Decoding the Russian enigma

Russia seems to be hewing ever closer to Churchill’s aphorism: as a riddle, wrapped in a mystery, inside an enigma. It is increasingly difficult to predict what may happen next. A mixture of outside events and curious self-defeating actions, at least from an external perspective, have effects that are extremely uncertain.

It may seem then a curious time to contribute a blog on what is likely to happen. However, it does seem an appropriate moment to remind ourselves of a few things that we do know.

I mostly focus here on the macroeconomics, but will follow up with more detail on the potential impact on the property market. There is quite a lot at play here, but I will summarize what are, in my personal view, some of the most important factors. These comments are based on what we know today. The known knowns. I will consider further below the known unknowns. I will leave the unknown unknowns for another day and another post!

Oil Price

The oil price has reached its highest level for 4 years, when it was in steep decline. The US President can bemoan the actions of OPEC and its allies for this, but it is the US’s own actions in Iran and its rhetoric against other oil suppliers that is causing uncertainty in the markets and this price spike. The uncertainty is likely to remain and suppliers seem perfectly content with the situation. A higher oil price seems likely to be the new reality at least in the near term. This is positive for the Russian economy and especially positive for the budget in the current exchange rate environment (see below)

GDP Growth

External factors have resulted in downgrades to expected GDP growth for this year and to the outlook for the next couple of years. Even if there are no changes to the sanctions targeting Russia growth expectations have moderated. 1.5% for 2018 is now about the consensus, with probably the same for 2019 and only a gentle acceleration in 2020. President Putin’s infrastructure and spending plans will be hard to finance potentially, absent a significant hike in the oil price, although the flip side is that the spending may provide a boost to GDP. It is unfortunate that the economy is still waiting for a number of badly needed structural reforms and is therefore largely hostage to outside factors.


The weaker ruble and the upcoming increase in VAT have pushed inflation up from its record lows. It is now likely to overshoot the Central Bank of Russia (CBR) target for 2018 of 4%, and may be closer to 5%. This will reduce the CBR’s room for manoeuvre and will reduce real increases in wage growth and spending. Because of this we will see slower growth in retail, which is a major engine of GDP growth, and in part therefore the lower levels described above. I expect, though, that inflation will fall back below 4% in 2019.

Central Bank Policy Rate

Until recently this was on a clear downward trajectory, which was a strong positive for debt markets and for property investment. The spike in inflation (above) and the weakening of the ruble (below) have forced the CBR’s hand. Despite some fairly inept comments from certain politicians the CBR is to be applauded for reinforcing its independence and raising its policy rate in response to these factors. The Central Bank remains strong and decisive and this is a real benefit to the economy, even if politicians do not always understand that (Turkey anyone?)

Exchange Rate

Sanctions continue to pile up as if we take some masochistic pleasure in causing ourselves economic pain. We are not alone in that strange desire (Brexit anyone?) but we do seem to excel at it. Each new round of sanctions has brought an immediate and one off weakening of the ruble. This time we have seen a small rebound, but no-one can be certain of what is coming next. The ruble weakness has pushed up inflation, lowered GDP growth and pushed the CBR to raise interest rates (see above) and therefore has been the single biggest factor effecting the economy.

The ruble has decoupled from the oil price (although it has tracked closer just of late) and is now buffeted around by geo-political factors rather than fundamentals. This makes it inherently more uncertain. I have heard talk of the ruble getting weaker, but also the opposite, that the weakness has overshot and that it is likely to strengthen in the short term. If I had to take an educated guess, and it would be no more than that, I would say barring any additional outside factors (perhaps unlikely) the ruble will strengthen slightly. However there is a very big elephant in the corner of this room as outlined below.

Domestic Budget

The balance of payments and reserves position for Russia remains strong. In ruble terms the oil price is the highest that it has ever been providing significant inflows to the budget and a surplus, despite the ambitious spending plans announced by President Putin shortly after his inauguration. This is much healthier than expected, and will allow increased government spending, which will support GDP growth, particularly in the medium term.

But what about sanctions I hear you ask.

Some of our recent actions on the World Stage have been, under a benign interpretation, self-defeating. We have managed to get ourselves in a position, with President’s Trump unwitting (not a typo) assistance, where either the US or the EU or both are almost obliged to strengthen sanctions against Russia. The latest mooted US sanctions that are before the Senate are particularly brutal and would have a severe and prolonged effect on the economy. I think when it comes down to it these sanctions will be watered down, but it is more or less inevitable that there will be further sanctions. The details though are impossible to predict with any accuracy. Each and every further round of sanctions will cause further ruble weakness together with the knock-on effects described above. Where this will end nobody knows. However, the US mid-term elections in November are likely to neuter some of the pre-occupation with Russia and there is increasing support amongst the members of the EU.

The short-term outlook is rather gloomy, but in the medium terms I expect the fundamentals to become more assertive and for the mood therefore to turn positive.

At this point you are no doubt wondering “isn’t this a blog about the property markets?”. Well, yes. But context is always important.

Our JLL Russia third quarter research will be published soon, but without spoiling the ending here is a sneak preview. Investment activity has all but stalled with buyers nervous of all of the economic uncertainty. It is difficult to price assets and to know where those prices are likely to be a week from now – let alone a year.

In all sectors though fundamentals are strong. I will follow up with more detail on each sector in a separate blog post, however in all markets vacancy rates are declining on the back of robust demand and constrained new supply. This will remain the case, particularly due to the length of the development cycle in Russia. Rental growth has already turned positive across the board and I expect this to gather pace as the fundamentals trump (small “t”) the geo-politics. Slowly as first but accelerating through 2019. My sunny optimism of earlier blogs may have been overcome by the recent gathering storm clouds, but there is still much about the Russia story and the market fundamentals which suggest that this is an epic buying opportunity screaming for attention



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