ED: This article is from the series DATACRUNCH that digs into details of macroeconomic and sectorial trends. It draws on bne IntelliNews’ premium PRO news service and bne IntelliNews’ monthly country reports (see a sample here). If you are interested in these trends then sign up for a trial to PRO here. If you would like to see this month’s Russia country report or would like more information then email firstname.lastname@example.org.
Russia’s economy contracted less than feared in 2020 and now it is bouncing back from the coronacrisis faster than analysts were expecting.
bne IntelliNews speculated in a cover story in December "Brighter days ahead" that the first quarter of this year could see a strong recovery as pent up demand is released, and that scenario seems to be playing out.
That’s good news but it doesn't mean Russia is not performing below potential and growing more slowly than it could. Thanks to geopolitical tensions the Kremlin is husbanding its resources and instead of leveraging its cornucopia of natural resources it has been in effect running an austerity budget since 2012, and that has hobbled growth and led to eight years of real income decline.
Russian President Vladimir Putin has been channelling all the spare case he can into building a fiscal fortress that makes Russia impervious to sanctions. But that comes at a high price of low growth. The Kremlin refuses to leverage is cornucopia of natural resources to boost growth and has chosen instead to pay down debt to ridiculously low levels and build up reserves to titanic proportions.
For example, when Russia ran a budget deficit in 2020 instead of tapping the cash pile in the National Welfare Fund (NWF), which is what the rainy day reserve fund was designed for, MinFin decided instead to run a 0.5% of GDP deficit instead to raise extra cash. That has the attractive side effect of putting more US investors on the hook for Russian spending, but doesn't increase Russia’s debt by any meaningful amount. Think like this dominates the Kremlin policies, not producing prosperity for the population.
Still, compared to most other countries Russia is doing very well, partly because thanks to those same geopolitical tensions it went into the coronacrisis crisis so much better prepared than most other countries.
“Crisis over (well almost), what is next?” says Vladimir Tikhomirov, the chief economist of BCS Global Markets. “Macroeconomic statistics indicated a fairly rapid recovery of the Russian economy – faster than we and consensus had expected. Indeed, in March, industrial production posted the first year-on-year growth in a year at 1.1%. The growth drivers were the consumer sectors, gas production, defence sector and automotive industry.”
Looking at the details and it seems the end-effects were still dragging on growth in January and February, but growth took off in March. Russia’s Ministry of Economic Development reported that GDP was up 0.5% y/y in March after contractions of 2.2% y/y in January and 2.5% y/y in February. But the recovery in March was not enough to compensate for the first two months of the year and the preliminary result for the first quarter was another contraction of 1.4% y/y in the first three months versus a contraction of 1.8% y/y in 4Q20, before the pandemic hit.
Russia’s economy was not really growing before the coronacrisis started, so much of the growth now is more to do with a bounce-back than any underlying momentum. What has changed is there is some growth momentum now and the Kremlin is hoping to capitalise on it by increasing social spending and heavy investment into infrastructure as Putin outlined in his State of the Nation speech on April 21. The hope is that the 12 national projects will return Russia to prosperity; these were launched in 2018, but keep getting delayed as Russia gets hit with multiple shocks. The national projects were supposed to be finished by 2024, but now the deadline has been postponed to 2030.
The job will be made easier as the whole world seems to be emerging from the annus horribilis of 2020. The improving Russian economy comes in the context of a general recovery in Central and Eastern Europe (CEE). The EC’s Economic Sentiment Indicators (ESIs) recorded their largest ever monthly aggregate improvement across Central and Eastern Europe in April and the World Bank is predicting 6% global growth this year.
“Sentiment remains below its pre-pandemic level but, with virus restrictions now being relaxed, we expect the rise in sentiment to continue and the region to enjoy a strong, sustained recovery from Q3,” Capital Economics’ Nicholas Farr said in a note commenting on Europe's improving sentiment.
Russia posted on a -3% contraction in 2020 after the government spent only about 3% of GDP on stimulus – one of the lowest levels of stimulus support in the world. This year GDP is anticipated to grow by 3.1%.
Manufacturing saw the strongest momentum, gaining 4.2% y/y in March (+5.5% on a seasonally adjusted month-on-month basis) vs. -1.7% y/y in February (+2.8% SA m/m).
Within the industrial sector, the best performance came from the production of non-food consumer goods, e.g. textiles and clothing, as well as investment goods, e.g. fabricated metals, machinery and transport equipment, as well as chemical production.
Transportation expanded 3.9% y/y thanks to the pick-up in the railway and automobile transportation segments. Elsewhere sectors such as mining and quarrying were still in decline but the pace of that decline was slowing.
Industrial production back in the black
Industrial production posted 1.1% growth in March, its first expansion in almost a year. However, it's still too early to open the champagne, as in the first quarter, industrial production was 1.3% lower than a year ago and the situation is still varied amongst the main industrial sectors, according to Bank of Finland Institute for Economies in Transition (BOFIT).
“Production in the extractive industries has gradually recovered and grew seasonally adjusted in February to March by less than 1% per month. However, production was still 5-6% lower in March than a year earlier, with the annual decline for the whole of the first quarter remaining above 7%,” BOFIT said in its weekly updates on April 30. “In the background there are still OPEC+ agreement restrictions on oil production, to be phased out by April next year. The agreement has kept Russian oil production a tenth lower than a year ago. In contrast, natural gas and coal production bounced back to growth in the first quarter (8% and 10% respectively) from last year’s pits.”
The recovery of the manufacturing industry was driving growth (thanks to rising demand and a falling ruble Russia is starting to develop its own light manufacturing base almost three decades late). But extractive industries have also bounced back after commodity prices started to rally strongly from about November last year.
In addition, services are also starting to recover now, as the most recent Services PMI indicators showed in March, which jumped to a seven-month high.
Interestingly, a boom in Russia’s pharmaceutical sector made a noticeable positive impact on Russia’s industrial production for the first time as the state ramped up production of Sputnik V and Russia’s other anti-coronavirus vaccines – production of medicines has tripled in the last year, BOFIT reports.
All this lifted industrial output back into the back for the first time in a year, registering 1.1% y/y growth in March after contracting in both January and February by more than 2%.
“The economic indicators for March point to a strong recovery when accounting for the base effects of 2020. The gains in IP came on the back of the greater production of both investment goods (metals, machinery and equipment) and consumer goods,” analysts at Sova Capital said in a note.
With industry, manufacturing, services and transport all recovering, that has had an impact on the labour market. In 2019 Russia was enjoying post-Soviet low unemployment and at the start of 2020 joblessness was around residual levels of about 4.5%. But as the lockdowns started unemployment soared to a peak of 6.4% in August as the Kremlin tried to contain sackings with modest, but targeted, support and rules that put the burden of keeping workers in their jobs on to the companies. As the restrictions started to come off at the end of the summer unemployment began to fall again and was down to 5.5% in March as things slowly get back to normal.
Federal budget back in the black
The accelerating growth has also had a positive impact on the government's finances. Russia’s budget revenue soared by a third in March and the balance was back in surplus.
“The budget thus ran a surplus in March, reaching RUB741bn [$9.9bn], while the 1Q21 surplus came to RUB205bn. With revenues recovering faster than expected (primarily non-oil and gas), we expect the government to further increase social spending, as well as reduce planned borrowing in 2021,” Sberbank CIB said in a note.
Russia’s budget revenues in March were up by a third (33%) y/y, reaching RUB2.5 trillion, according to preliminary estimates of Ministry of Finance. The largest increase was recorded in non-oil and gas revenues (by 45% versus by 8% versus February), which reached RUB1.97 trillion – a monthly record. Import rated tax revenues also jumped by 31.7% y/y as commerce came back to life and "other income" was up a massive 273% y/y to RUB588bn.
The outlook for the rest of the year is equally good. Revenues are anticipated to climb to RUB18.8 trillion in 2021, up from RUB17.9 trillion in 2020, and then rise to RUB20.6 trillion in 2022 and RUBR22.3 trillion in 2023. Expenditures will shrink to RUB21.5 trillion in 2021, down from RUB22.6 trillion in 2020. The higher spending this year was due to measures taken to combat the pandemic. Nominal expenditures are then slated to rise to RUB21.9 trillion in 2022 and to RUB23.7 trillion in 2023.
As a result of these plans, the budget deficit is anticipated to shrink to RUB2.8 trillion (2.4% of GDP) in 2021, versus RUB4.7 trillion (4.4% of GDP) in 2020. In 2022-23, the deficit is set to stabilise at RUB1.2-1.4 trillion (1.0-1.1% of GDP).
“MinFin reported the federal budget in 1Q21 showed the first surplus in more than a year, albeit marginal (0.2% of GDP). Still, the very fact of the deficit turning to surplus is a milestone as it signals stability of Russia’s state finances, despite geopolitical challenges,” Tikhomirov said.
Corporate profits best in five years
Down at the microeconomic level the upswing in activity is resulting in more cash in the till. Russian corporates booked their best profits in five years in February, the latest data available, increasing to RUB1,757bn ($23.35bn) in the month, up from RUB1,359bn a month earlier. February’s result was almost triple the RUB609bn that companies earned in the same month in 2020 – well before the economy received any of the shocks that dominated last year’s story – and also well ahead of the same month's results in 2019, the first year of strong growth since the 2014 oil shock. On a cumulative basis Russian companies have now earned RUB3,116bn ($41.3bn) in the first two months of this year, an amount it took them four months to earn in 2018 and 2020, although they earned the same in three months in 2019.
The story is very similar in the banking sector, where currently cumulative profits are on a par with the pre-crisis 2019 and 2020, after the sector reported RUB578bn in income for March, almost exactly as much as in the same month in the last two years. Analysts are expecting the sector to have a good year this year.
Problems still remain
Russia’s economy was clearly recovering in March, but it is also clearly only stepping off square one. Three big problems remain: inflation is too high; incomes are still declining in real terms; and the ruble is extremely volatile.
Incomes: In 2012 Putin made a decision to sacrifice the prosperity of the noughties and dedicated every spare ruble to invest into modernising the military. That process came more or less to an end in 2018 (Putin said in his State of the Nation speech that 76% of the military would be modern this year) and he has turned his attention back to improving Russians' quality of life, but it has come at the cost of eight years of stagnant real income growth. Tellingly, this month Rosstat delayed releasing the latest real income data – and for good reason. Out in the last days of April, they show another drop in real incomes in the first quarter of 3.6%.
“The fall in real incomes was the result of ruble devaluation, a spike in inflation and the pursuit of conservative fiscal policy. It came in contrast to the improving the labour market and has shown the limits to the recovery in the consumer sector,” BCS GM's Tikhomirov said.
The news is not all bad, as from here on in last year’s crash will start to distort all the data releases thanks to a low base effect, making it much harder than normal to tell what is actually going on. Economists have taken to quoting the fast moving indicators and quoting month-on-month data to get a better picture.
According to Rosstat, the nominal average income per capita rose 3% y/y in the fourth quarter of last year versus 3.7% y/y in 4Q20, -0.6% y/y in 3Q20 and -4.7% y/y in 2Q20). Real money incomes were down 2.8% y/y in 4Q21 (vs. -0.7% y/y in 4Q20, -4.1% y/y in 3Q20 and -7.6% y/y in 2Q20) and real disposable incomes were down 3.6% y/y in 4Q21 (vs. -0.9% y/y in 4Q20, -5% y/y in 3Q20 and -7% y/y in 2Q20).
“We think there were several reasons for the fall in real disposable incomes in 1Q21. The first reason is the base effects, as pensions were paid out earlier due to the non-working week of 30 March 2020 to 3 April 2020 and the beginning of [coronavirus] COVID-19 outlays. Second, the inflation rate surged from 2.4% y/y in 1Q20 to 5.5% y/y in 1Q21, trimming revenue by more than 1ppt. Finally, Rosstat did not count in full the shift in household savings from deposits to financial markets,” Sova Capital said in a note.
“Despite household income falling for the eighth straight year, this is unlikely to stop the recovery momentum because of higher savings buffers, the continued surge in credit and a lack of popular travel destinations, all of which support spending at home.”
There is no doubt that incomes are stagnant and have been for years. Wages have been rising slowly over the last two years in nominal ruble terms, but as the chart shows, in dollar terms they have barely changed and are currently at $689 per month as of February and have probably fallen if you discount the Christmas bonus paid in December as a stimulus measure. (The trendlines in the chart below show well how nominal wages have grown, but dollar equivalents are almost entire flat or falling.) The (hopefully temporary) surge in inflation has distorted the real income results (which is an inflation adjusted measure of nominal income rises), muddying the waters.
Retail: Declining incomes have fed through to poor retail sector results. Consumption is one of the three big drivers of economic growth (investment and construction are the other two) and it is also going backwards.
Retail turnover was still in the red on a y/y basis in March, contracting 3.4% in March after a milder fall of 1.8% the month before.
That looks bad, but the numbers were already starting to get distorted in March last year. This year’s result is poor, as it is measuring against March 2020 when retail sales surged 6.1% y/y, as the population panicked and started stockpiling goods ahead of the lockdown that came a few weeks later.
“This was a one-off, and we expect to see a significant acceleration in y/y growth in retail sales by the end of April,” Sberbank CIB said in a note. “Overall, we think that economic activity in March picked up considerably versus February, when basic sectors' output was down 2.3%, and that headline growth likely went into positive territory. However, 1Q21 GDP is still likely to remain down y/y.”
Analysts report that if you dig into the numbers and ignore these aberrations then there are many signs of underlying consumption starting to pick up.
“Household consumption continued to improve, with demand for goods and services expanding on a seasonally adjusted m/m basis for the fourth month in a row,” Sova Capital said.
The point is highlighted by the latest Watcom Shopping index, which uses 3D technology to measure foot traffic in Moscow’s leading malls in real time and so gives one of the most up-to-date takes on consumption. The results for this year show that foot traffic has been fairly consistent, although the index has fallen slightly in recent weeks and remains about a third lower than in previous years, which is partly due to the big rotation out of physical shopping in malls and going online to buy groceries instead; Russia's e-grocery business is the fastest growing part of retail at the moment.
There is also strong growth in mortgages, with mortgage lending accounting for the biggest part of bank retail lending in the first quarter, boosted by the state’s subsidised mortgage programme.
Car sales have also recovered somewhat and demand for car loans from banks has also been consistently rising since a dip caused by the last year’s shock in April, although sales remain down on last year. Russia's sales of cars and light commercial vehicles (LCVs) in March 2021 declined 6% y/y to 0.15mn units, according to the latest data from the Association of European Businesses (AEB). Overall 1Q21 sales were down 3% y/y to 0.39mn vehicles.
Measuring the changes from now on is going to be more difficult as the Watcom chart shows: y/y comparisons become meaningless thanks to the collapse due to last year’s lockdown that came into force in April, but the fast moving data suggests things are not quite as bad as the headline figures paint.
“The main driver remained non-food consumption, which gained 1.6% on a SA m/m basis vs. a gain of 0.9% on a SA m/m basis in February,” Sova Capital said. “Car sales continued to post positive results, expanding 2% on a SA m/m basis in March vs. a gain of 4.2% on a SA m/m basis in February.”
Another place to look is in the balance of payments that shows the dynamics of imports that is another good indicator of domestic demand. Rising imports usually mean the population is feeling a bit better off and is buying more expensive, imported, goods.
“The recovery in domestic demand is also seen by the balance of payments data; according to CBR’s preliminary estimates, Russia’s current account surplus in 1Q21 was $16.8bn (-27% y/y). The prime reason for the decline is a lower trade surplus due to a hike in imports (+12% y/y), while exports were down 2% y/y due to OPEC+-induced restrictions on crude oil sales,” says Vladimir Tikhomirov, the chief economist of BCS Global Markets.
Inflation: The fly in the ointment is that inflation has surged in the first months of this year, forcing the Central Bank of Russia (CBR) to hike rates in both March (25bp) and April (50bp), ending almost six years of easing and promising more hikes later this year unless inflationary pressures subside.
There is a lot to unpack in understanding what is driving inflation, but the short story is that much of it is due to the coronacrisis dislocation and the effects will probably be temporary as economies, not just Russia’s, find new equilibria.
Happily inflation seems to have already peaked, with the consumer price inflation (CPI) dropping from 5.8% y/y in March to 5.5% y/y in mid-April, but it will probably remain higher than the CBR’s target rate of 4% for the rest of the year.
The central bank estimates that consumer prices will rise in the second quarter at the same pace as in the first quarter. In the second half of the year, it expects consumer price inflation to slow. It forecasts annual inflation at 4.7–5.2% (previously 3.7–4.2%) at the end of the year. It expects to meet the inflation target (4%) in mid-2022 (previously in the first half of 2022). After that, it believes annual inflation will remain close to the inflation target.
The CBR's decision to hike rates early and more aggressively is designed to nip the problem in the bud as, while inflation pressure already seems to be falling, the inflation expectations of the population have "gone through the roof" and are currently at four-year highs; Russians think inflation will go to 11% or more, so the CBR needs to send a clear message that it is on the case.
Rising food prices are one of the main drivers of inflation and because Russia has become a big agricultural producer and trades actively with the rest of the world price increases are easily transmitted across the border. Sugar is made cheaply in Russia but if the ruble devalues and the price of sugar in Russia falls in dollar terms then the producer can simply export and earn more. The result is the domestic prices rise to match the international prices and that is exactly what happened, with sugar prices jumping by some 75% last year.
The Kremlin has intervened with voluntary prices controls and other administrative means. There is also a restriction on grain exports to try to keep domestic prices down, but as Russia is the biggest grain exporter in the world this causes shortages elsewhere and drives the global price up, as it did last year. Again, the inflation contagion seeps back across the border, as grain is an input into many products such as meat production, where it is used as feed. To prevent this happening the controls the government needs to build quickly become increasingly complicated and add more distortions to the market and prices.
The bottom line is administrative controls may be politically attractive, but they don't work and can at best provide some temporary relief. However, the very same rising prices cause the producers to react and increase supplies until the market again finds a new equilibrium and the inflation stops. All governments can really do is help the poorest citizens with targeted subsidies and wait for the markets to correct.
Another important point to note is that the CBR is helpless to fight inflation caused by rising food prices. Too much cash chasing too few goods is the classic cause of inflation and hiking interest rates makes people spend less and save more and so will curb inflation. But if the problem is that cabbages are too expensive, hiking rates has little affect and will only reduce inflation at the margin – although the psychological impact it has is important.
FX: The other big driver of inflation has been a devaluation of the ruble, which dropped from the 60s in 2019 to touch on RUB80 to the dollar in the bowl of the crisis.
Devaluations are inflationary, as obviously the stock a shopkeeper imported has become more expensive in dollar terms so they have to put the price up. However, the shopkeeper is also keen not to lose his market share and as the stock is already paid for he will put the prices up slowly. The more competitive the niche the more incentive there is to increase prices slowly to win market share from competitors. In a niche where the shopkeeper is the monopolist he can pass on the price increase to the punter immediately and indeed in the less developed markets inflation has risen a lot faster than in Russia. The upshot is devaluation effects takes three to six months to pass through to prices.
As bne IntelliNews reported, the value of the ruble has become in the last year totally decoupled from the oil price and is now a prisoner to the ebbs and flows of geopolitical threats, swinging wildly, moving by several rubles a day, depending on the news flow. The recent tension associated with the April 15 US sanctions and the troop movements on Ukraine’s border sent the ruble tumbling by nearly four whole rubles in a matter of weeks.
As tensions ease and normal forces come back into play the outlook for the ruble is good and it is anticipated to strengthen. Renaissance Capital’s chief economist for Russia and the CIS Sofya Donets, who spent 12 years as an analyst at the CBR, says she sees the ruble strengthening in every scenario through to the end of the year to between RUB74 (high tensions) and RUB69 (calm). A strengthening ruble should be disinflationary, but uncertainty has a similar effect on currency traders who discount the rate to take account of the swings. The rapidly recovering health of the government’s finances will also help the ruble.
Trade: The turnover of trade was down to $43.8bn in February, the latest data available, just before the oil and pandemic shocks, and will certainly drop as new data is released. However, the year-on-year comparisons will improve due to the low base effect. Trade results are further distorted by the OPEC+ oil production deal, which has another year to run, that reduces Russia's oil exports.
Exports of goods are already down in the first two months, but again this is partly due to a high base effect, as this year’s trade is post-crisis which is being compared to the pre-crisis January and February of last year. In that context the export of goods is holding up relatively well. As the chart shows, the turnover in goods last year did fall, but not that heavily.
And while exports are down that was partly offset by an even more dramatic fall in imports, so the balance of trade tends to automatically adjust to crises to some extent, which accounts for the positive current account surplus being maintained.
The outlook for trade this year is much better. Russia is planning to expand both exports and imports in 2021 by a quarter and 10% respectively, according to a new forecast from the Ministry of Economic Development released on April 26.
According to the ministry’s outlook for Russia’s socio-economic development, outbound shipments of goods from the county are set to reach $411.7bn this year – a 23.9% increase compared to 2020, when exports stood at $332.2bn.
Russia's current account surplus reached $16.8bn in 1Q21, up from $13.1bn in 4Q20 but still below the $23bn registered a year earlier, according to the CBR's preliminary estimates, the central bank said on April 13.
The main reason for the y/y contraction was a weaker trade balance (a $24.4bn surplus in 1Q21 versus a $33.1bn surplus in 1Q20).
Exports fell 2% y/y to $87.5bn in 1Q21, driven by a decline in crude and oil product exports (down 20% y/y), which was mostly offset by an increase in exports of natural gas (up 44%) and non-oil and gas exports (up 12%).
Meanwhile, imports continued to recover in 1Q21, rising 12% y/y to $63.1bn, which is already eating into the current account surplus.
The bottom line is the economy has just suffered a big shock that knocked it out of kilter but it is already adjusting and should return to normal towards the end of this year or sometime in 2022. Where it goes after that comes down to how effective the government’s national project plans are and how much, if any, progress is made in reducing geopolitical tensions.