Russian Oil Revenues, Budget Outlook and USDRUB levels

Inflation in the week to 16 January slowed to 0.1% wow, from 0.3% wow in the first nine days of January. On our estimates, headline inflation was 5.3% yoy as of 16 January, down from 5.4% yoy in the previous week. We expect headline inflation to drop to 5.1%-5.2% yoy in January. In its meeting last Monday (16 January), the government decided not to spend windfall oil and gas revenues. According to Finance Minister Siluanov (who revealed this news yesterday), the government made a decision to save extra oil and gas revenues from higher oil prices, instead of spending it. According to the government estimates, the government will receive additional RUB 1tn (1.1% of GDP) with the average Urals oil price at $50/bbl, or RUB 1.4tn (1.6% of GDP) with the average Urals oil price at $55/bbl. (In the federal budget law, the government assumes average Urals oil price at $40/bbl in 2017- 2019.)

The decision to save windfall oil and gas prices is favorable for the prospects of the policy rate cut by the central bank (CBR) and for sovereign credit (as Russia would not use its declining fiscal reserves for financing the deficit). Although the government is unlikely to reduce net OFZ issuance in the local market (according to the law the government will increase net issuance to 1.2% of GDP in 2017 from 0.5% of GDP in 2016), the CBR’s more accommodative policy will support demand for OFZ from local investors. In our view, the decision should be taken positively by fixed income investors. Another near-term implication of this news is that the market should price in a policy rate cut as early as in the next rate-setting meeting (on 3 February).

We are not saying that the CBR will cut the policy rate at that meeting but the likelihood of such an outcome has increased to around 25%, in our view. We are still expecting the first policy rate cut in the second meeting of 2017 (on 24 March). The CBR may consider regular FX purchases for the replenishment of Russia’s FX reserves, if the scenario with higher oil prices materializes. Such FX policy will be coordinated with the Finance Ministry, in the absence of a fiscal rule. Although this news (revealed yesterday) is in line with our expectations, it does not provide us with any new information about the conditions under which the CBR will resume regular FX purchases. However, we reiterate our view on that issue.

We expect the CBR to resume FX interventions (to buy FX) in 1Q 2017, as it did in 2015, when the rouble strengthened beyond 50 against the dollar. Our view is based on the idea that, in real effective exchange rate terms, the rouble is trading as strong as in 2015. In 2015, the CBR held volume-based intervention in the amount of $200mn a day (for more than two months) and purchased roughly $10bn in the local FX market. In our view, both, the CBR and the government are quite sensitive to potential further strengthening of the rouble (especially in real effective exchange rate terms). In our view, the CBR will be reluctant to allow the rouble to strengthen beyond 57-58 against the dollar.