Russian economy beat market expectations to grow by 2.5% YoY in Q2, the highest growth in 14-quarters as compared to 0.5% YoY in the previous quarter. The monthly data suggests that the growth was likely driven by industrial production, construction, transportation activity and retail trade. Household consumption is likely to have continued increasing in Q2, on the back of higher real wages and improving consumer confidence, declining household savings rate due to lower real interest rates, and improving household credit.    August data shows Russia is doing fairly well, but it is too early to call that 2Q performance can extend into 3Q. Construction output was up 6.1% YoY in August relative to 5.3% YoY in June. Transportation output also has been on positive side with August reading being 7.8% YoY. Retail sales and real wages being representative of demand have shown considerable improvement in past 2 months. The average retail sales for the first two months of Q3 is close to 1.6% YoY as compared to 1% YoY growth in Q2. Similarly, real wages have been showing positive trend with 2 months average being close to previous quarter’s average. A relatively slower growth in industrial output and real disposable income in July and August can be a drag on Q3 growth.    Inflation surprised on the downside in August; likely to continue to decelerate. We expect the disinflationary trend to continue with annual inflation falling further to 3.1% YoY by year-end on the back of declining food prices and base effects. See EMEA Snap - Russia: August inflation opens door for more aggressive easing by CBR for more details.    The CBR decided to cut the key policy rate by 50bps to take rate to 8.50% in September. However the CBR remained cautiously hawkish in their tone. We expect the CBR to ease the policy rate by 2x25bps at the remaining two meetings this year to take the policy rate to 8.00%. See EMEA Snap - Russia (CBR): 50 bps cut served with a hawkish twist for more details.    The Finance Ministry approved federal draft budget for 2018-2020 that should be welcomed by investors. The authorities expect the federal budget deficit to fall to 1.4% of GDP in 2018 and 0.8-0.9% of GDP in 2019- 2020. In 2017, the federal budget deficit is planned at 2.1%. The authorities plan to reduce domestic debt issuance to RUB 868bln in 2018 (RUB 870bn in 2019 and RUB 1.34bln in 2020). Revenues are expected to increase to RUB 15.18tn in 2018 and RUB 15.55tn-RUB 16.28tn in 2019 and 2020, respectively. On the spending side, the FinMin wants to raise expenditure to RUB 16.51tn in 2018 and subsequently to RUB 17.2tn in 2020. A RUB 1.11tn drawdown of the National Wealth Fund is factored in to finance the budget deficit in 2018. This amount is to decline to RUB 4.5bn and RUB 3.8bn in 2019 and 2020, respectively. Special presidential advisor Alexei Kudrin presented a fiscal reform strategy in September. The proposals envisage fiscal deficit reduction to 1% of GDP by end of 2024. On the revenue side, Kudrin identifies high reliance on oil revenues as a problem and looks to stabilize revenues at 33% of GDP by switching from taxing oil exports to higher royalties paid for oil extraction and by eliminating some tax benefits. Expenditure reduction plans are more ambitious and Kudrin suggests increasing the retirement age and improving targeting to bring down social security spending. He favors higher spending on infrastructure, education, healthcare, but proposes to lower defence spending further.

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