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SBERBANK OF RUSSIA
External Shocks of 2015: Unpleasant But Not Catastrophic
July 20, 2015
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2015 was marked by escalation of risks associated with the situation
around Greece, reaching an agreement on Iran and more significant and
rapid slowdown in China’s growth.
Increasing the Federal Reserve System Rate in 2015 will cause capital
inflows into the United States. But the appreciation of the dollar has
already happened, so we are not expecting a strong decrease in the
dollar price of commodities on account of this factor.
Although the level of turbulence of the global markets will grow
significantly, catastrophic scenarios at the global and regional levels are
unlikely to happen.
Decline in raw material prices, especially oil, and additional turbulence
in the currency market will be the main factors in the impact of these
shocks on Russia.
As a result, the restoration of the Russian economy and its way out of
recession may be delayed.
In the current recession conditions, the growth of the negative
consequences of the risks will not be dramatic.
Risks and Shocks of 2015
New risks of 2015
The level of macroeconomic uncertainty has increased greatly in 2014.
The geopolitical crisis in Ukraine and the hostilities in the territory of
neighboring state have greatly increased the political risks and led to the
present economic shocks, i.e. the consequences of the application of the EU
and US economic sanctions. No one expected the halving of oil prices in
2014, but this decrease has made the Russian economic recession and
currency crisis inevitable. In 2015, the situation is more calm and
predictable (especially in the 2nd quarter of the year). Nevertheless, the
significant risks of external shocks on the macroeconomic stability in
Russia are already obvious. They may materialize in 2015 and have a
significant impact on the fundamental factors for the country. We are
going to analyze four major events:
1) Greek
withdrawal
from the
Eurozone
1. Events around Greece, i.e. Grexit: Although market expectations
regarding the development of a negative scenario are formed and
included in the price of assets, it is difficult to calculate the specific
dynamics of the developments and take into account all the risks. The
direct effect of Greece on Russia is negligible, but we cannot exclude
shocks on the foreign exchange market and the devaluation of the euro
as a short-term risk.
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2) Collapse of
economic
bubble on
China’s stock
market
2. China’s stock market bubble has burst: Slowing of economic growth
in China has become a fact in the years 2013-14, but the bursting of the
bubble of the stock market, which lost 30% of capitalization in the last
month, can accelerate this process. For Russia, the result of the
slowdown is the raw materials demand shock. Reduction of prices on
energy carriers and metals should be expected.
3) Cancellation of
sanctions against
Iran
3. Agreement on Iran and cancellation of sanctions: For all the
positivity of this event, the shock on the supply side of the oil market
can be easily predicted. Moreover, this factor takes effect almost
immediately.
4) Increase of
Federal Reserve
System Rate
4. Increase of FRS rate: In 2015, a new cycle of the US Federal Reserve
monetary policy will begin. The first stage is expected to take place in
September-October 2015 (more likely in October). Raising rates will
cause a strengthening of the dollar and, thus, an additional decline in
gold and oil prices.
Impact of shocks on
Influence of these external shocks will be mitigated due to the isolation of the
Russia will be mitigated Russian economy from the global capital markets. Under normal
due to isolation from
circumstances, the global shocks could cause a significant change in
capital markets
interest rates and the outflow of capital from Russia. The shocks broadcast
channel is currently blocked.
Nevertheless, the
consequences will be
severe
Thus, with a deep reduction of oil prices and a new spiral of destabilization
in the currency market, the macroeconomic situation in Russia may
significantly deviate from our baseline scenario: the recession will deepen,
the budget will require more funding, the ruble weakening will accelerate,
and the exchange rate will get even more volatile. A new acceleration of
inflation is a major challenge for the monetary authorities in such a
situation. The reduction in real wages and incomes will cause new
challenges for banks.
Greek Withdrawal from the Eurozone
Probability of Greek
withdrawal from the
Eurozone increased
The Greek debt crisis in 2015 reached its peak. The first two programs
involving the three creditors could not stop the growth of government
debt, so another restructuring was a matter of time. The progression of
events accelerated after the relatively radical party, Syriza, came to power
in January and advocated for the abandonment of the three creditors
program.
“Greece in the Eurozone” Scenario
New ‘three creditors
program’ postpones
the state debt
problem instead of
solving it
The least traumatic and most likely scenario for the near term
development of the situation around Greece is the postponement of the
problem. This exact scenario is now being realized. So far, European
lenders have agreed on lending the Greeks only €7 billion euros of bridge
financing, €4.2 billion of which will be paid on July 20th by the ECB; 2
billion euros will be paid by the IMF as part of an overdue debt. Further
funding (€86 billion) as part of the Greece's third program involving the
three debtors is yet to be approved by the national parliaments. In
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addition, the ECB has increased the volume of liquidity provision by €990
million (up to €90 billion), so on July 20th the Greek banks may be able to
resume work. This is all part of a temporary agreement.
Government debt
will continue to
grow
Privatization
objects are not
specified
Firstly, according to the IMF estimates, Greece will not be able to pay off
the government debt. Even a complete relief of €53 billion issued in 2010
from the Greek Loan Facility will not be enough to put the debt issue on a
steady path. While, according to Germany, the debt relief is impossible in
accordance with the Eurozone agreements, the experience of the previous
restructuring (private sector involvement in 2012) suggests otherwise.
Moreover, without the debt relief, the IMF is likely to stop the
participation.
Secondly, it is not clear what assets worth €50 billion Greece is going to
privatize in the coming years. The agreement merely states that "valuable
assets" are going to be transferred to the fund. Obviously, art objects and
territories (islands) are not being considered. Shares of Greek banks,
which the state will receive as a result of the emergency recapitalization,
will cost very cheap. Sale of infrastructure objects for €50 billion is hardly
possible. The creditors will return to this issue in the 4th quarter of this
year since the unclear privatization plan was one of the most criticized
aspects of the Greek proposals to the three creditors.
Probability of social
unrest has
increased
Thirdly, the set of measures, for which the Greek Parliament voted almost
unanimously (229 out of 300 votes), contradicts the results of the
referendum held two weeks ago. Social unrest and protests are inevitable,
although their scale is difficult to predict.
Grexit is not
cancelled, it is
postponed
In summary, the agreement will stay in effect as long as the Greeks are not
convinced that the reform package adopted on July 15 does not help to
stop the recession, deflation and rise of the government debt. At this point,
the government will decide to loosen the fiscal discipline and creditors will
suspend another tranche of the third anti-crisis program. Moreover, if a
number of European parliaments rejects the anti-crisis plan or if the ECB's
support is not enough to restart the Greek banks and abolish the
restrictions on capital flows, or the IMF refuses to participate as a creditor,
then the Grexit will become one of the most suitable ways to solve the
problem.
Chaotic Withdrawal from the Eurozone
Grexit can still happen
by the end of the year
ECB will determine the
Grexit's final moment
Due to the intermediate agreement with creditors, Grexit is now less likely
to happen. In addition, European countries have repeatedly warned about
the preparation for Grexit, meaning that technical and legislative solutions
will be in a high readiness mode. This will ensure a less chaotic
withdrawal. This is how we see the withdrawal progressing if it actually
happens this year.
A government bonds default will breach the balance sheets of Greek banks
worth €46 billion, €13.6 billion of which represent the government debt
(according to ECB as of April) and €30 billion represent the instruments
with state guarantees. The ECB will stop providing liquidity to Greek
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banks, which is €90 billion as part of the ECB's emergency liquidity
program of ELA. Greece does not have enough money to recapitalize the
banking system, so we think that the Icelandic option will be chosen.
Banks will be divided into an "external one" and several "internal ones"
with the external debts moratorium. This will help to preserve the banking
system which is vital for the restart of growth after the withdrawal from
the Eurozone. This will mark the end of the collapse's acute phase, but the
economic contraction will stop only in the middle/end of 2016.
Drachma's deprecation
is not going to be
critical
The first key question is how critically will the new Greek currency
(drachma) deprecate? The most extreme estimate is the current discount
which is applied by the ECB for Greek bonds as part of ELA, namely 45%
(according to Bloomberg). This rate may be considered probable in the
case of recalculation of foreign debt into national currency. Although we
believe that this estimate is too high. Greece's current account positions in
the 1st quarter were balanced at the level of +0.2% of GDP (for
comparison, the current account positions balance in Iceland in 2008 was 23% of GDP). All the capital that could have been disinvested was already
disinvested, and the probability of the complete abolition of the imposed
restrictions on the capital outflow is very low. However, the situation is
worsening because of the trade balance deficit (€1.3 billion as of May). So
far, we believe the potential of drachma depreciation is 15% and
increasing with each passing month.
...and the cost of
introducing a new
currency is low
The second question concerns the cost of introducing a new currency. The
costs of conversion of all financial reports into the drachma, in our
opinion, are small in macroscale. Although the transition will definitely
create many legal problems and will take several months. The costs of
printing new drachmas will be quite reasonable. Printing banknotes via
outside organizations is a widespread practice: almost half of the countries
with their own currency uses such services. Price of one note varies from
$0.02 to $0.06. According to our calculations, the replacement of the
circulating euro bills (approximately 520 million pcs.) will cost Greece $21
million. These costs should not pose a big problem.
Government bonds interest rates are not
influenced by the situation in Greece
Source: Bloomberg
© Center of Macroeconomic Studies of Sberbank of Russia
Major part of the debt is on the Eurosystem’s
balance sheet (€323 billion in total)
Source: Public sources
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Budget catastrophe in
Greece is not expected
Exit from the Eurozone will obviously be accompanied by unforeseen
expenses. Greece has very little space for budget maneuvers, but there is
space nonetheless: in January-May the primary surplus of the central
government budget amounted to €1.4 billion, and the primary surplus of
the consolidated budget amounted to €0.5 billion. Also, Greece has a plan
of further increase in budget income coordinated with the three creditors.
Serious budget spending cuts in real terms can not be avoided, but the
budget catastrophe is not expected.
So, the hardest part of Greece's withdrawal from the Eurozone is already
behind. Recession can not be avoided, but we believe that it will be
shallow and short.
Potential Withdrawal Effect
Grexit’s direct effect on
Eurozone will be
insignificant…
Direct damage from Grexit for the Eurozone countries will also be
moderate. Since 2008, the private sector has almost gotten rid of the Greek
debt, its bigger part (€213 billion) is now on the balance sheet of the
Eurosystem (ECB and the EFSF, ESM, GLF fund system). Writing off the
debt from the balance sheet of the Eurosystem may require additional
capital investments by the ECB. Prior to the start of the quantitative easing
program, this could have posed a problem, but now it will just be a part of
QE. The direct effect on trade, due to the small size of the Greek economy,
will be unable to slow down the growth of the Eurozone. Our conclusions
are confirmed by the dynamics of rates on government bonds of the
periphery: they did not react to default on the IMF debt or the Greek
referendum results.
...while the indirect
effect might be the
final step towards the
Eurozone's collapse
But we do not overestimate the current calm on the markets.
Paradoxically, the calmer the Greece's withdrawal from the Eurozone is,
the worse its effect on the rest of the Eurozone will be. If Grexit turns out
to be painless, by the end of the year we will see the growth in the activity
of political parties in the countries of the periphery calling for the exit
from the Eurozone. Government debt interest rates will increase,
expectations will be self-fulfilling. Italy, Spain, Ireland and Portugal are
already in the red zone in the IMF reports on debt sustainability. A slight
slowdown in growth, growth of rates, weakening of fiscal discipline and
preservation of low inflation put their debt to the trajectory of growth.
Grexit could be the final trigger of such transition.
Global effect:
turbulence of currency
market and capital
outflow from emerging
markets
If events develop in such a way, eurosceptics will grow in number, the
euro could fall in price to parity with the US dollar, and emerging markets
will once again face the outflow of capital due to the growth of global risks.
We believe this is what poses the main risk and the main channel of
influence of the events around Greece on Russia. We estimate the
additional capital outflow from Russia in this scenario in 2015 to be worth
$5 billion.
Agreement on Cancellation of Iran's Sanctions
Iran's sanctions will be
completely cancelled in
a few weeks
Negotiations on Iran were very hard, but the compromise was reached.
The parties agreed on Iran's commitment to reduce the number of
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centrifuges and the 15-year-old ban on new uranium enrichment facilities.
The annexes to the document determine the procedure of sanctions
cancellation, including the cancellation of sanctions on Iranian oil exports,
supply of oil industry equipment, the lifting of sanctions in relation to
banking, insurance and disconnection from SWIFT. Sanctions will be
renewed in case of Iran's violation of the agreement. The document comes
into force 90 days after its approval by the UN Security Council.
It is a positive example
of quick termination of
sanctions...
Agreement between the Six, i.e. the USA, Germany, France, China, Britain
and Russia, and Iran is great news, which opens up new prospects to
Russia as well. It will make the resumption of a full-fledged nuclear
cooperation and work on other joint projects possible. Most importantly,
such agreement shows the possibility of cancellation of the toughest
economic sanctions 3+ years after their declaration (Cuba wasn't that
lucky).
...and a serious shock on However, the lifting of sanctions will give Iran new opportunities in the
the raw material
production and export of oil, which is taken in consideration by all the
market
market players. Despite the fact that the country will not be able to
immediately increase the supply of oil, market expectations have already
caused quite a significant decrease in oil prices. When the supply of oil
actually increases, three major trends will manifest more harshly: First, oil
prices will go down, and for a short period may even drop below
$50/barrel. Second, the price spread between Brent and Urals brand
prices will expand and amount to the previous $2/barrel. Third, the price
war and the struggle for market shares will exacerbate causing the
increase in price volatility in both the amplitude of their oscillations and
the frequency of price changes.
What Can the Increase in Oil Supply be Like?
Recovery of Iran's
export deliveries is
around the corner
In order to answer the main question about the additional volumes of oil
supply, let's take a look at the dynamics of oil production in Iran before
sanctions were imposed. After all, the extraction and export of Iranian oil
was severely affected by the imposition of sanctions by the United States
in late 2011 and the support of this imposition by the EU in summer 2012.
The country's energy sector was affected by the ban on investment in the
Decrease of Iranian oil exports by directions
Source: EIA
© Center of Macroeconomic Studies of Sberbank of Russia
Net exports and consumption of oil by Iran
Source: EIA
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oil and gas sector, the closure of access to Western capital markets, the
trade embargo on the purchase of Iranian oil, as well as the ban on
insurance of Iranian oil tankers. The ban on investment did not have an
immediate impact on production, but the deferred effect is expected to last
long (it will affect the first half of 2016). Effects of other sanctions
manifested quicker, but the recovery after the lifting of sanctions is
expected to be quick, it will require only a few months. Thus, the dynamics
of the recovery of production in Iran will begin in October 2015
Let's conduct simple estimates of potential production growth. According
Iranian oil exports
declined due to sanctions to EIA, from 2011 to 2014 the export of oil (crude oil and condensate) fell
by 1.2 million barrels per day reaching the 1.4 million barrels per day
by 1.2 ml b/d
mark. Nearly half of the reduction (0.6 million barrels per day) fell on the
decline in exports to the EU. EU replaced the imports of Iranian oil
supplies mainly by importing from other OPEC countries. Since 2012, the
share of Saudi Arabia in EU imports grew from 5.9% to 8.8%, while the
share of Nigeria grew from 4.1% to 8.2%. Russia’s share decreased from
34.7% to 33.7% by 2014.
Potential of +1 million
barrels/day recovery
Now, during several months since October 2015, Iran will be able to ramp
up production at 0.5+ million barrels per day, as well as export the
accumulated reserves (estimates vary from 7 to 35 million barrels). But
the potential for further growth in supply has been limited by low
investment in oil and gas sector during the last three years of sanctions
and will not exceed 1 million barrels per day in the next 12 months.
Iranian oil characteristics are similar to the
Urals oil
Source: U.S. Energy Information Administration, based on Energy Intelligence
Group
…although a
significant increase in
volumes is possible in
the long term
Iran's reduced exports contributed to the
decline of Urals/Brent discount
Source: Reuters
In the medium term, the production growth could reach an additional 1
million barrels/day, but only with the inflow of investments by
international energy companies. It is quite a possible scenario, too: in May
this year a number of companies, including Shell and Eni, reported about
the resumption of business relations with Tehran and the beginning of the
discussion of their return to Iran. Still, it is quite unlikely that the oil and
gas complex of the country will reach their investment attractiveness of
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2010. Today, the oil prices are relatively low and not growing, therefore
the profitability of such investments is reducing.
Oil price could fall to
$48-50 per bbl Brent
It is easy to guess what will happen to the oil price if the market receives
additional volumes. According to the Rosneft experts, additional supply
volumes of 1 million barrels per day reduces the price by about 10%, i.e. in
this case by $6-7 per bbl. It's close to a consensus. According to the EIA (US
Energy Information Administration), the decline in oil prices from a full
package of agreements on Iran will amount to $5-15 per bbl to the
baseline scenario of 2016 (the basic forecast of the Administration is $67
per bbl). The effect is partly included in the oil prices as the markets
always took into account the likelihood of resolution of the situation
around Iran. However, the initial proposal of larger volumes of stocks
(from 7 to 35 million barrels) may well cause the markets to react to an
agreement aggressively. In other words, we should not exclude a shortterm reduction of Brent price to $50 per bbl and a lower level compared to
the baseline of $55-60 per barrel in 2016.
Expansion of Spread Between Urals and Brent
Iranian oil is similar to
the Russian oil
Iranian oil is similar in characteristics to the Russian oil grade Urals.
Iranian and Russian oils are heavy, sour grades, which under normal
conditions of the market provides a price discount relative to the marker
grade Brent. This is largely explained by the technological peculiarities of
processing, which is easier and cheaper when dealing with light oil grades.
Iranian sanctions
contributed to the
decline of Urals-Brent
discount
Reduction of Iranian oil supply after the introduction of Western sanctions
in 2011-2012 contributed to the reduction of price discount of Urals to
Brent. High interchangeability of the Russian and Iranian oil, as well as
technological limitations of the refinery to quickly shift to another type of
oil, determined the growth in Urals oil demand.
Discount is unlikely to
rise after sanctions
cancellation
In this case, the lifting of sanctions will launch a reverse process, i.e. the
expansion of Urals-Brent spread, but the discount is unlikely to exceed the
ten-year average of $2.5/barrel. Getting an accurate assessment is
difficult: the discount size was always characterized by high volatility and
depended on many factors, including the seasonal effects (Urals discount
is traditionally lower in summer). Today, the Urals price exceeds the Brent
price due to interruptions in sour crude supplies from the Iraqi province
of Kirkuk controlled by the Kurds. But this is a temporary phenomenon. It
is not clear how long the expansion of the spread might take. It should
happen in 2016, so the price of Urals crude oil, due to the increase in
Iranian supplies, is unlikely to exceed an average of $54-59 per barrel in
2016.
Economic Slowdown in China
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Bubble is deflating; the
consequences are
unclear
The collapse of the stock market in China was so rapid and profound that
it shaped the expectations of further uncontrolled reduction. The Shanghai
stock exchange index has lost about 30% from mid-June to early July.
Given the starting level of stock indices at the beginning of 2014, the
decline could continue, as in the previous eight months the market grew
by 117%. Reduction of market capitalization now amounts to about $2
trillion (from $10 to $8 trillion, i.e. from 100% to 80% GDP). Many
analysts fear the negative effects on economic growth, especially in case
the reduction continues. Although, the market has stabilized in the last 2
weeks. During the collapse of China's stock market, the authorities were
actively discussing the possibility of banning the IPO and the creation of
stabilization fund to support the stock market. All 28 companies with an
allocation permission in 2015 decided to postpone it. The last action of the
authorities was the introduction of a six-month moratorium on the sale of
shares by majority owners (over 5%). Nevertheless, in spite of the
stabilization of the market, we think that this is not the end of the story.
Currently, about a third of companies listed on the Shanghai Stock
Exchange, took a wait and are not trading in the market. Their entry into
the market could lead to a new increase in volatility.
Economic slowdown is
possible
Yet, we are not expecting a catastrophic scenario regarding the market;
the negative consequences for the real economy in the short term will be
limited. The state has a sufficient amount of reserves and supervision over
the financial system in order to avoid the escalation of the stock market
crash into the economic crisis. Although, the economic slowdown can not
be avoided, which carries the risks of raw materials price reduction.
China has had an Experience with Bubbles
China's stock market
has already
experienced bubbles
Classic dynamic of stock market bubble deflation is not new to China.
Previous bubble appeared in 2007 and deflated in 2008 before the onset
of the acute phase of the global financial crisis. Particularly strong growth
of stock indices happened in 2007: at the beginning of the year, the
Shanghai Composite Index was at 2,600 and by October 2007 rose to 6,100
Shanghai Composite stock index suffered even worse times
Source: Haver Analytics, calculations of the Center of Macroeconomic Studies
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points (a record of 5150 points in June 2015). The volume of China's stock
market capitalization at its peak time was 131% of GDP (the peak of June
2015 - just 100% of GDP).
Although, the
situations are
somewhat different
People's Bank of China at that time followed a restraining monetary policy.
Key rate of the annual loan was raised from 5.58% to 7.47% during 20062007. However, these restrictions were not enough, so the market was still
growing. The stock market access of foreign capital was very limited then,
although today the share of foreign investors remains low and does not
exceed 10%. Another important difference of this bubble from the 2007
bubble is the margin trading. During the 2007 bubble the margin trading,
i.e. trading with borrowed money, was banned. It is permitted now, which
creates additional risks for the banking system.
China’s economic
slowdown…
Growth Slowdown: Plans and Reality
China has been the most dynamic economy in the world in the last 15
years, but a couple of years ago the slowdown in its growth became
noticeable. Even the Chinese government, which is not prone to public
recognition of problems in the country, is using the "new normality" term
more and more often. The recognition of the fact that the economic
slowdown is structural was the main breakthrough. Aggressive
investment increase (up to 48% of GDP) did not lead to the maintenance of
high growth figures. Exhaustion of possibilities of export and investment
growth model made it necessary to rely on a new growth driver, i.e.
consumption. However, consumption growth was not sufficient to sustain
high rates of economic growth in general. At present, the Chinese economy
is experiencing a slowdown that threatens to cause a hard landing. In
2014, GDP grew by 7.4%, which is the lowest figure in the modern history
of China. The slowdown continues; the opinion that the growth target of
7.0% in 2015 will not be achieved has become widespread. If Chinese
administration chooses the path of economic liberalization, the growth in
the second half of the year will slow down to 6.0-6.5%, and the slowdown
will continue in 2016. Trying to maintain the economy using the familiar
measures of strict state regulation can support growth in 2015 and 2016,
but in the future this may lead to full-fledged economic crisis.
Consumption should become the new incentive of
China's growth
Source: Haver Analytics, calculations of the CMS
© Center of Macroeconomic Studies of Sberbank of Russia
Investment growth did not sustain the Chinese economy
Source: IMF
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… will significantly
influence the world
economy
China is not the only country interested in the stability of Chinese
economy, the developed countries are as well. The share of export to China
is gradually increasing: Japan's export exceeds 20%, the US - 12%,
Germany - 8%. The slowdown in China could undermine the already slow
recovery in the developed countries which also faced the problem of low
rates of consumption growth. China is important for Russia as the world's
largest consumer of raw materials and energy, affecting the world prices.
Further Easing of the Monetary Policy
PBC has Scope for
easing monetary
policy
In 2007, in order to fight the stock market bubble and the possible
overheating of the economy, the People's Bank of China tightened the
monetary policy and introduced additional measures of stock market
regulation. Today, the situation is opposite. The bubble is deflating under
the influence of non-monetary factors, and the economy is slowing down.
From the perspective of monetary policy, the current situation creates
more incentives for mitigation. Chinese banking sector is still one of the
most regulated in the world. Reserve requirements are extremely high
(18.5% for large banks), the ratio of loans to deposits should not exceed
75%, but is, in fact, less than 70% (cancellation of this limitation is
planned for 2016), the key rate is gradually declining, but still remains
relatively high. Since autumn 2014 the PBC has lowered the key interest
rate from 6% to 4.85%. Reserve requirements were reduced from 20% to
18.5%. PBC has the opportunity to free up a significant amount of
liquidity; estimated reduction of reserve requirements by 50bp will
release about $80 billion from reserve bank accounts. There is space for
further monetary stimulus as the inflation stays at a low level (1.0-1.5%
yoy). Therefore, there is every reason to believe that several rounds of rate
cuts and reserve requirements will be held in 2015.
Effects of 2015 Bubble Collapse
Role of the stock
market in the economy
is not as great as in the
developed countries
The effect on the banking system and crediting is expected to be
limited, provided that the state employs leverages that support lending to
the real sector. It is known that Chinese commercial banks are controlled
by the state one way or another. According to the World Bank estimates,
the direct state presence in the capital of the banking system is 67%. But
at the same time, the effective control is even wider, because the
state/party can appoint senior managers and board members. In addition,
the presence of the state is also large in other financial sectors coupled
with the banking system: in insurance (80%+ control), trust companies
(85%+), companies that operate on the stock market (60%+). For
example, an indicator of the degree of influence of the state in the
brokerage segment was the recent collective promise of the largest
brokers not to sell the shares on the market when the Shanghai Composite
Index is below 4,500 points (it reduced to 3,500 points on Wednesday, July
8).
Banking system is out
of the risk zone
Thanks to state control over the financial system, classic spiral of falling
asset values during the crisis will not be able to unwind to its fullest.
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Market-based indicators suggest that banks feel safe enough, i.e. interbank
rates remain at a low level, despite the panic in the stock market. But in
the long run, government intervention in the operation of the banks will
aggravate the problem of hidden bad debts.
Well-being of the
population will
decrease only slightly
The effect on household welfare does not seem significant either. The
number of individual investors in China is less than 90 million. According
to HSBC estimates, the shares represent less than 15% of household
assets, meanwhile less than 10% of households are involved in the stock
market trade. The previous stock market drop in 2008, a significantly
larger one, had almost no effect on the rate of growth of household wealth.
Financing of businesses The effect on the financing of enterprises will also be negligible. The
amount of funding through the issuance of shares in China is 10-20 times
will remain on the
less than traditional bank lending. In 2015, new bank loans were issued at
same level
an average of $170 billion per month, while the issue of shares brought
companies $9.5 billion per month.
Although, reforming
will slow down
The effect on the financial sector reforms seems to us as one of the
most significant negative impacts:

Measures that are currently applied by the Government to stabilize
the stock markets reduce the investor confidence in the declared
intentions of the liberalization

Growth of bad debts in the banking system and the stress in the
asset management sector will force to suspend the process of
increasing the transparency of the financial sector and reducing the
role of the state

The undesirability of capital outflows from the country is expressed
in slowing down of the process of liberalization of the external
capital account. Accordingly, the convertibility of the Yuan will be
PBC has room for easing monetary policy
Source: Haver Analytics, Bloomberg, calculations of the Center of Macroeconomic Studies
© Center of Macroeconomic Studies of Sberbank of Russia
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postponed
Oil demand from
China will continue to
grow, albeit slower
Copper and Nickel can
lose up to 25% of the
price
The effect on world oil prices will be negative in the short term due to
increase of uncertainty. However, market analysts believe that the demand
from the transport sector (65% of China's oil demand) will not slow down,
but rather accelerate. International Energy Agency expects China's oil
demand to increase by 3.8% in 2015 (3.0% in 2014) with the economic
growth of 6-7%. British Petroleum expects the growth in oil demand from
China to amount to average of 3% per year over the next 20 years.
However, these projections were formed before the stock market collapse.
We expect that a stronger slowdown in economic growth will reduce, in
turn, the growth in oil demand. Although it is unlikely that the latter will
be lower than last year which means that the effect on the price of oil
during 6-12 months will not exceed $2-3/barrel, but it can persist for quite
a long time (up to a new acceleration of growth).
The effect on world prices of metals will probably be strong. China is the
largest consumer of copper and iron ore. In the last year, amid the slowing
Chinese economy, the talk about the likely collapse in prices in the metals
market was widespread. Stock market collapse will endanger one of the
key sectors of China's economy, i.e. the construction sector, which will
have a negative impact on copper and steel prices. But steel prices are
already low: they are only 7-10% higher than the historic lows, and they
have already fallen by 15% since January, 2014. Aluminum prices, which
fell one level lower since the beginning of 2014, are unlikely to be severely
corrected. A sharp drop in copper and nickel prices is expected, whereas
China produces more than half of the demand (construction of skyscrapers
will suffer more than the industry as a whole). Copper and nickel can lose
up to 25% of the price. This will result in a loss of up to $4 billion a year
for Russia.
Hidden Threat: Lack of Transparency
As in any other analysis of the stability of the Chinese economy, there are
blind spots associated with the lack of transparency of the banking system.
Quality of banks
balance sheets is not
clear, additional
stress carries risks
The problem of bad debts of regional and local governments,
accumulated in 2009-10 during the period of credit and investment
stimulation of the economy, remains unresolved. State, or rather, the
banks it controls, prefer to extend and refinance bad regional debts.
Additional problems due to the falling stock market are non-critical by
themselves, they bear the risk of further deterioration of banks balance
sheets, and can lead to a credit crunch.
Increase of Federal Reserve System Rate
CMS predicts the first
rate increase at the
FRS meeting in October
The rate of the US Federal Reserve was technically on the lowest level
during the last 6 years, and the beginning of its increase, which is expected
in the second half of the year, will definitely affect the financial markets. In
2013, the news of the FRS discussion of the rate increase prospects alone
triggered a significant increase in market dollar rates and the outflow of
capital from emerging markets. The exact time and trajectory of
© Center of Macroeconomic Studies of Sberbank of Russia
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Increase of FRS rate is
expected in the 4th
quarter of 2015
Reduction of stock
exchange dollar prices
will be insignificant
improvement of the Federal Funds Rate is still unclear and are
significantly dependent on the US economic growth prospects. It is now
clear that the increase will be gradual; for now, the FRS management
predicts the FFR rate of about 0.8% by the end of 2015, and less than 2%
by the end of 2016, but the negative risks for the US growth, mainly
external, exceed the positive ones. CMS predicts the first rate hike at the
FRS October meeting and the FFR rate of 0.5% by the end of 2015.
Increase of the FRS rate could lead to some rise in the dollar price
compared to other currencies of developed countries. Central Banks of the
Eurozone and Japan will not raise their rates in the short term, and return
on assets in dollars will increase in comparison with the assets in euros
and yen. Thus, all things being equal, stock prices could fall, denominated
in US dollars. Simple calculations show that the strengthening of the dollar
by 1% causes a decrease in gold prices by 1.4% and the decline in oil
prices by 2.9%. However, in 2015, this effect on the prices of
oil/gold/metals is likely to be negligible, since the future increase of rates
in the US is mostly taken into account by the market. You could even say
that the markets, and the FRS itself, were too optimistic in the first half of
2015 and overestimated the speed of rate hikes. Accordingly, the dollar
may be overvalued now as its nominal effective exchange rate has
appreciated by 12% since August 2014. This means that a possible
correction of the gold price will not exceed 1-2%, and oil - 2-4%, which is
within the ordinary market volatility.
Russian Economy after the Shocks
Worsening of
conditions can be
harsh:
If all the shocks described above are implemented, the external conditions
of the Russian economy will worsen. The main blow will fall on the export
volumes due to the high proportion of metal and energy. However, a
slowdown in China will not affect the volumes of supplies, but the prices.
Decomposition of Russian Exports
© Center of Macroeconomic Studies of Sberbank of Russia
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Petroleum and
petroleum products
account for 70% of
Russian exports
Commodity structure is well-known. Energy carriers (oil, gas and oil
products) account for 70% of Russian exports, so the drop in oil prices is
critical to its dollar value. But the directions of export flows are such that
we do not expect further reduction of export volumes. Indeed, the main
markets for oil and oil products for Russia are the EU countries with the
Netherlands at the top, from which the Russian energy carriers are reexported to third countries via the port of Rotterdam.
Metals occupy a
smaller share
Ferrous metals occupy a small but important share - 4.1% of the exports,
non-ferrous metals - 3.1% and precious metals - 2.4%. Wood and its
products occupy only 2.2% of the total volume. Basic supply of ferrous
metals and metal products fall on Turkey, the United States and the
Customs Union partners. Netherlands lead in the non-ferrous metals
supply. China's share is less than 1%.
Share of exports to
China is small; China's
slowdown will
insignificantly affect
the exports volume
China accounts for 7.5% of Russia's exports, which is $37.4 billion. China's
share is only high in the export of energy carriers and it continues to grow
rapidly. In 2014, China became the Russia's fourth market for oil and
refined products sales, which accounted for 74% of total Russian exports
to China, which is $27.7 billion. Timber exports (8.8%) holds the second
place. Nuclear reactors and ores account for 3.7% and 2.8%, respectively.
Thus, the Russian timber exports to China valued at $3.3 billion is only
0.7% of the Russian export.
Consequences of Raw Materials Prices Reduction
1) Reduction of Urals
price to $55/bbl in
2016
First, the recovery of oil prices to an average of $65/barrel in 2016 should
not be expected, given the effect of a larger slowdown in China and the
growth in supply of Iranian Urals oil average price may reach only
Russian exports structure ($497.8 bln)
Source: Federal Customs Service, data for 2014
Non-ferrous metals sales markets ($15.5 bln)
Source: Federal Customs Service, data for 2014
© Center of Macroeconomic Studies of Sberbank of Russia
Energy carriers sales markets ($346.1 bln)
Source: Federal Customs Service, data for 2014
Ferrous metals sales markets ($23.7 bln)
Source: Federal Customs Service, data for 2014
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$55/barrel (the subsequent trajectory of prices in 2017-18 will be lower
than predicted).
2) Acceleration of
capital outflows
by $5 billion in the
4th quarter 2015
Second, the shock on the currency market in the 4th quarter 2015 is
probable due to the growth of the euro-dollar volatility. The decline of the
ruble may exceed the natural rate of decline due to the fall in oil prices.
Capital outflow will accelerate by an additional $5 billion in the 4th
quarter 2015 (it will fall by the same amount in 2016 when the CBR
returns the repo).
3) Reduction of exports
Third, the fall in metal prices will cause the export revenues to drop by $4
by $7 billion in
billion in 2016 and by $3 billion in 2017.
2016-17
Crisis recovery is
postponed
The results of our calculations show that under these conditions, the
country will face another year without consumption growth: inflation
declines slower than in the basic scenario, real wages and incomes
continue to fall in 2016. Crisis recovery is delayed until 2017, but the
contribution of net exports into growth will remain positive at the
beginning of 2016. The transition to the regime of more budgetary
expenditure savings will be inevitable. Indexation of pensions will take
place in the amounts proposed by the Ministry of Finance, below inflation
(5.5% in 2016), which will deliver another blow to the incomes of the
population.
© Center of Macroeconomic Studies of Sberbank of Russia
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SBERBANK OF RUSSIA
Conclusion
Shocks will exacerbate
the old issues,
however, the scenario
is not catastrophic
Although the events that are now unfolding may have a truly dramatic
effect on the world, they will affect Russia tangentially. Indeed, during the
period of economic boom such shocks can expand the growth trends. But
changes under the recession conditions at the qualitative level look
insignificant. The fact that the country was cut off from international
capital markets even before the emergence of new challenges, reduces its
vulnerability against new shocks and reduces the number of channels for
their transmission. As a result, the negative impact is reduced to a
decrease in raw material prices, a slight acceleration of capital outflows
and further decline of the ruble. A flexible exchange rate policy helps the
economy to adapt to new environmental conditions by reducing the effects
of shocks. Old issues (for example, the depletion of the Reserve Fund in the
event of a prolonged period of low oil prices) will, of course, worsen. The
consumers' situation will get worse again (especially in the first six
months after the shock), and the crisis recovery will take longer. However,
catastrophic scenarios are not expected.
Time Period
Macroeconomic Attribute
2015_q1
2015_q2
2015_q3
2015_q4
2015
2016
2017
2018
53
61
58
52
56
60
65
70
Real GDP growth, %yoy
-2.2
-3.5
-3.0
-3.2
-3.0
-0.5
2.0
1.3
Industrial production growth, %yoy
-0.4
-4.9
-3.7
-3.1
-2.5
0.0
1.5
2.0
Retail trade growth, %yoy
-6.4
-9.4
-5.8
-6.5
-7.0
0.5
3.5
3.0
Growth of consumer prices rate, %yoy (end of the period)
16.9
15.3
15.3
10.9
10.9
7.8
7.5
7.5
Key rate (%, end of the period)
14.0
11.5
11.0
10.5
10.5
8.0
7.5
7.5
62.2
52.7
56.0
60.0
57.7
55.6
57.3
60.0
Raw material prices
Urals oil, dollar/barrel
Economic activity
Inflation
Currency rates
RUB/USD rate, RUB (average)
External sector
Capital outflow, bln USD
-33
-11
-13
-18.0
-75
-50
-60
-45
Current account positions, bln USD
28.9
19.2
14.5
16.4
79
55.0
61.0
46.0
-9.0
-9.4
-8.4
-9.0
-9.0
-0.0
1.6
1.0
Household income
Real average wages, %yoy
© Center of Macroeconomic Studies of Sberbank of Russia
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SBERBANK OF RUSSIA
Overview prepared by
Yulia Tseplyaeva
[email protected]
Danir Zulkarnaev
[email protected]
Aleksey Kiselew
[email protected]
Konstantin Kozlov
[email protected]
Kirill Mavrin
[email protected]
Vasily Nosov
[email protected]
Aleksandra Filippova
[email protected]
Nikolay Frolov
[email protected]
You can direct your questions to the CMS via phone number (495) 747–38–79 or one of the Emails of the overview
authors.
Standard disclaimer that is attached compulsorily to all analytical products.
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