Russia Economics - CBR Updates Forecasts, Lowers Neutral Key Rate

The CBR has updated its macroeconomic forecasts for 2020-22. It is now more optimistic on oil prices in 2020-21 than it was back in April, when it last updated its forecasts. It expects the Urals price to average $38/bbl in 2020 (versus $27/bbl in April), $40/bbl in 2021 (versus $35/bbl) and $45/bbl in 2022 (unchanged). Because of this, its previous forecasts of current account deficits of $35 bln in 2020 and $18 bln in 2021 have turned into projected surpluses of $2 bln and $3 bln, respectively, while its forecast for the surplus in 2022 was revised upward from $5 bln to $10 bln. The regulator now anticipates a 4.5-5.5% GDP contraction in 2020, having narrowed its initial forecast range of 4.0-6.0%. It then expects economic growth to rebound to positive 3.5-4.5% next year (up from 2.8-4.8% previously) and then slow to 2.5-3.5% in 2022 (versus the previous 1.5-3.5%). It now projects inflation of 3.7-4.2% this year (versus 3.8-4.8% in April), 3.5-4.0% in 2021 (versus 4.0%) and 4.0% in 2022 (the same as before).Our GDP outlook is very close to what the CBR now envisages. We believe that 2Q20 will mark the low point for economic growth this year and that the GDP dynamics will start to improve in 2H20. We then expect a fairly strong rebound in 2021 given the low base, but we do not believe this will be enough to make up for this year's contraction. In 2022, we see the pace of growth slowing and beginning to more closely reflect long-term trends. We still forecast a 4.0% decrease in GDP this year and a 3.5% increase next year, but we will revisit these estimates when the State Statistics Service publishes its 2Q20 GDP estimates.We share the CBR's view that there is a risk that inflation will come in below 4% both this year and next. We forecast 3.6% in 2020 and 3% in 2021, as domestic demand remains sluggish after the lockdown and household income has deteriorated. We have higher forecasts for the average oil price: $45/bbl Brent ($43/bbl Urals) in 2020 and $55/bbl Brent ($53/bbl Urals) in 2021. This is the main reason we expect a stronger current account surplus for both this year and next ($26 bln and $35 bln). The other reason is related to our expectations about capital flight. The CBR expects capital flight (roughly the sum of the financial account balance and net errors and omissions) at $20 bln in 2020. But for 1H20, it reported outflow of around $30 bln, which means that it expects net inflow of $10 bln in 2H20. This seems a bit optimistic to us. It is true that the current Covid-triggered crisis did not trigger massive capital outflow, in contrast with 2008 and 2014 (see our report "Moderate Capital Flight Helped Ruble Rebound In 2Q20" from July 13). However, such a significant inflow of capital in 2H20 does not look achievable. We expect moderate outflow in the single-digit billions of dollars in 2H20, which would also increase the current account surplus. In 2021, the CBR forecasts capital outflow of $15 bln, an estimate that is close to ours. Overall, the combination of a sluggish economic performance in 2020-21 and low inflation is allowing the CBR to continue cutting the key rate. In 4Q20, the key rate may even go below 4%. However, it bears keeping in mind that once inflation starts returning to close to 4%, the CBR will likely start hiking the key rate. During today's press conference, CBR Governor Elvira Nabiullina said that the CBR now sees the real neutral key rate at 1-2% instead of 2-3% previously. Back in October of last year, we called for the neutral key rate estimate to be revised lower (see our report "Reconsidering the Neutral Key Rate"). Given the 4% inflation target, the nominal range for the neutral rate is estimated at 5-6% now, down from 6-7% previously. Thus, if the CBR forecasts inflation at 4% 12 months ahead, the key rate could be expected to return to 5%.