Economic policy inconsistencies
Overview:
The conflict in Georgia and Russia's unilateral recognition of South Ossetia and Abkhazia have clearly raised the perceived political risk of investing in Russia. This has adversely affected Russian financial markets and may well have implications for its WTO bid and beyond. A moderation in oil prices had already started to undermine investor sentiment in Russia to some extent1. However, economic developments in Russia are likely to remain extremely robust. Indeed, domestic demand is growing too fast and is being fuelled not only by huge capital inflows but by insufficiently tight monetary policy and an ill-timed loosening of the non-oil fiscal balance. While strong investment growth and rising productivity are raising aggregate supply, policy must be tightened if a broad-based rise in inflation is to be contained.
Recommendation:
Despite high political uncertainty and concerns about the implications of recent events for stability in the Caucasus we are overweight on the Ruble. While the path of oil prices is difficult to forecast it remains likely that Russia will continue to run huge external account surpluses. There is increasing pressure to spend more of this oil windfall. Thus monetary policy must be tightened to rein in rising inflation. Tightening Minimum Reserve Requirements can only go so far here. The policy of stability against the EUR/US$ basket is unlikely to prove sustainable.