Russia’s recovery continues but remains fragile. Growth in the first quarter remains around the 2% mark and no surprises are expected for the rest of the year.

The GDP growth forecast for this year was recently revised down to 1.9%, while the outlook for industry has dipped back into the red after the manufacturing PMI turned red in May and June. Inflation and unemployment remain at record lows, although inflation is expected to rise from the current 2.3% towards 4% over the next year.

The list of factors driving the headline inflation higher -- robust wage growth and the low base effect of 2017 -- was extended by the decision to raise the VAT base rate hike 2pp from the current 18% in July. While the hike is planned for 2019, we are likely to see the pass-through effect frontloaded to 2H18.

Mortgages continue to boom which is lifting the construction and banking sectors. Rates are expected to continue to fall, although the CBR decided to pause in June and made no cuts to the key rates. However, bankers see rates falling by another 100-150bp over the rest of the year to finish around 7%.

The higher than expected oil prices this year – average oil is about $65 over the first seven months vs the $44 assumed in the budget – is feeding through into good tax revenues and growing gross international reserves (GIR) which are over $450bn and the reserve fund is over $77bn.

The high oil prices are also pushing up the current account surplus. Higher oil prices, the new fiscal rule and the World Cup all supported Russia’s currency account balance in the second quarter of this year leading to a $22.3bn surplus, the Central Bank of Russia (CBR) reported on July 10, putting Russia on course for its biggest surplus in seven years.

Russia's federal budget surplus in the first half of 2018 reached RUB0.9 trillion ($14.4bn) or 1.9% of GDP, according to finance ministry data. Budget revenues stood at RUB8.6 trillion, jumping 21% y/y due to a 33% surge in oil and gas revenues attributed to the 35% growth in the oil price. Non-oil revenues also increased by 11%. Despite the positive fiscal outlook, the finance ministry previously firmly stood behind the "budget rule" which caps spending at the $40 per barrel oil price cut-off benchmark.

While Russia’s economic story is not sparkling, it is rock solid. Standard & Poor's has affirmed the 'BBB-/A-3' foreign currency long- and short-term sovereign credit ratings on Russia, as well as its 'BBB/A-2' local currency long- and short-term sovereign credit ratings with a Stable outlook, the agency said on July 20.
"We consider that Russia's solid external and public balance sheets, coupled with a flexible exchange rate and prudent fiscal framework, should enable its economy to absorb shocks from possible new international sanctions," S&P argues. S&P sees the backbone of Russia's rating as its commitment to conservative macroeconomic management, "formidable" net external asset position, low government debt, and "considerable" monetary flexibility.