The World Bank bases most of its projections on the Russian economy on assumptions that the economic sanctions imposed against Russia will stay in force until 2018, according to the updated Russia Economic Report published Wednesday. Only one scenario (baseline) implies that economic sanctions will be lifted in 2017.

“An alternative baseline scenario combines the baseline oil-price forecast with the projection assumption that economic sanctions would be lifted as early as 2017, while all other scenarios assume that economic sanctions would remain in place until 2018,” the report said.

According to the World Bank, the economic sanctions against Russia cut off Russian businesses and banks from global financial markets and foreign investment whereas the cost of local credit resources remained high due to the slowed pace of monetary easing by the Central Bank.

“In 2015 the Russian economy began its difficult adjustment to the impact of the economic sanctions regime imposed in July 2014. Meanwhile, economic sanctions against Russia were extended, depressing economic confidence and cutting off Russian businesses and banks from global financial markets. A lack of affordable credit and plummeting consumer demand caused investment to contract for the third consecutive year. Despite regulatory forbearance and a massive recapitalization program, the financial sector remains vulnerable,” the report said.

“As the Russian economy gradually adapts to an adverse external environment marked by lower oil prices and ongoing economic sanctions, the focus of its economic adjustment challenges is now shifting to fiscal and financial sector restructuring,” the WB said.

Russia’s Reserve Fund to be fully spent by end of 2016

The report also says that Russia is unlikely to meet it 2016 deficit target of 3% of GDP, and the country’s Reserve Fund is expected to be exhausted by the end of the year.

“While the government announced its commitment to fiscal consolidation, continued budget overruns will further deplete the already shrinking Reserve Fund,” the World Bank reported.

“Financing the deficit is expected to fully deplete the Reserve Fund by end-2016, compelling the authorities to either increase borrowing or generate revenues from privatization,” the report says.

This situation [Reserve Fund depletion – TASS] will require bold choices during the 2017 budget-planning process, as the authorities strive to determine the structure and policy priorities of the country’s new medium-term fiscal framework, the World Bank says.

Poverty levels in Russia will rise irrespective of oil prices

The report states that the poverty level in Russia will grow in any economic development scenario and irrespective of oil prices.

“Poverty levels are expected to rise in 2016 under all three scenarios, even if oil prices swiftly recover,” the report says. According to the World Bank’s assessment, “dim prospects for income growth are likely to continue to negatively impact shared prosperity and poverty trends.”

Under the baseline scenario the headcount poverty rate is expected to increase from 13.4% or 19.2 million people in 2015 to 14.2% or 20.3 million people in 2016, the World Bank reports. The projected increase in 2016 would return poverty rates to their 2007 levels, undoing nearly a decade’s worth of gains, the Bank says.

Poverty in 2016 is projected to increase further in all scenarios, the World Bank says. “The projected increase in the poverty rate under all three scenarios is due in part to the deeply negative carryover effect of the sharp contraction in real income in 2015 combined with the continued deterioration of employment indicators,” the Bank adds.

Russia’s GDP contraction

The bank has downgraded its forecast on Russian GDP dynamics to 1.9% contraction in 2016 and 1.1% growth in 2017.

“While the conditions that pushed Russia’s economy into recession may be gradually abating, the World Bank’s current baseline scenario anticipates a further contraction of 1.9% in 2016 before growth is expected to resume at a modest rate of 1.1% in 2017,” the report said.

In its previous report published in September 2015 the institution projected GDP contraction of 0.7% for Russia for 2016 and GDP growth of 1.5% for 2017.

Currently, the WB implies oil prices at the average level of 2015 – $37 per barrel whereas the previous report was based on $53 per barrel oil price.

Lower-bound scenario

The World Bank’s lower-bound scenario says oil prices will fall to $30 per barrel in 2016 while Russia’s GDP will contract by 2.5%.

“The lower-bound scenario projects that oil prices will fall well below the baseline forecast and that GDP will contract by 2.5% in 2016, before recovering modestly in 2017. This scenario assumes that a further oil-price shock in the second part of 2016 would push oil prices to an annual average of just $30 per barrel,” the report said.

In this scenario, oil price will rise to $40 per barrel in 2017 and $45 per barrel in 2018 while Russia’s GDP will grow by half a percent in 2017 and 2% in 2018.

The scenario implies budget deficit at 5.6% of GDP in 2016, 3.6% of GDP in 2017 and 2.7% of GDP in 2018.

Average annual inflation rate will reach 8.5% in 2016, 6% in 2017 and 5% in 2018.

Opportunities for competitiveness improvement of Russian non-resource industries

“Rapid devaluation of the ruble created a relative price advantage for Russian exporters, giving rise to considerable optimism regarding Russia’s potential to expand into new products and nontraditional export markets,” the report says.

“While the ruble’s depreciation has created an important price advantage for non-resource exports, yet well-known obstacles are inhibiting investment in sectors with high growth potential,” the World Bank reports. Export volumes rose in the wake of the depreciation, especially to countries outside the former Soviet Union countries, the Bank said. However, “the improvement in relative prices did not significantly impact exports for most of Russia’s manufacturing sector, and many of the country’s industrial products remain uncompetitive on international markets,” the report says.

Experienced exporters appear to be benefitting from the weaker ruble, while firms that have traditionally produced for the domestic market have been less able to take advantage of the shift in relative prices, the World Bank says. “Adjusting product profiles and achieving compliance with international quality standards will require both time and investment. This process already appears to be underway, and investment in certain sectors has increased substantially in recent years,” the World Bank adds.

Russia’s economic policy uncertainty obstructs investments and consumption.

According to the bank, Russia’s economic policy uncertainty turned to be the key obstacle to investment and consumption.

“Recent trends in business and consumer sentiments show that confidence has not yet been restored,” the World Bank said. Investor confidence is undermined not merely by continuing weak domestic demand but also by uncertainty of the economic situation, the bank reported.

Russian banking sector to remain vulnerable by 2017

The Russian financial sector is reported to remain extremely vulnerable until 2017 year-end despite recapitalization and regulatory forbearance.

“Despite regulatory forbearance and a massive recapitalization program, the financial sector remains vulnerable,” the World Bank said. “It is clear that the sector will remain highly vulnerable through 2017, requiring the authorities’ constant vigilance and readiness to implement further stabilization measures,” the report says.

At the same time, more than 100 banks were closed during the past year, and the consolidation of the banking sector is expected to continue as the Bank of Russia tightens regulatory compliance, the World Bank reports. “In the near-term, the resolution of troubled banks should be encouraged, including the merger and/or takeover of smaller banks, possibly by raising the minimum capital requirements,” the World Bank says.

Achieving and maintaining a sustainable level of reserves would allow further banking sector consolidation while still protecting depositors, the report says.