is likely to remain supportive for the year to come, the economy is set to face headwinds from fiscal consolidation beginning in 2021. Throughout 2020, the Russian government has embarked upon fiscal spending not dissimilar to other major economies, even as the pandemic corroded tax revenues. However, the 2020-2023 budget proposal released in September suggests an unwinding of stimulus in 2021, narrowing the budget deficit from 4.4% in 2020 to 2.4%, after a 1.8% surplus in 2019. In 2023, the deficit is expected to shrink to 1.1% of GDP. While Russia’s low government debt-to-GDP ratios prior to the pandemic  provides ample room for the government to dip into reserves and borrow more in the coming year to fund the contracting budget deficit with debt, it is unlikely they will veer too much from its conservative stance unless additional economic shocks force their hand.


MinFin projections see deficit narrowing in coming years

Source: Russia Ministry of Finance


Projected government expenditures are set to show spending decline from 21.1% of GDP in 2020 to 17.9% in 2023.

The overall budget balance deteriorated by 2.4 percentage points vs 2019, which can be explained by the drop in oil output following the OPEC+ production cuts. With regards to taxation, the budget shows the government is taking a generally hawkish approach. The Finance Ministry announced an increased taxation on the non-fuel mining sector and excise duty on tobacco. Earlier, income tax on the wealthy was raised along with dividend taxes. Although the combined effect is less than a percentage point of GDP, the initiatives paint a picture of the government’s approach going forward with regards to fiscal consolidation in order to achieve a diminishing budget deficit over the coming years.

While the increase in income tax focused on the wealthy and therefore likely only had a mild effect on consumption, household incomes in Russia remain one of the biggest domestic risks to the macroeconomic outlook. In 2020, households’ real disposable incomes were down 4.8% YoY in Q3 following an 8.4% YoY drop in Q2. The fall came as real hourly wages were growing at a slower rate and have not fully recovered to pre-pandemic levels yet, while unemployment also printed above 6%. The headline rate may also underreport the true level of slack within the labour market too as it doesn’t capture the informal workforce. This may also continue to weigh on wage growth going forward. Additionally, household income levels aren’t being suppressed by just sluggish wage growth but also employees working less hours. With unemployment rising and the output gap widening, low levels of real disposable income and sluggish wage growth will continue to weigh on the rebound in domestic consumption.


Household income in Russia remains depressed as the pandemic puts a heavy burden on wage growth and even more so on hours worked


Noting this effect of the pandemic on the labour market, the Russian government has offered payments to companies and individuals to prevent job losses and expanded benefits to employees who were sacked. However, with unemployment still rising, the net effect of the temporary welfare support measures are likely to fade as the new budget policies come into play in 2021-2022. Ultimately, this would mean that fiscal policy will become a net drag on growth in the coming year under consolidation efforts due it coinciding with consumption constraints as household incomes remain in a tentative position.

Russia’s conservative approach to fiscal stimulus goes to show that the 1988 default crisis left its scars. Even with debt-to-GDP ratios being low compared to peers, Russia generally avoids borrowing as a means to finance budget deficits and instead makes use of its fiscal rule. During the pandemic, however, the fiscal rule was temporarily suspended and will only be reinstalled in 2022. Under the fiscal rule, any extra fuel revenues received due to Urals trading above US$42.4/bbl are to be saved in the National Wealth Fund. This protects government finances from swings in oil prices and allows the government to draw down funds from the NWF to replace the revenue shortfalls. The suspension of the rule creates short-term flexibility of the budget policy as it reduces Russia’s need to access financial markets and issue more debt as oil prices climb above the fiscal breakeven. This move comes in the face of a deteriorating GDP outlook. However, it also puts a strain on Russia’s fiscal savings, which are considered to be the backbone of Russia’s macro stability. While fiscal stimulus remains supportive of the recovery in the initial stages, the reintroduction of the fiscal rule in 2022 and the pivot towards early fiscal consolidation in 2021 are likely to provide headwinds for domestic growth and therefore the ruble rally. In addition to the changes in fiscal policy, a weak recovery in household incomes and a possible extension of oil production cuts are likely to become a drag on growth in 2021 as they slow down the release of demand.



Russia faced an 8.0% decline of real GDP YoY in Q2 2020 after posting a 1.6% rise in Q1. The Q2 GDP numbers showed that Russia suffered a more modest output drop compared to other major economies during that quarter, likely due to Russia’s milder lockdown measures. The advanced GDP reading for Q3 printed at -3.6% YoY, a significant uptick from the Q2 number. The improvement was mostly driven by a rebound in trade and transport, following the loosening of mobility restrictions after Q2, while manufacturing and agricultural production also picked up.

Sentiment and activity data suggests that the economy stalled again in Q4, however, after a resurgence of the virus case count and deaths. Purchasing Managers’ Indices from all sectors dropped back below the threshold 50-level in October and November, with the manufacturing sector performing only slightly better than services. Inflation in Q4 increased, with the October and November figures both printing a 0.7% increase on a month-on-month basis, but the uptick relates to the recent ruble weakness which caused much of the inflation to be imported along with transitory food price inflation. With the ruble selling off prior to the US election, inflation spiked.


Urals crude oil prices remain depressed below $50/bbl– fair value index January contract

An important assumption to take into account for the next year when considering the ruble outlook is the expected further appreciation of the euro vs USD. We envisage 2021 as a year in which most EM currencies should gain against the USD based on broad dollar weakness and an improvement in risk appetite. However, the ruble should also appreciate against the euro. With Russia being reliant on the eurozone economy for trade, a downside risk remains that the eurozone economy may not recover rapidly enough should potential vaccines or their distribution plans prove to have faults, causing economies to reopen later than expected. Until a vaccine is widely available, governments in the eurozone but also the Russian government may be forced to extend lockdown measures or even impose tighter restrictions. This would weigh on both the Russian economic recovery and risk appetite.


As other European countries aim to slow down the second wave, Russia’s first wave never ended

For now, Russia’s increase in Covid-19 infections continues to accelerate. Unlike Western Europe where the first wave was followed by a period of loosening lockdown measures and lower daily case count before entering the second wave, Russia’s first wave never really ended. Rosstat, the Federal Statistics Service in Russia, reported that 55,671 people have died from Covid-19 from April through to September, which is more than double that reported earlier in the year. As the figures are based on death certificates, the Rosstat figures are likely to be more accurate than the totals released by the virus-response center. Although the rate of infections continues to rise, Russia has begun vaccinations already, with over 100,000 people saying to have been vaccinated as of Dec 2. Even more so than in the West, however, Russia struggles with a lack of trust in the rollout of the vaccine: in October, 59% of the respondents in a poll said they would not take the vaccine. This may be explained by the conspicuous speed at which the vaccine became available in the country. President Vladimir Putin stated in August already that Russia had become the first country to approve a vaccine. Critics responded by saying he was dangerously short-circuiting the crucial process for developing a safe vaccine. While the rollout of a vaccine remains positive for the 2021 outlook, conditional on it having a high efficacy rate and widespread take-up, the damage of the rise in cases in Q4 is likely to have already been inflicted on the Q4 GDP data.



In the background, geopolitical risks remain elevated. Uncertainty around US sanctions has been weighing on the ruble over the last six months, and with President-elect Joe Biden incoming, Russia could face threats of tighter US sanctions moving forward. While a Biden administration is considered to be less focused on external relationships, especially in the coming months as the focus remains on the domestic economic recovery and containment of the virus outbreak, the latest headlines regarding a large cyber-attack on US government agencies by Russian hackers poses a risk of sanctions. The attack was made on several systems within the US treasury and Commerce departments, and is part of a larger campaign that included the hack of FireEye. The series of attacks may pressure the currency going forward if they lead to a response by the US in the form of renewed sanctions or even warnings of sanctions. Meanwhile, existing sanctions remain a drag on trade and investment as well.

Over the medium-term however, an expected pick up in global growth along with further developments in oil prices could spark a return for foreign investors to the Russian debt market and in turn a sustained rebound for the ruble. However, this assumption is dependent on investor appetite which remains at the mercy of US-Russia tensions.


Simon Harvey, FX Market Analyst
Ima Sammani, FX Market Analyst



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