UNCLASSIFED 26 March 2013

Russia Economic Report: April 2013

After resilient growth through much of 2012, there are now

clear signs that the economy is slowing. Inflation continues

to rise, reaching 7.3% in February. The Cyprus bail-out

dominates the economic headlines, with President Putin ECONOMICS SECTION describing the initial bank levy proposals as “unfair, Duncan Sparkes unprofessional and dangerous”. The President nominates International & Bilateral Relations Elvira Nabiullina, currently his senior economic aide, to be the [email protected] next Governor of the Central Bank of Russia. BP and Rosneft Alexander Wright conclude a deal to sell BP’s 50% stake in TNK-BP to Rosneft Economics & Finance in exchange for $28 billion in cash and shares. [email protected]

Emily Holdup Overview and outlook Trade & Business Russia’s economy performed relatively well in 2012, with GDP [email protected] growth of around 3.4%. Growth has slowed in recent months, but

Tom Oppenheim most analysts predict the economy will grow by around 3% in Energy & Industry 2013. Although inflation is above the Central Bank of Russia’s [email protected] target, unemployment is low and the budget is close to balance.

The main downside risk is from adverse developments in the world economy, principally the euro zone, and a sustained fall in world energy prices, which would undermine Russia’s export and budget

revenues and financial stability. In the medium term, economic

and institutional reforms are needed if Russia’s economy is to achieve its full potential and reduce its vulnerability to global commodity price changes. These reforms include modernising and diversifying the economy; improving investment, innovation and the business environment, notably by tackling corruption and reducing the role of the state; and reorienting public spending towards

healthcare, education and infrastructure.

Economic developments

 Clear signs have emerged that Russia’s economy is slowing, like many other emerging market economies, following resilient growth through much of 2012. Initial data for January and February suggest that the economy may now be growing at an

underlying rate of only 1% a year on an annualised basis. Recent reporting: Some slowdown was expected, because Russia’s economy World Bank Economic Report: recovery was operating close to full capacity in 2012. But the slowdown and beyond has been exacerbated by continued sluggish growth in the World Bank Report: trends In regulatory high-income economies: Europe is Russia’s largest trading burden and corruption partner. The slowdown seems broadly-based, with consumers Prosperity: looking back and forward expenditure, investment and exports all affected. Fiscal and monetary policy debate

 Commentators have responded to the slowdown by More reporting from the Embassy’s downgrading their rather bullish forecasts for the Russian economic section can be found online.

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UNCLASSIFED British Embassy Moscow

economy in 2013, noting that the outlook now depends on a recovery in the world economy, a recovery in domestic investment, and a relaxation of monetary policy.

 However, despite signs of economic slowdown, the unemployment rate fell slightly to 5.8% in February.

 Consumer price inflation rose to 7.3% in February, the highest rate since August 2011 and well above the official 5-6% target range. The increase was driven largely by food prices: a measure of core inflation was stable at 5.7%. Commentators judge that inflation is now close to peaking, though it will remain uncomfortably high for a while longer. The Central Bank once again left interest rates unchanged at its monthly meeting on 15 March, citing the economic slowdown as a key factor underlying its decision. The combination of a slowing economy and high inflation has continued to fuel a wider debate about the policy stance, though President Putin said on 7 March that the Central Bank should not be forced to reduce interest rates to support the economy.

 The global oil price, on which much of Russia’s export and budget revenues depend, has eased by about 10% since mid-February, though the current price of $107/barrel is not problematic for Russia. The rouble has been broadly stable. Net capital outflows have persisted.

Policy issues  The EU’s bail-out of the troubled Cyprus economy aroused intense interest in Russia. Cyprus is the leading offshore financial centre for Russian companies and depositors. The proposal to impose a levy on large deposits in certain Cypriot banks was greeted with particular indignation. President Putin described the EU bail-out, as originally conceived, as “unfair, unprofessional and dangerous”. Cypriot Finance Minister Sarris held emergency talks in Moscow on 19-21 March to discuss the role that Russia might play in helping Cyprus. But it appeared that Russia agreed to do no more than relax the repayment conditions for a €2.5 billion loan that it granted to Cyprus in 2011. Commentators suggested that Russia might be seeking, in return for this concession, privileged access to new offshore gas reserves near Cyprus and more information about the identity of Russian depositors in Cyprus. Meanwhile, policymakers have played down suggestions that the situation in Cyprus poses significant macroeconomic or financial sector risks for Russia.

 President Putin nominated his senior economic adviser and former Minister of Economic Development, Elvira Nabiullina, as the next governor of the Central Bank of Russia, on 12 March. The announcement surprised commentators, as Nabiullina had not previously been considered a front-runner to take over from Sergey Ignatiev, who will retire in June. If the State Duma ratifies the nomination, Nabiullina will become the first woman central bank governor in a G8 country. She will face two main challenges: bringing down the rate of inflation, and establishing the central bank as a “mega-regulator” after it absorbs the functions of the securities & insurance regulator.

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UNCLASSIFED British Embassy Moscow

 Finance Minister Siluanov told investors that Russia’s long-awaited privatisation programme would resume this summer. Attention is focusing on the possibility that the government may sell minority stakes in VTB Bank, the Rusnano technology company, United Grain Company and Rostelecom.

Energy sector  On 21 March, Rosneft finalised its purchase of BP’s 50% stake in the TNK-BP joint venture for $28 billion in cash and shares. BP exited the transaction with $12.48 billion in cash and a 19.75% stake in Rosneft, now the world’s largest publically traded oil company by both production and reserves. Rosneft also purchased the other 50% of TNK-BP for $28 billion in cash from the Alfa-Access- Renova consortium. The newly enlarged Rosneft will account for about 40% of Russian, and over 5% of global, production, roughly on a par with Iran.

 New Chinese President Xi Jingping visited Moscow on 22-24 March for talks with President Putin. Xi’s choice of Russia for his first overseas visit was seen as symbolic. During his visit the President witnessed the signing of several deals in the energy sector, including a $2 billion loan for oil deal and proposals to triple Rosneft’s exports to China. Gazprom also signed a memorandum of understanding with the Chinese side, which re-emphasised the parameters of a 38-60 bcm gas supply deal which has been under negotiation for 15 years. But there was no obvious progress on the most important and contentious issue – price.

Trade and international issues  Speaking ahead of the BRICS Summit in Pretoria on 26-27 March, President Putin said that he wanted the BRICS group (Brazil, Russia, India, China and South Africa) to broaden its role from a dialogue forum on a limited number of issues into a full- scale strategic cooperation mechanism that allowed the group to address the key issues of global politics together. Commentators expect the Summit to confirm the creation of a BRICS Development Bank and possibly a currency swap arrangement.

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UNCLASSIFED British Embassy Moscow

Calendar of Events

March’s main events April’s forward look

20-21 EU President Barroso and 18-19 G20 Finance Ministers meeting in Commissioners visited Moscow Washington DC

25-27 BRICS Summit held in Durban, South Africa

Key Economic Indicators

Indicator Latest A year earlier Real GDP (% annual change) Q3 2.9% 5.0% Industrial production (% annual change) 3m to Feb -0.5% 4.3% Retail sales volume (% annual change) 3m to Feb 3.7% 8.0% Unemployment (% of workforce) Feb 5.8% 6.5% Consumer prices (% annual change) Feb 7.3% 3.7% Budget balance (% of GDP) 2012 -0.02% 0.8% Government debt (% of GDP) 2011 9.6% 11.7% Policy interest rate (%) 31-Mar 8.25% 8.0% Current account balance (% of GDP) 2011 +5.5% +4.7% International reserves ($ bn) 01-Feb 526.2 514.0 Exchange rate (Rub/$) 25-Mar 30.94 29.04 Urals oil price ($/bbl) 25-Mar 107.15 120.90 Sources: Rosstat, Central Bank of Russia, Bloomberg, Trading Economics

This report’s contents were believed (at the time that the report was prepared) to be reliable, but no representations or warranties, express or implied, are made or given by the Foreign and Commonwealth Office (FCO) as to the accuracy of the report, its completeness or its suitability for any purpose. In particular, none of the report’s contents should be construed as advice or solicitation to purchase or sell securities, commodities or any other form of financial instrument. No liability is accepted by the FCO for any loss or damage (whether consequential or otherwise) which may arise out of or in connection with the Report.

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