Category Archives: Russian GDP

28/7/17: 1H Marker: Russia on Track to a Weak Recovery in 2017


A quick top level update on the Russian economy from Bofit and Fitch Ratings.

Fitch Ratings today: “The recovery in Russia continues to gain traction. Domestic demand is responding to greater confidence in the economic policy framework, particularly as the inflation-targeting regime becomes entrenched. Activity in Turkey has bounced back rapidly from the coup attempt, with growth hitting 5% yoy in 1Q17. Momentum was supported by government incentives, including temporary fiscal measures and a jump in the Treasury commitment to the fund that backs lending to SMEs.”

Chart from BOFIT confirms the above:



Overall, the recovery is still on track, and remains gradual at best, posing elevated risks of reversals. For example, industrial output, having previously posted gains in January-May 2017, contracted in June 2017 on a quarterly basis. Still, industrial output was up 2% in 1H 2017 y/y.  Despite the U.S. and European sanctions, and generally adverse trends in the commodities sectors, mineral extraction sector expanded 3% y/y in 1H 2017 according to BOFIT. Oil output was up 2% and gas output was up 13%. The above figures imply that higher value added manufacturing posted sub-1% y/y growth in 1H 2017.

Agricultural production was basically flat - due, in part, to poor weather conditions, rising only 0.2% y/y in 1H 2017 and unlikely to post significant growth for FY2017 as crops reports are coming in relatively weak. That said, 2015-2016 saw record crops and very strong growth in agricultural output, so barring a major decline this year, agricultural sector activity will remain robust. Food production sector was the fourth highest growth sector over 2013- 1H 2017 period across the entire Russian economy, rising cumulative 17%  in 1H 2017 compared to 1H 2013 in real (inflation-adjusted) terms.

Construction sector posted a robust 4-5 percent expansion in 1H 2017 compered to 1H 2016, a rather positive sign of improving investment.

Pharmaceuticals (+36%), plastics (+25%), Chemical industry (+22%), paper industry (+19%) were the main sectors of positive growth over 2013-2017 period, according to data compiled by Rossstat.

Really good news is that household demand is now recovering. Retail sales by volume were up ca 1% y/y on a seasonally-adjusted basis and real disposable household income rose from the cycle lows to the levels last seen in May-June 2016. Bad news is that with income growth slower than retail sales and even slower than actual household consumption (which grew faster than domestic retail sales due to accelerating purchases abroad), Russian households are dipping into savings and credit to fund consumption increases.

We shall wait until July 2017 PMI figures come out over the next few days to see more current trends in the Russian economy, but overall all signs point to a moderate 1H and 3Q (ongoing) expansion in the economy, consistent with 1.2-1.3% real growth. The Economy Ministry recently reiterated its view that Russian GDP will expand at more than 2% rate in 2017. Achieving this will clearly require a large and accelerated cut in the Central Bank rate from current 9% to below 8%. Even with this, it is hard to see how above-2% growth can be achieved.

Agricultural and food production are quite significant variable in the growth equation. In 2016, Russia became number one exporter of wheat in the world, with annual production tipping 120 million tons - historical record. Bad weather conditions in 2017 mean that current expected output is estimated at around 17% below 2016 levels. Russia consumes 70 percent of its wheat output internally, so cuts to exports are likely to be on the magnitude of 1/2 or more in 2017. Domestically, food prices inflation is rising this year, threatening overall Central Bank target and putting pressure on CBR to stay out of cutting the key policy rate. Inflation rose in June to 4.4% - moderate by historical standards, but above 4% CBR target.

28/4/17: Russian Economy Update, Part 4: Aggregate Investment

The following is a transcript of my recent briefing on the Russian economy. 

This part (Part 4) covers outlook  for aggregate investment over 2017-2019. Part 1 covered general growth outlook (link here), part 2 covered two sectors of interest (link here) and part 3 concerned with monetary policy and the ruble (link here).

From the point of Russian economic growth, investment has been the weakest part of the overall ex-oil price dynamics in recent years.

Rosstat most recent data suggests that the recovery in seasonally adjusted total fixed investment continued in 1Q 2017, with positive growth in the aggregate now likely for the 2Q 2017:

  • 4Q16 investment was down about 1% from 2015
  • Total investment rose from 22.12% of GDP in 2015 to 25.63% in 2016, and is expected to moderate to 22.23% in 2017, before stabilsing around 22.9% in 2018-2019
    • The investment dynamics are, therefore, still weak going forward for a major recovery to take hold
    • However, 2017-2019 investment projections imply greater rate of investment in the economy compared to 2010-2014 average
  • However, last year fixed investment was down by 11% from 2014
    • This is primarily down to Rosstat revision of figures that deepened the drop in investment in 2015
  • About a quarter of total aggregate investment in Russia comes from small firms and the grey economy
    • Rosstat data suggests that such investment was roughly unchanged in 2016 compared to 2015
  • Other fixed investments, which are mostly investments of large and mid-sized companies, shrank by about 1% in 2016
    • This compounds the steep drops recorded in the previous three years (down 10% in 2015 alone), so the level of investment last year remained below that of the 2009 recession
    • Investments of large and mid-sized companies within oil & gas production sector rose robustly in 2016
      • This marked the third consecutive year of growth in the sector
      • Much of the increases was driven by LNG sub-sector investments which is associated (at current energy prices) with lower profit margins 
      • On the positive side, investments in LNG facilities helps diversify customer base for Russian gas exporters - a much-needed move, given the tightening of the energy markets in Europe
    • In contrast to LNG sub-sector, investment in oil refining continued to shrink, sharply, in 2016 for the second year in a row, 
    • Other manufacturing investment also recorded continued sharp declines
    • The same happened in the electricity sector
    • In contrast, following two years of contraction, investment in machinery and equipment stabilised for the mid- and large-sized corporates
    • Construction sector activity was down 4% y/y in 2016, marking third consecutive year of declines
      • Exacerbating declines in 2015, commercial and industrial buildings completions fell again in 2016
      • Apartments completions also fell y/y marking the first drop in housing completions since 2010

As the chart above illustrates:

  • The forecast if for 2017-2019 improvements in investment contribution to growth, with trend forecast to be above 2010-2014 average
  • However, historically over 2000-2016 period, investment has relatively weak/zero correlation (0.054) with overall real GDP growth, while investment relative contribution to growth (instrumented via investment/growth ratio) has negative correlation with growth even when we consider only periods of positive growth
  • This implies the need for structural rebalancing of investment toward supporting longer-term growth objectives in the economy, away from extraction sectors and building & construction

Going forward:

  • Russia's industrial / manufacturing production capacity is nearing full utilisation 
  • The economy is running close to full employment
  • Leading confidence indicators of business confidence are firming up
  • Corporate deleveraging has been pronounced and continues
  • Corporate profitability has improved 
  • Nonetheless, demand for corporate credit remains weak, primarily due to high cost of credit 
    • Most recent CBR signal is for loosening of monetary policy in 2017, with current rates expected to drop to 8.25-8.5 range by the end of 2017, down from 10% at the start of the year
  • Irrespective of the levels of interest rates, however, investment demand will continue to be subdued on foot of remaining weaknesses in structural growth and lack of reforms to improve business environment and institutions

Taken together, these factors imply that the recovery in fixed investment over 2017-2019 period is likely to be very slow, with investment recovery to pre-2015 levels only toward the end of forecast period.

Thematically, there is a significant investment gap remaining across a range of sectors with strong returns potential, including:

  • Food production, processing and associated SCM;
  • Transportation and logistics
  • Industrial machinery and equipment, especially in the areas of new technologies, including robotics
  • Chemicals
  • Pharmaceuticals and health technologies


28/4/17: Russia Cuts Headline Rate by 50bps


Bigger than forecast move by the Russian Central Bank to cut rates (down 50bps against consensus - and my own - forecast of 25bps cut) signals the CBR's comfort with inflationary expectations forward.


As noted in my regular advisory call on the Russian economy earlier this week (transcript here), inflation fell substantial in 1Q 2017, with current FY 2017 forecast sitting at around 4.3 percent. In line with this, CBR started cutting rates at the end of March, moving from 10% to 9.75% for its benchmark one-week auction rate. Today, the CBR lowered the rate to 9.25%.

According to CBR: "“Inflation is moving towards the target, inflation expectations are still declining and economic activity is recovering. Given the moderately tight monetary policy, the 4 percent inflation target will be achieved before the end of 2017 and will be maintained close to this level in 2018-2019.”

Median Bloomberg estimate is for the rate to fall to 8.5% by the end of the year. As I noted in the call: "I expect ...year-end (2017) rate target of around 8.25-8.5% if inflation remains on the path toward 4.3% annual rate, or 8.75-9% range if inflation stays around 4.6% annual rate".

The latest move helps the cause of the Federal budget (championed by the Economic Ministry) that needs to see ruble lose some of its attractiveness as a carry trade currency. In recent months, ruble has been the third best performing currency in the world, resulting in investors willing to borrow in foreign currencies to invest in rubles denominated assets. The net effect of this on the Russian economy is improving demand for imports and deteriorating budget dynamics (as Russian budget operates ruble-based expenditure, funded to a large extent by dollar and other forex revenues from exports of primary materials).

Nabiulina's move today, however, should not be interpreted as the CBR surrender to the Economic Ministry agenda of lowering ruble value. Instead, the rate cut is clearly in line with inflation targeting and also in line with previously stated CBR concerns about investment environment in Russia. Russian aggregate investment has been extremely weak in recent years, and economic recovery needs to involve a dramatic reversal of investment volumes to the upside, especially in areas of technology, R&D, and product and processes innovation. High interest rates tend to significantly reduce investment by making capital expenditure more expensive to fund.

27/4/17: Russian Economy Update, Part 3: Ruble and CBR Rates


The following is a transcript of my recent briefing on the Russian economy. 

This part (Part 3) covers outlook  for ruble and monetary policy for Russia over 2017-2019. Part 1 covered general growth outlook (link here) and part 2 covered two sectors of interest (link here).

Outlook for the ruble and CB rates

The ruble has appreciated this year about 6.6% against the US dollar, from 61.15 at the start of 2017 to just above 57.10 so far, and 3% against the euro from 64.0 to 62.06, compared to the start of 2016, ruble is up on the dollar ca 21.3% and on the euro some 22.4%

  • The ruble has been supported by the strengthening in the trade surplus in late 2016 into early 2017, and by improved foreign investment inflows
  • The ruble has been on an upward trend after hitting the bottom at the start of 2016
  • However, rate of appreciation has fallen in recent months, while volatility has risen
  • March real effective (trade-weighted) exchange rate (RER) was up nearly 30% y/y, as reported by BOFIT (see chart below)
  • As noted by some researchers (e.g. BOFIT), “in Russia, exchange rate shifts tend to pass through relatively quickly and strongly to consumer prices, so ruble strengthening tends to curb inflation” which, in turn, increases private and fiscal purchasing power
  • Another effect of the ruble appreciation is that it lowers government ruble-denominated tax revenue through direct link between energy exporting taxes (oil and gas) and oil prices, which are denominated in dollars 


For domestic businesses, a stronger ruble:

  • Reduces their price competitiveness with respect to imports, but also 
  • Lowers the cost of imported capital, technology and intermediates
    • Majority of Russian manufacturers are relatively highly dependent on such imports and have very limited non-ruble exports


  • Stronger ruble has very limited effect on the volume of Russian exports, primarily due to heavy bias in exports in favour of dollar-denominated energy and other primary materials
  • Ruble appreciation reduces the costs of foreign debt service for firms (a positive for larger firms and banks) and can lead, over time, to lower borrowing costs within Russian credit markets (a positive for all firms)


In line with the export-import effects discussed above:

  • Volume of Russian exports grew by over 2 % last year (primarily driven by oil and gas prices recovery and continued elevated volumes of Russian production of primary materials), plus by another (second consecutive) year of grain harvests 
    • In 2017, export growth should slow as both harvest and energy prices effects dissipate
    • Volume of exports of goods and services fell 1.87% in 2014, 0.41% in 2015 and 0.68% in 2016. Current forecasts suggest that the volume of exports will rise 4.5-4.6% in 2017
  • Volume of imports was much harder hit by the crisis
    • Volume of imports of goods and services fell 7.6% in 2014, followed by 25.0 drop in 2015 and 4.0% decline in 2016
    • Current forecasts suggest strong, but only partial recovery in demand for imports, with volumes expected to rise 7.0-7.2% in 2017
    • Key driver for imports growth will be the recovery in aggregate demand, plus appreciation of the ruble
    • Key downward pressure on imports will continue to come (as in 2016) from trade sanctions and from ongoing reforms of public and SOEs procurement rules and systems (more on this later)
  • Russia’s current account surplus contracted last year to less than 2% of GDP, printing at USD 22.2 billion, down from USD69 billion in 2015
    • 2017 projections of the current account surplus range widely, although no analyst / forecaster projects a negative print, despite expected increase in imports
    • IMF’s most current (April 2017) projection is for 2017 CA surplus of USD51.5 billion
    • This level of CA surpluses would stand above the 2014-2016 average (USD 49.6 billion), but below 2010-2013 average (USD67.4 billion) and lower than 2000-2007 average (USD 55.7 billion)
    • If IMF projection comes through, CA surplus will be supportive of significantly tighter fiscal deficit than currently projected by Moscow
    • As a percentage of GDP, CA surplus is expected to come in at 3.30% in 2017, slightly above 2014-2016 average of 3.19% and slightly below the 2010-2013 average of 3.42% of GDP


Inflation


  • With Russian inflation falling and current account surplus strengthening, 2017 will witness further pressures on the ruble to appreciate vis-à-vis the dollar and the euro
  • Russia’s annual inflation fell below 5% in 1Q 2017
  • The CB of Russia has kept a relatively tight monetary stance, holding the key rate at nearly 10% through most of 1Q, as consistent with the CBR strict targeting of the inflation rate (4% inflation target set by the end of 2017)
    • CBR dropped rate to 9.75% at the end of March, noting a faster-than-expected drop in inflation and a slight decline in inflation expectations 
  • Inflation fell from 4.6% in February to 4.5% in March and 4.1% as of mid-April
    • 12-month forecast now at 4.3%
    • CBR governor Nabiullina said the central bank does not share the finance ministry's view of a overvalued ruble, which is consistent with her projecting continued cautious stance on inflation
    • Finance Minister, Anton Siluanov, recently stated that the ruble is overvalued by 10–12%
    • Consistent with this, I expect a 25 bps cut at April 28th meeting of CBR Council and year-end (2017) rate target of around 8.25-8.5% if inflation remains on the path toward 4.3% annual rate, or 8.75-9% range if inflation stays around 4.6% annual rate