Credit Suisse doesn’t expect catastrophe to strike the Russian economy, but they recommend keeping an eye on these three factors

Even as the rouble continues to deteriorate and the fighting in Ukraine looks like it may become a modern proxy war, Credit Suisse analysts argue that the most likely outcome is two years of recession while Russia adapts to cheap oil. But for anyone invested in or otherwise exposed to the Russian economy, there are three key risks to keep an eye on: the rundown of hard currency reserves, the ratio of external debt to GDP, and the stability of Russia’s banking sector.

Russia balance of payments

Russian economy – Credit Suisse expects at least two years of recession in Russia

As a base case, the Credit Suisse report forecasts Russian GDP growth will be -4.7% in 2015 and 0.5% in 2016, assuming Brent crude stays around $50 this year and then rises to $65 next year (the report also assumes no significant changes to US/EU sanctions). They expect Russia’s current account surplus to fall from $56.7 billion in 2014 (3% of GDP) to $20 billion (1.8% of GDP) this year, and for the rouble to stabilize around 77.7 against the dollar compared to 66 right now and 35 a year ago. None of that is good news, but if the Credit Suisse base case pans out then Russia should stabilize and rebound without a catastrophe.

“Nonetheless, at this junction, the risk that adverse external factors quickly change the picture is not small. With no positive signs from the sanctions regime and the risk of a relapse in oil prices, a spiral of negative dynamics could push Russia’s creditworthiness to concerning levels,” says the Credit Suisse report.

Three danger signs to watch out for

The first danger is that Russia runs down its FX reserves, which are being used as the primary source of finance the balance of payments gap as long as Russia is cut off from international markets. In the base case, Russia’s reserves will fall from $385 billion at the end of 2014 to less than $300 billion by year-end 2015, but at the extremes it could even go as low as $180 million.

Russia FX reserves

Credit Suisse projects that GDP contraction and currency devaluation will push Russia’s external debt-to-GDP ratio from 32.5% in 2014 to 59.4% this year, which is already an enormous jump, but if the rouble doesn’t find a floor the ratio could cross 70% or even get up to 79%. Russian government debt is less sensitive to FX shocks, and Credit Suisse thinks Russian businesses will be able to roll over their debt even in extreme cases, but it would be headwind to growth.

Russia external debt to GDP Russian

Finally, Russian banks’ capital ratios are starting to deteriorate. As long as the Central Bank of Russia is able to help with liquidity that’s not necessarily a problem, but it means that the financial sector can’t handle as much strain from the rest of the economy. That could be a problem if companies do have trouble rolling over external debt and need to borrow locally or if impairment charges start growing faster than expected.

Russia bank capital ratios