Thursday, April 27, 2017

26/4/17: Russian Economy Update, Part 1: Growth Outlook


The following is a transcript of my recent briefing on the Russian economy. This part (Part 1) covers general economic outlook for Russia over 2017-2019. 

Growth outlook and recovery analysis

Russia's Composite PMI = 56.7 in 1Q 2017, the strongest growth performance since 4Q 2006
  • In both Manufacturing and Services sectors, Russian economy has outperformed in 1Q 2017 global economic growth momentum
  • Russia is currently the strongest BRIC economy for the fourth consecutive quarter
  • Russian Manufacturing PMIs averaged 53.2 in 1Q 2017, unchanged on 4Q 2016 and up on 49.1 average for 1Q 2016  
  • 3rd consecutive quarterly PMI reading for Manufacturing that sits above 50.0 marker
  • Russia Services PMI for 1Q 2017 came in at a blistering pace of 56.8, up on already significant growth in 4Q 2016 at 54.6 and significantly above 1Q 2016 reading of 50
  • All in, this was the fourth consecutive quarter of Services PMIs above 50.0
  • Energy and commodities prices
  • Lack of structural reforms within Russia
  • Key support was higher output in natural gas and the broader extractive sector (+ more than 1% y/y in 1Q 2017)
  • Seasonally adjusted manufacturing output recovered in March, but still down almost 1 % y/y.
  • Growth will be led by private domestic demand which also stimulates imports; and
  • Firmer oil prices.
  • The latest forecasts of the CBR and Econ Ministry expect GDP increasing by 1–2% pa over 2017–2020
  • The forecasts assume the annual price of Urals crude to average USD40–50 a barrel
  • Key drivers for growth assumed to be household consumption and fixed investment (both expected to rise 2–3 % pa)
  • In contrast, imports are expected to outpace in growth terms exports, with current account surplus falling, although remaining in the ‘black’ at USD6-8 billion range
  • The financial account deficit (excluding currency reserves) is expected to be within the range of USD6–10 billion annually
  • GDP growth will be expected to fall to around 1% if Urals price falls to USD35 a barrel and zero growth will kick in at the USD25 per barrel. This astonishingly low level for zero growth oil price is a testament to aggressive deleveraging of fiscal and private sector balancesheets during the 2014-2016 recession
  • Approaching presidential elections of 2018 may put pressures on Moscow to increase public spending. While this would be running contrary to current budgetary plans, it will provide a short run boost to growth. However, such a boost would come at the expense of reducing Russian fiscal policy resilience in the longer term
  • Continued tensions in Syria can spillover into a [limited] conflict involving Russia and either Turkey or the U.S.-led coalition or even the U.S. forces. Such an event would trigger massive spike in geopolitical uncertainties and will undoubtedly severely disrupt markets and investment flows, as well as global trade flows
  • Emerging tensions (with growing Russian involvement) around North Korea, where Russian traditional role of being a distant secondary guarantor to China is gradually moving up the scale, just as China appears to be more accommodative of he Western demands
  • Currently stable, but nonetheless risky and ambiguous outlook in Eastern Ukraine, with continued risk spillovers (albeit much more subdued) to Easter European politics
  • Still evolving (and for now benign) re-alignment of powers in Central Asia that can spiral out of control 
  • Emerging and occasionally visible (albeit relatively benign) policy confrontations with Belarus
  • Potential for re-igniting of the Nagorno-Karabakh conflict
  • Internal protests focusing on lack of meaningful anti-corruption reforms, especially set against the backdrop of continued, but abating, internal power struggles, involving some close past allies of the Kremlin – struggles that occasionally involve accusations of corruption and graft
  • Internal issues relating to human rights abuses, especially and most recently, highly visible and robust accusations of suppression of LGBT minorities in Chechnya
Another factor is import recovery: 
  • Imports recovery can run stronger than forecast, hitting largely modest in scale, although rather successful in the short run in some sectors, policies aimed at import substitution
  • This stability suits both the West and Russia, where the sanctions are supporting domestic producer
  • Given these dynamics, there is no pressure for Russia to abandon its current trade sanctions stance, despite the public statements by the Government to the contrary
  • This is exemplified by the lack of changes in trade relations with Turkey post-normalisation of relations, and especially by March 2017 changes to Turkish tariffs on Russian exports of grains (corn and wheat)
  • In mid-March this year, Turkey imposed 130% import tariff on imports of certain food items from Russia, including wheat and corn imports
  • Although Turkey is one of the largest export markets for wheat and corn for Russian producers (Russian exports last year valued at roughly USD550 million), Russia did not attempt to trade food tariffs for its own import bans on Turkish products, including fruit and vegetables
  • A year-old ban is beneficial to both Turkey and Russia from geopolitical perspective, even though it fuels higher inflation in Russia so much so that instead of relaxing its own prohibitions, Russia expanded the imports ban for Turkish goods to a wider range of plant materials
Overall, in the long run, achieving faster sustainable and resilient growth will require deeper structural reforms. These include: improving the business environment and institutional structures, accelerating modernization of the capital base and adoption of new technologies, raising R&D and technological capital investments, accelerating modernization of management systems, and significantly reducing the state share of the economy, including the extent of the State Owned Enterprises (SOEs) dominance across a range of sectors
  • Implementation of such reforms will support private investment and raise productivity growth rates for both TFP and labour productivity
  • Structural reforms would also reduce economy’s dependence on extraction industries and, if targeted toward processing sectors, can significantly improve value added component of these sectors, helping to de-link economic growth from energy prices and commodities prices in general
  • While the Economic Ministry is now tasked with drafting a set of economic policy reforms to cover the period through 2035, to-date, we have no indications which reforms are being considered. We are unlikely to see any official drafts prior to the onset of the 2018 Presidential election campaigns, and the impact of any such reforms is unlikely to materialise before 2020.



Despite some robust numbers, the economy remains relatively exposed to the downside risks, including


Somewhat deflating the leading indicators, Rosstat reported that seasonally and workday-adjusted industrial output recovered in March on a relatively weaker February


After a two years-long recession, real GDP growth should be + 1.3-1.6% this year (mid-point 1.4-1.5%)


Continued sluggish performance in 2017-2019 is due to the economy already running near full capacity and lacking deeper structural reforms to boost long term growth potential. Thus, my expectation is for real GDP growth to remain around 1.4-1.5% mark over 2017-2019

Risks:

Biggest short-term risk (upside and downside): the price of oil


A second risk factor involves geopolitical and political triggers that could hit Russian growth outlook hard, either directly or indirectly via increased political instability and adverse investors’ and entrepreneurs’ perceptions


Relating to both, imports substitution drive and the issue of geopolitical risks, the current sanctions regime (for both Russian sanctions vis-a-vis Western producers and Western sanctions vis-a-vis Russian economy) appears to be stable






Stay tuned for more transcripts

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