12/8/19: Russian Markets Risk Assessments 2Q 2019

Euromoney on Russian markets risk performance in 2Q 2019 with comments from myself and others: https://www.euromoney.com/article/b1g9cypjfm97xh/ebri-q2-results-putin-joins-the-party-as-russia-steps-up-a-gear.

13/7/19: Russian v European Dependency Ratios: 1950-2100

Doing some numbers crunching on a different project, I just came across this interesting database from the UN showing population projections through 2100. One interesting aspect of this data is the forecasts/projections for the dependency ratio - basically, a number of working age population per 100 people of non-working age.

There are caveats attached to the analysis of this data, including the changes in the duration of the working age (over the years, younger age dependency has moved toward 24 years from 19 years due to extended period spent in education, while for older age dependency, the mark has been moving from 64 years to 69 years as the last year in working age group). These caveats aside, here is a really eye-opening chart:

We consistently hear about the demographic catastrophe that has visited Russia since 1990-1991 collapse of the USSR. We are also constantly hearing the claim that the Russian society is demographically so challenged, it is running out of people. The chart above shows that, actually, that is not exactly true. Russia has been showing pretty decent readings on population dependency ratio compared to its peers ever since the mid-1970s. More so, through 2020, the estimates from the UN suggest that Russia is performing better than its peers in Europe in terms of overall dependency. This is expected to change - to the detriment of the Russian society and economy - in 2030-2040, but thereafter, Russia is expected to once again perform better than overall Europe.

Similar picture arises when one looks at more modern definition of dependency age ranges:

This data suggests that the popular narrative about the relative decline of Russian population dynamics compared to other European states is at least highly imperfect.

14/5/19: Agent Trumpovich Fails to Deliver... Again...

In the months following China's retaliatory introduction of tariffs on U.S. soybean exports, both traditional and social media were abuzz with the screeching sound of 'analysts' claiming that Trump Administration trade war with China is a boon to Vladimir Putin's Russian economy.

Behold this from the

• Venerable CFR (albeit intellectually vulnerable): https://www.cfr.org/blog/trumps-trade-war-china-makes-russia-great-again and 
• WSJ: https://www.wsj.com/articles/russia-exploits-u-s-china-trade-tensions-to-sell-more-soybeans-11550745001 and 
• Bloomberg: https://www.bloomberg.com/news/articles/2018-05-17/china-buys-record-amount-of-russian-soy-as-it-shuns-u-s-growers and more Bloomberg https://www.bloomberg.com/news/articles/2018-11-07/china-turns-to-russia-in-search-to-replace-u-s-soybeans and 
• And a good collection of sources across the media here: https://www.dailykos.com/stories/2019/1/7/1824363/-Is-Russia-profiting-from-Trump-tariffs-on-China and
• The Hill: https://thehill.com/blogs/blog-briefing-room/388178-china-buys-record-amount-of-russian-soybeans-amid-halt-on-us-imports and
• A more somber and sober analysis from Carnegie Moscow Center: https://carnegie.ru/commentary/77443 and so on

 Alas, given that Russia supplies less than 1% of Chinese imports of soybeans, it might take a major Congressional investigation and a few PoliSci 'Russia experts' to get serious imaginary beef on the Trump Administration's alleged Russia-benefiting policies. Here is the data from ... well... Bloomberg, via Global macro Monitor (https://global-macro-monitor.com/2019/05/14/who-pays-the-tariffs/) showing that Russia is hardly a major winner from Trump's Trade Wars when it comes to soybeans:

Let's put the thin blue line of 'Russia winning, thanks to Trump' through some analysis:

1. There is no dramatic massive rise in Russian exports of soybeans to China in 2018, and some dip in 2019.
2. 2018 increase - moderate - came in after 2017 moderate decrease.
3. Russian exports of soybeans to China have been rising-falling-rising very gently since 2013.

Friendly Canada quietly dramatically increased its sales of soybeans to China in the wake of the Trade War, although its exports were rising since 2015. Argentina also acted as a substitute supplier to China during the Trade War period so far, but that increase came on foot of massive collapse in exports to China since the start of this decade. In fact, while the U.S. share of Chinese imports of soybeans fell 30 percentage points, Brazil's share rose 35 percentage points. Trump's Administration-triggered Trade War with China has helped Brazil first, followed by Canada and Argentina. Russia hardly featured in this dastardly plot to serve Vladimir Putin's interests by Agent Trumpovsky.

Sorry, my dear friends in American mass media. You've faked another factoid.

10/4/19: Russian Foreign Exchange Reserves and External Debt

As recently posted by me on Twitter, here are three charts showing the evolution of Russian foreign reserves and external debt:

Remember the incessant meme in the Western media about Russia eminently in danger of running out of sovereign wealth funds back at the start of the Western sanctions in late 2014? Well, the chart above puts that to rest. It turns out, Russia did not run out of the reserves, and instead quite prudentially used funds available to carefully support some economic adjustments (especially in agriculture and food sector), while simultaneously balancing out its fiscal deficits.

Do note that the reserves above exclude over USD 91 billion worth of Gold that Russia holds and continues to buy at rising clips.

The result of the prudentially balanced management of the reserves and the economy was deleveraging out of debt (a lot of this was done via restructuring of intracompany loans and affiliated enterprises refinancing), with a reduction in the external debt (chart below), without use of sovereign funds:

As of current, Russian foreign exchange reserves ex-gold are more than sufficient to cover the entirety of the country public and private sectors external debts.

If the above chart is not dramatic enough, here is a contrasting experience over the same years for the U.S. economy:

Nothing that CNN and the rest of the Western media pack ever managed to capture.

5/12/18: BRIC PMIs for November: A Moderate Pick Up in Growth

BRIC PMIs are in, although I am still waiting for Global Composite PMI report to update quarterly series - so stay tuned for more later), and the first thing that is worth noting is that, based on monthly data:

1. Brazil growth momentum has accelerated somewhat, in November (103.2) compared to October (101.0), although both readings are consistent with weak growth (zero growth in my series is set at 100). November reading is the highest in 9 months, although statistically, it is comparable to growth recorded in March, April and October this year).
2. Russia growth momentum de-accelerated from 111.6 in October to 110 in November, although, again, statistically, the two numbers are not significantly different from each other. November was the second highest reading in nine months, and the third highest reading in 2018.
3. China growth has improved from 101.0 in October to 103.8 in November. Despite this, last two months remain the lowest since April this year. From statistical significance point of view, October reading was distinctly below November reading, but November reading was consistent with August-September.
4. India posted substantial rise in growth conditions, from already robust 106.0 in October to a 24-months high of 109.2. This reading is statistically above all other period readings, with exception of being tied with July 2018 level of 108.2.

Thus, overall, BRIC Composite growth indicator rose from 102.8 in October to 105.3 in November, the highest in 10 months. BRIC ex-Russia reading was at 105.4 in November, compared to 102.7 in October. November reading for ex-Russia BRIC growth indicator was also the highest since February 2013.

Couple of charts to illustrate monthly data trends:

While the chart above clearly shows that Russia supports BRIC block growth momentum to the upside, this effect is somewhat moderating due to both ex-Russia BRIC growth momentum rising and Russia growth momentum slowing slightly.

The chart below highlights BRIC estimated growth contribution to global growth momentum:

Overall, as the chart above shows, BRIC economies contribution to global growth momentum has accelerated in November, but remains bound-range within the longer-term trend of weaker BRIC growth for the last five and a half years.

As noted above, I will be posting more on BRIC growth dynamics signalled by the PMIs once we have Global Composite PMIs published by Markit. Stay tuned.

9/10/18: Russian Growth, 'Putin;'s Call' and the Middle Income Growth Trap

Quick chart showing relative underperformance in the Russian economy in recent years, incorporating latest 2018 forecasts:

The above clearly shows that since 2013, Russian economic growth has statistically underperformed the 'Putin's Call' levels of growth, defined as rates of growth in real GDP achieved during the period after the immediate post-1998 crisis recovery and into 2012, omitting the period of the Global Great Recession impact of 2009. 'Putin's Call' rate of growth is set at around 6% pa, with the 95% confidence interval around this at [2.83, 9.15].

The lower bound of this confidence interval is important. While no one can expect the Russian economy to grow at the 'Putin's Call' levels of 6%, let alone the upper bound levels of 9.15%, Russian economy does require longer-term average growth rates at around 2.8-3%, slightly above the lower bound of the 'Putin's Call'. As of consensus forecasts forward, the economy is expected to expand at around 1.5-1.8 percent pa over 2018-2023, which implies significant cumulative underperformance relative to medium term growth requirement.

Fiscally, structurally lower rates of growth are sustainable for Russia, but socio-politically, Russia needs serious acceleration in its growth rates to offset adverse demographic pressures (rising pensions dependencies) and global economic pressures (much faster growth rates in the Emerging Markets). The lower bound of the 'Putin's Call' and Russian economy's sub-par performance relative to it is a clear illustration of the Middle Income Growth Trap that Russia has entered ca 2010 post-GFC and the Great Recession (see https://www.global-economic-symposium.org/knowledgebase/escaping-the-middle-income-trap for the definition and here http://trueeconomics.blogspot.com/2015/04/18415-escaping-middle-income-trap.html for discussion. My earlier post on the subject for Russia here: http://trueeconomics.blogspot.com/2014/01/2212014-russia-and-middle-income-trap.html).

24/8/18: Moscow's Fiscal Resilience in the Headwinds

Back in September 2017, Fitch (with Russia rating BBB-) estimated that the U.S. sanctions were costing Russia ‘one notch’ in terms of sovereign ratings, with ex-sanctions risk conditions for the Russian sovereign debt at BBB. Last week, Fitch retained long term debt rating for Russia at BBB- with positive outlook, noting the Russian economy’s relative resilience to sanctions.

Budgetary Resilience

Per Fitch, and confirmed by the Russian Finance Ministry analysis, Russia is looking at recording a budgetary surplus in 2018:

Fitch analysis projects the budget surplus to average 0.1% of GDP in 2018 and 0.3% in 2019, from deficits of 1.0% and 0.5%, respectively. This, alongside Russia’s strong performance in monetary policy have been noted by Fitch as core markers of the Russian economy’s resilience to external shocks, including the sanctions acceleration announced back in April 2018.

Looking forward, President Putin's RUB 8.0 trillion (ca USD127 bn) new spending priorities announced back in May will amount to roughly 7.0% of GDP over the next six years. These funds will go to support higher wages and pensions for the recipients of Federal and Local funding, as well as public investment uplift in education and core infrastructure. Per Fitch: “Due to a stronger fiscal position and a robust oil price outlook, the planned measures will not threaten the country's future budget surpluses. The government will also increase available funds by enforcing a tax overhaul and increasing [domestic] borrowing.” (see Chart below)

Policies Resilience

Resilience-inducing policies, when it comes to macroeconomic management of risks arising from sanctions regimes face by Russia include:

• Increase the Value-added Tax (VAT) rate from 18.0% to 20.0% starting in 2019, which will provide (based on Moscow estimates) ca RUB 600bn (USD 9.5bn) per annum. Social and aggregate demand impacts of VAT increases were mitigated by keeping 10% rate on certain foods, children’s goods, printed publications and pharmaceuticals, or roughly 25% of all goods and services. Some transport services will continue benefiting from 0% VAT rate.
• A phased reduction of the export duty on oil and petroleum products from 30.0% to zero and a concurrent increase in the tax on the extraction of minerals by 2024
• The combined tax rate on wages for mandatory social contributions will remain at 22%. 
• The tax on the physical capital of companies (capped at 2%), will no longer apply to moveable assets (the tax will remain for fixed capital, e.g. for buildings).
• Russia will also establish special administrative zones on Russky Island next to Vladivostok and on Oktyabrsky Island, which is part of the Kaliningrad enclave. Both will act as offshore centres where foreign-registered firms owned by Russian nationals can “redomicile” their assets. Tax advantages granted in these zones will cover taxes on profits, dividend income and different types of property.
• A recent increase in the pensionable age (men from 60 to 65, women from 55 to 63) system will lower the burden of an ageing population and a shrinking labour force, “propping up the state Pension Fund's income”

Impact on Debt Markets

Net outrun is that even faced with escalating sanctions, and having unveiled a rather sizeable macro stimulus program, Moscow's finances remain brutally healthy. Fitch research foresees “a contained uptick in government debt levels over the coming years, with the debt burden rising from 17.4% of GDP in 2017 (IMF statistics) to about 18.3% GDP by 2020.” As share of Russian debt held by external funders continues to decline, these forecasts imply increased sustainability of overall debt levels.

In it’s recent assessment of the potential impact of the ‘Super-sanctions’ (The Defending American Security from Kremlin Aggression Act of 2018 (DASKAA)) planned by Washington, the worst case scenario of all U.S.-affiliated investors dumping Russian bonds implies 8-10% decline in foreign holdings of Russian Sovereign debt, which will likely raise yields on long-dated Russian Ruble-denominated debt by 0.5-0.8 percentage points. Based on August 6 analysis from Oxford Economics, Russia will have no trouble replacing exiting Western debt holders with Ruble-denominated debt issuance.

Key Weaknesses Elsewhere

The key weakness for Russia is in structurally lower economic growth that set on around 2010-2011 and is likely to persist into 2022-2023 period (see IMF projections below):

Russian GDP growth rose from 1.3% y/y in the 1Q 2018 to 1.8% in the 2Q, with 1H growth reading 1.6% y/y. The uptick was led by faster industrial output growth (rising almost 4% y/y in 2Q) and manufacturing (up 4.6% y/y in 2Q). These are preliminary estimates, subject to revisions and, based on the recent past revisions, it is quite likely that we will see higher growth rates in final reading. 1H 2018 fixed investment rose 3% y/y. Real wages rose 8% y/y in real terms, but household disposable real income was up only 2% at the end of 2Q 2018 due to slower growth in the 'grey economy' and in non-wage income. Despite the rising household credit uptake (up 19% y/y at the end of 2Q 2018), retail sales were up only 2.5%, broadly in-line with real income growth.

All of these trends are consistent with what we have been observing in recent years and are indicative of the structurally weaker economic conditions prevailing in the wake of the post-GFC economic recession and the energy prices shocks of 2014-2017.

22/8/18: Emerging Markets Risks and International Reserves

Emerging markets are at the point of risk contagion these days, with a potential spillover into advanced economies. This brings us back to the memories of the past EM crises, such as the currencies crises of the late 1990s in the year (and month) that marks the 20th anniversary of Russian Sovereign Default.

Here is an interesting chart that shows just how far Russia has traveled from the past in terms of its macroeconomic management:

What the chart omits, of course, is a simple fact: of all these economies, Russia is the only one that (rightly or wrongly or both) is trading under severe financial and economic sanctions imposed by its major trading and investment partners. Which makes this performance even more impressive.

When it comes to a 'higher altitude' view of the Russian economy within historical and current geopolitical perspective, which is discussed here: http://trueeconomics.blogspot.com/2018/01/6118-spent-putins-call-means-growing.html.

6/7/18: Central Bank of Russia Injects Capital in Three Lenders, Continues Sector Restrcturing

Reuters reported (https://www.reuters.com/article/russia-banks/russian-c-bank-says-to-deposit-2-8-bln-at-otkritie-trust-and-rost-idUSR4N1TT00E) on Central Bank of Russia (CBR) setting up a 'bad bank' to resolve non-performing assets in three medium- large-sized banks that CBR controls. In 2016, the CBR took over control over three medium- large-sized banks, Otkritie, B&N Bank and Promsvyazbank. Last month, the CBR announced an injection of RB 42.7 billion of funds to recapitalise Otkritie with funds earmarked to cover losses in Otkritie's pension fund.  Most Bank received RB37.1 billion in new capital. The CBR also deposited RB 174.2 billion (USD2.78 billion) in three banks (RB63.3 billion of which went to Otkritie) on a 3-5 years termed deposit basis.

The funds will be used to reorganise banks operations and shift non-performing and high risk assets to a Trust Bank-based 'bad bank' which will operate as an asset management company.

After divesting bad loans, Otkritie is expected to be sold back to private investors.

CBR's total exposure to troubled banks is now at RB 227 billion (USD3.5 billion), with CBR having spent RB 760 billion (USD 12 billion) on its overall campaign to recapitalise troubled lenders. CBR holds RB 1.3 trillion (USD30 billion) on deposit with lenders it controls.

As BOFIT note: "...the CBR to date has used over 45 billion USD (about 3% of 2017 GDP) in supporting the three banks that it took over last year. Some of this amount, however, should be recovered when assets in banks acquired by the CBR are sold off as well as in the planned privatisations of the banks." At the beginning of June, Otkritie stated that the bank aims to float a 15-20% stake in 2021. The bank said t's target for pricing will be "at least 1.3 times the capital the bank has at the end of 2020". Otkritie targets return on equity of 18% in 2020, and so far, in the first five months of 2018, the bank made RB 5.4 billion in net profit, per CBR.

Otkritie ranked sixth largest bank in Central and Eastern Europe by capitalisation by The Banker in 2017 prior to nationalisation. Following nationalisation, Otkritie ranked 16th in CEE, having lost some USD2.4 billion in capital.

Another lender, Sovetsky bank from Saint Petersburg lost its license on July 3. The bank gas been in trouble since February 2012 when the CBR approved its first plans for restructuring. In February 2018, the bank was in a "temporary administration" through the Banking Sector Consolidation Fund. The latest rumours suggest that Sovetsky deposits and loans assets will retransferred to another lender.  Sovetsky was under original administration by another lender, Tatfondbank, from March 2016, until Tatfondbank collapsed in March 2017 (official CBR statement https://www.cbr.ru/eng/press/PR/?file=03032017_105120eng2017-03-03T10_47_12.htm, and see this account of criminal activity at the Tatfondbank: https://en.crimerussia.com/financialcrimes/collapse-of-tatfondbank-robert-musin-siphoned-off-funds-from-state-owned-bank/ and https://en.crimerussia.com/financialcrimes/tatfondbank-officially-collapses/). Tatfondbank's tangible connection to Ireland's IFSC was covered here: https://realnoevremya.com/articles/1292-tatfondbank-raised-60-million-via-obscure-irish-company-just-before-collapse.

Overall, CBR have done as good a job of trying to clean up Russian banking sector mess, as feasible, with criminal proceedings underway against a range of former investors and executives. The cost of the CBR-led resolution and restructuring actions has been rather hefty, but the overall outrun has been some moderate strengthening of the sector, hampered by the tough trading conditions for Russian banking sector as a whole. A range of U.S. and European sanctions against Russian financial institutions and, more importantly, constant threat of more sanctions to come have led to higher funding costs, more acute risks profiles, lack of international assets diversification, and even payments problems, all of which reduce the banking sector ability to recover low quality and non-performing assets. The CBR has zero control over these factors.

Russia currently has 6 out of top 10 banks in CEE, according to The Banker rankings:

Source: http://www.thebanker.com/Banker-Data/Banker-Rankings/Top-1000-World-Banks-Russian-banks-mixed-fortunes-influence-CEE-ranking?ct=true.

These banks are systemic to the Russian economy, and only the U.S. sabre rattling is holding them back from being systemic in the broader CEE region. This is a shame, because opening up a banking channel to Russian economy greater integration into the global financial flows is a much more important bet on the future of democratisation and normalisation in Russia than any sanctions Washington can dream up.
 


As an aside, new developments in the now infamous Danske Bank case of laundering 'blood money' from Russia, relating to the Magnitzky case were reported this week in the EUObserver: https://euobserver.com/foreign/142286.

17/5/18" Timeline of Russian Growth 1992-2023 (forecasts)

I have annotated the timeline of Russia's GDP per capita from 1992 through forecast (IMF) out to 2023 with the inflation dynamics and presidential terms. For comparison, BRICS ex-Russia GDP per capita dynamics are presented as well.

Draw any conclusions you want:

6/1/18: Spent 'Putin's Call' Means Growing Pressure for Reforms

Some interesting new trends emerging in Russian public opinion as the next Presidential election approaches. State-linked Russian

Academy of Sciences publishes relatively regular polls of public opinion that look into voters' preferences, including preferences for either "significant changes" in policy course in Russia or "stability" of the present course.

Here is the latest data:

Some 'Russia analysts' in the Western media have been quick to interpret these numbers as a sign of rising anti-Putin sentiment. Things are more subtle than that.

There is, indeed, a rather remarkable shift in public preferences in favor of "significant changes". Which can be attributed to the younger demographic who are predominantly supportive of reforms over their preferences for "stability". This is good. However, we do not know which changes the voters would prefer. Another potential driver for this shift is the ongoing weak recovery in the Russian economy from the 2014-2016 crisis - a recovery that fades to the background voters' previous concerns with the Russian State's geopolitical standing in the international arena (key pillar of Putin's third presidency) and the movement to the forefront of economic concerns (key pillar of Medvedev's interim presidency and, so far, an apparent area of significant interest for Putin looking forward to his fourth term).

These gel well with other public opinion data.

Here is Pew data from earlier 2017 showing that Russian voters nascent sentiment in favor of reforms may not be incongruent with their simultaneously continued support for Putin's leadership:

When one looks at the same polls data on core areas of domestic policy that the Russians feel more concerned about, these are: corruption (#1 priority), economy (#2 priority) and civil society (#3 priority). In other words, more liberal issues are ranked toward lower priority than other reforms (economy and corruption, which are both seen by the majority of the Russians as the domain of State power, not liberal order reforms). Civil society is an outlier to this. And an interesting one. Perhaps, indicative of the aforementioned demographics shift. But, perhaps, also indicative of the dire lack of alternatives to Putin-centric political spectrum in Russia. Again, whether the voters actually see Putin as a barrier to achieving these reforms is the key unknown.

Worse, not a single one area of domestic policies has plurality disapproval rating.

Somewhat confusing, Putin's personal approval ratings - for specific areas of policy - have been deteriorating over time:

This is significant, because traditionally, Russians view Presidential office as distinct from the Government (the 'good Tzar, bad Boyars' heuristic) and the tendency to view domestic objectives as key priorities or targets for disapproval would normally be reflected in falling support for the Government, not the President. This time around, things appear to be different: Russian voters may not be blaming Putin's Presidency outright, but their confidence in the President's ability to manage the policy areas of their key concerns is deteriorating.

The 'Putin call' - past bet on forward growth to sustain power centralization - is now out of money:

Weakest points are: corruption and economy. And these are the toughest nuts to crack for Putin's regime because it rests strong Federalization drive of 1999-present on the foundations of balancing the interests of the rent-seekers surrounding it (aka, on corruption around it, a trade-off between loyalty to the Federal State and the President, in return for access to wealth and the ability to offshore this wealth to the likes of London, a world's capital for grey and black Russian money).  Ironically, Western sanctions and broader policies toward Russia are actively constraining the scope and the feasibility of all reforms - be it reforms of the economy or civil society, anti-corruption measures or political liberalization.

Note: an interesting read on the changes in the Kremlin-backing 'opposition' is also afoot, as exemplified by the new leadership emerging within the Russian Communist Party (read this well-researched and unbiased view, a rarity for WaPo, via David Filipov: https://t.co/8OfqCZzdOY).

Taken together, the above suggests that Putin needs some quick wins on the hardest-to-tackle issues: corruption and economy, if he were to address the pivot in voters' preferences for change. The 'if' bit in this statement reflects severe uncertainty and some ambiguity. But assuming Putin does opt to react to changes in the public opinion, we can expect two policy-related moves in months ahead:

1. Corruption: we are likely to see public acceleration in prosecution of smaller/lower-end bureaucrats, deflecting attention from the top brass surrounding the centre. Alongside promotion of some fresh names to regional leadership posts (governors etc), already ongoing, we are also likely to see some additional consolidation of the oligarchic power in the economy. There will be no cardinal wide-spread change in power ministries and within the Deep State institutions. But, even the beginnings of such acceleration in cleaning up mid-tier of the top echelons of power will prompt hysterical comparatives to Stalin's purges in the Western media.              
2. Economy: we are also likely to see a new 'Program for 2030' aiming to 'modernize' the economy, deepen capital investment, on-shore funds stashed away in Cyprus, Austria, Germany, the Baltics, the UK and elsewhere. Note, the list of Russian-preferred offshore havens - it is littered with the countries currently beating the Russophobic drums, which will make such on-shoring double-palatable for Kremlin, and more acceptable to the Russian power circles. The process of on-shoring has already began, even if only in the more public and more benign context (https://www.bloomberg.com/news/articles/2017-12-21/russia-to-issue-fx-bonds-to-help-repatriate-cash-putin-says). The Program is also likely to see some reforms of the tax code (potentially, raising 13% flat tax rate and tweaking capital gains tax regime). A deeper push can come on enforcement and compliance side, with Moscow finally attempting to shift tax enforcement away from its current, highly arbitrary and politicized, practices. Putin is acutely aware of the fact that Russian public investment sits too low, while ammortization and depreciation are accelerating. We can expect some announcements on this front before the election, and, assuming economic growth becomes a new priority of the fourth term, an acceleration in State funding for infrastructure projects. This time around, new funding will have to flow to key public services - health and education - and not into large-scale transport projects, .e.g Crimean and Vladivostok bridges. Russia is well-positioned to support these initiatives through some monetary policy accommodation, with current inflationary dynamics implying that the current 7.75% benchmark CBR rate can be lowered to around 6% mark (this process is also ongoing). beyond fiscal and monetary aspects of reforms, Russia can opt to move more aggressively with revamping its Byzantine system of standards and certification systems to align them more closely to the best practices (in particular, those prevalent in the EU). Such alignment can support, over time, diversification of Russian exports to Europe and to other regions, where european standards effectively goldplate local ones.

What we are not likely to see, in the short term, is unfortunately what is needed as much as the above reforms: changes in legal and enforcement regimes. Poor legal enforcement and outdated, politicized and often corrupt judicial system are stifling entrepreneurship, enterprise scaling, international and domestic investment and, equally importantly, development of the civil society. It also weakens the Federal State by presenting a bargain in which local loyalty to Moscow is secured by allocating local authorities power to shadow justice systems. This bargain undermines voters' trust and reduces efficiency of resources flowing across regions and from Moscow.

As a number of more astute observers, e.g. Leonid Bershidsky (@Bershidsky) and David Filipov (@davidfilipov) have implied/stated in the past, promising reforms after nearly two decades in power will be a hard sell proposition for Putin. Which means Programs alone won't cut it. Kremlin will need to deliver and deliver fast, in order to break away from the 'Putin 3' track:

3/12/17: Russian and BRICS debt dynamics since 2012

Back in 2014, Russia entered a period of recessionary economic dynamics, coupled with the diminishing access to foreign debt markets. Ever since, I occasionally wrote about the positive impact of the economy's deleveraging from debt. Here is the latest evidence from the BIS on the subject, positing Russia in comparative to the rest of the BRICS economies:

In absolute terms, Russian deleveraging has been absolutely dramatic. Since 2014, the total amounts of debt outstanding against Russia have shrunk more than 50 percent. The deleveraging stage in the Russian economy actually started in 1Q 2014 (before Western sanctions) and the deleveraging dynamics have been the sharpest during 2014 (before the bulk of Western sanctions). This suggests that the two major drivers for deleveraging have been: economic growth slowdown (2013-1Q 2014) and economic recession (H2 2014-2016), plus devaluation of the ruble in late 2014 - early 2015.

The last chart on the right shows that deleveraging has impacted all BRICS (with exception of South Africa) starting in 2H 2013 - 1H 2014 (except for China, where deleveraging only lasted between 2H 2015 and through the end of 2016, although deleveraging was very sharp during that brief period).

In other words, there is very little evidence that any aspect of Russian debt dynamics had anything to do with the Western sanctions, and all the evidence to support the proposition that the deleveraging is organic to an economy going through the structural growth slowdown period.

20/11/17: Russian economic growth slides. Structural issues loom large

An interesting view of the Russian economy (as usual) from Leonid Bershidsky: https://www.bloomberg.com/view/articles/2017-11-14/russia-s-economy-is-growing-with-borrowed-money

Credit, is not a sustainable source for growth in Russia, especially as the Russian households’ leverage capacity (underpinned by expected future wages) is not exactly in rude health. A recent study from the Russian government's own Analytical Center found that roughly 17% of the working population, or about 12.1 million Russians, can be classified as the working poor - those earning less than enough to cover the minimum purchases required to sustain a family. The study also found that majority of the working poor in Russia rely on microcredit, short term payday loans and/or traditional bank or credit card borrowing to meet daily necessary expenditure.

Low wages, rising credit

Rosstat data confirms the findings. Roughly 7% of all wage-earners are paid wages below the monthly subsistence minimum. Over 17% of people working in the education sector or various municipal services earn below-subsistence wages.

Moscow has set a target of 2019 for raising wages to the legally required subsistence minimum level, with minimum wages hiked in 2016 and mid-2017. Current minimum wage is set at Rub 7,000 per month (roughly EUR115) which is only about 60% of the average subsistence minimum levels and close to 20% of the average monthly wage, according to BOFIT report. This is about half the level (of 40%) ratio of the minimum wage to the average wage across the OECD countries.

Accumulation of household debt, therefore, is hardly the good news for the economy in the long run, as debt affordability is only sustained today by the falling interest rates (cost of carry), and is not consistent with the wages dynamics, and wages levels, especially at the lower end of earnings.

Meanwhile, the latest data on economic growth came in at a disappointing print. Russian GDP growth fell from 2.5% y/y in 2Q 2017 to 1.8% in 3Q 2016, driven down by slower expansion in both exports and domestic investment. Over the period from January through September, Russian economy grew by roughly 1.6% y/y - well below the official forecasts and analysts consensus expectations. Oil output fell, despite the rise in global oil prices, as Russia continued to implement OPEC-agreed production cuts.

On external trade, exports of oil and related products were up in 3Q 2017 in line with oil prices, rising 26% y/y. Exports of metals and other primary materials were down sharply. In January-September, exports of goods were also up 26% y/y with the share of oil and gas in total goods exports up sharply to 60%.

Notably, the value of exports of goods and services (at USD250 billion) over the first nine months of 2017 has robustly exceeded the value of imports (at USD 170 billion).

Structural Problems

Russian growth slowdown is structural, as I wrote on numerous occasions before. The structural nature of the slowdown is reflected in subdued private investment growth and lack of dynamism in all private enterprise-led sectors, with exception, perhaps of the cyclical agriculture. Even food production sector - which should have benefited from record crops (over 2014-2017) and trade sanctions (import substitution) is lagging. Capital deepening and technological innovation are far behind where these should have been after roughly 19 years of post-default recovery in the economy.

The structural decline in the private sectors activities is contrasted by expansion of the state sector.

According to the Rosstat figures, over recent years some 11-12% of total earnings in the Russian economy was generated by the larger state-owned or part-state-owned enterprises. This figure excludes direct Government spending. In other words, state spending and state-owned companies revenues now account for close to 40% of the Russian GDP. As reported by BOFIT, state-owned enterprises “revenues are highly concentrated. Surveys by the Russian Presidential Academy of National Economy and Public Administration (RANEPA) show that just 54 large state-owned enterprises (SOEs) account for 8% of revenues [half of that accrues to only two companies: Gazprom and Rosneft]. When 20 indirectly state-owned firms are added the share rises to 12%.” This is in line with the figure of 11% reported by Expert.ru based on their list of 400 biggest companies in Russia.

Outright direct Government (local, regional and federal) expenditure amounts to slightly above 13% of GDP, based on Rosstat figures. This means that, raising the larger enterprises share to account for smaller and medium sized state-owned companies, the total state-owned enterprises and Government share of the economy can be around 38% mark, slightly above the 2010 estimate of 35%, provided by the ENRD. Interestingly, the above imbalances in the structure of the Russian economy do not seem to reflect too poorly on the country rankings in the World Bank Doing Business report. Out last week, the rankings put Russia in 35th place globally, our of 190 countries, placing it just below Japan and well ahead of China (78th).

In summary, Russian economy will not be able to get onto a higher growth path (from the current 1-1.5 percent range) until there is a significant shift in growth drivers toward capital deepening (necessary both to offset adverse demographics and the chronic under-investment in new capital over the recent years), and technological deepening (required to modernise industrial and services sectors). To effectively trigger these processes, Russia needs to hit, simultaneously. three policy targets:

1. Improve overall relationship with Europe, while continuing to build on positive trade and investment momentum with Asia-Pacific region;
2. Increase the share of private enterprise activity in the economy, by reducing the state share of the economy to below 35% of GDP; and
3. Focus on reforming institutional frameworks that currently hold Russian investors from investing in the domestic production, including closing gaps on product/services certification between Russia and Europe, and effectively (not pro-forma) reforming legal frameworks.

28/9/17: Pimco on Russian Economy: My Take

An interesting post about the Russian economy, quite neatly summarising both the top-line challenges faced and the resilience exhibited to-date via Pimco: https://blog.pimco.com/en/2017/09/Russia%20Growth%20Up%20Inflation%20Down. Worth a read.

My view: couple of points are over- and under-played somewhat.

Sanctions: these are a thorny issue in Moscow and are putting pressure on Russian banks operations and strategic plans worldwide. While they do take secondary seat after other considerations in public eye, Moscow insiders are quite discomforted by the effective shutting down of the large swathes of European markets (energy and finance), and North American markets (finance, technology and personal safe havens). On the latter, it is worth noting that a number of high profile Russian figures, including in pro-Kremlin media, have in recent years been forced to shut down shell companies previously operating in the U.S. and divest out of real estate assets. Sanctions are also geopolitical thorns in terms of limiting Moscow's ability to navigate the European policy space.

Banks: this issue is overplayed. Bailouts and shutting down of banks are imposing low cost on the Russian economy and are bearable, as long as inflationary pressures remain subdued. Moscow can recapitalise the banks it wants to recapitalise, so all and any banks that do end up going to the wall, e.g. B&N and Otkrytie - cited in the post - are going to the wall for a different reason. That reason is consolidation of the banking sector in the hands of state-owned TBTF banks that fits both the Central Bank agenda and the Kremlin agenda. The CBR has been on an active campaign to clear out medium- and medium-large banks out of the way both from macroprudential point of view (these institutions have been woefully undercapitalised and exposed to serious risks on assets side), and the financial system stability point of view (majority of these banks are parts of conglomerates with inter-linked and networked systems of loans, funds transfers etc).

Yurga, another bank that was stripped of its license in late July - is the case in point, it was part of a real estate and oil empire. B&N is another example: the bank was a part of the Safmar group with $34 billion worth of assets, from oil and coal to pension funds.

The CBR knowingly tightened the screws on these types of banks back in January:

• The new rules placed a strict limit on bank’s exposure to its own shareholders - maximum of 20% of its capital, forcing the de-centralisation of equity holdings in banking sector; and
• Restricted loans to any single borrower or group of connected borrowers to no more than 25% of total lending.

I cannot imagine that analysts covering Russian markets did not understand back in January that these rules will spell the end of many so-called 'pocket' banks linked to oligarchs and their business empires.

The balance of the banking sector is feeling the pain, but this pain is largely contained within the sector. Investment in Russian economy, usually heavily dependent on the banks loans, has been sluggish for a number of years now, but the key catalyst to lifting investment will be VBR's monetary policy and not the state of the banking sector. 

Here is a chart from Reuters summarising movements in interbank debt levels across the top 20 banks:

The chart suggests that net borrowing is rising amongst the top-tier banks, alongside deposits gains (noted by Pimco), so the core of the system is picking up strength off the weaker banks and is providing liquidity. Per NYU's v-lab data, both Sberbank and VTB saw declines in systemic risk exposures in August, compared to July. So overall, the banking system is a problem, but the problem is largely contained within the mid-tier banks and the CBR is likely to have enough fire power to sustain more banks going through a resolution. 

12/8/17: Some growth optimism from the Russian regional data

An interesting note on the latest data updates for the Russian economy via Bofit.

Per Bofit: "Industrial output in Russian regions rises, while consumption gradually recovers." This is important, because regional recovery has been quite spotty and overall economic recovery has been dominated by a handful of regions and bigger urban centres.

"Industrial output growth continued in the first half of this year in all of Russia’s eight federal districts," with production up 1.5–2% y/y in the Northwest, Central and Volga Federal Districts, as well as in the Moscow city and region. St. Petersburg regional output rose 3-4% y/y.

An interesting observation is that during the recent recession, there has been no contraction in manufacturing and industrial output. Per Bofit: "Over the past couple of years, neither industrial output overall nor manufacturing overall has not contracted in any of Russia’s federal districts. Industrial output has even increased briskly in 2015–16 and this year in the Southern Federal
District due to high growth in manufacturing and in the Far East Federal District driven by growth in the mineral extraction industries."

This is striking, until you consider the nature of the 2014-2016 crisis: a negative shock of collapsing oil and raw materials prices was mitigated by rapid devaluation of the ruble. This cushioned domestic production costs and shifted more demand into imports substitutes. While investment drop off was sharp and negative on demand side for industrial equipment and machinery, it was offset by cost mitigation and improved price competitiveness in the domestic and exports markets.

Another aspect of this week's report is that Russian retail sales continue to slowly inch upward. Retail sales have been lagging industrial production during the first 12 months of the recovery. This is a latent factor that still offers significant upside to future growth in the later stages of the recovery, with investment lagging behind consumer demand.

Now, "retail sales have turned to growth, albeit slowly, in six [out of eight] federal districts."

Here is why these news matter. As I noted above, the recovery in Russian economy has three phases (coincident with three key areas of potential economic activity): industrial production, consumption and investment. The first stage - the industrial production growth stage - is on-going at a moderate pace. The 0.4-0.6 percent annual growth rate contribution to GDP from industrial production and manufacturing can be sustained without a major boom in investment. The second stage - delayed due to ruble devaluation taking a bite from the household real incomes - is just starting. This can add 0.5-1 percent in annual growth, implying that second stage of recovery can see growth of around 2 percent per annum. The next stage of recovery will involve investment re-start (and this requires first and foremost Central Bank support). Investment re-start can add another 0.2-0.3 percentage points to industrial production and a whole 1 percent or so to GDP growth on its own. Which means that with a shift toward monetary accommodation and some moderate reforms and incentives, Russian economy's growth potential should be closer to 3.3 percent per annum once the third stage of recovery kicks in and assuming the other two stages continue running at sustainable capacity levels.

However, until that happens, the economy will be stuck at around the rates of growth below 2 percent.

3/8/17: BRIC Composite PMIs: July

Having covered BRIC Manufacturing PMIs in the previous post (http://trueeconomics.blogspot.com/2017/08/3817-bric-manufacturing-pmis-july.html), and Services PMIs (http://trueeconomics.blogspot.com/2017/08/3817-bric-services-pmi-july.html), here is the analysis of the Composite PMIs.

Table below summaries current shorter term (monthly) trends in Composite PMIs:

Brazil has slipped into a new sub-50 Composite PMI trend in 2Q 2017 and, as of July, remains in the slump, although at 49.4, July Composite PMI reading signals much weaker rate of economic activity contraction than the June reading of 48.5. The problem for Latin America’s largest economy is that the hopes for an extremely weak recovery, set in 50.4 readings in April and May are now gone. In fact, 2Q 2017 average Composite PMI for Brazil stood at 49.8, which was stronger than July reading and marked the strongest performance for the economy since 3Q 2014. All in, July marked the start of the 14th consecutive quarter of Composite PMIs signalling economic recession.

Russia Composite PMI at the end of July stood at 53.4, a respectably strong number, signalling good growth prospects for the economy, but down from 54.8 in June and 56.0 in May. In fact, July reading was the lowest in 9 months. Given the economy’s performance in 1Q 2017, set against composite PMIs, the July and 1-2Q readings suggest that Russia is on track to record 1.0-1.5% growth this year, but not quite 2.0% or higher as expected by the Government. We will need to see 3Q and 4Q averages closer to 56-57 range to have a shot at above 1.5% growth.

China posted 2Q 2017 Composite PMI at 51.3, which is below July 51.9 reading. Still, July improvement is yet to be confirmed across the rest of 3Q 2017. China’s Composite PMI slowed from a recent peak of 53.1 in 4Q 2016 to 42.3 in  1Q 2017 and 51.3 in 2Q 2017.

India’s Composite PMI reflected wide-ranging weakening in the economy struck by both botched de-monetisation ‘reform’ and equally bizarre tax reforms. Sinking from appreciably strong 52.2 in 2Q 2017 to 46.0 in July, this fall marked the lowest PMI reading since 1Q 2009 and the second lowest reading on record. India’s economy has been in a weak state since 3Q 2016 when Composite PMI averaged 53.1. The PMI fell to 50.7 and 50.8 in 4Q 2016 and 1Q 2017 before recovering in 2Q 2017. This recovery is now in severe doubt. We will need to see August and September readings to confirm an outright PMI recession, but the signs from July reading are quite poor.

All in, in July, Russia was the only BRIC economy that came close (at 53.4) to Global Composite PMI reading of 53.5. Two BRIC economies posted a sub-50 reading. In 2Q 2017, Global Composite PMI was 53.7, with Russia Composite PMI at 55.4 being the only BRIC economy that supported global economic growth to the upside. In fact, Russia lead Global Composite PMIs in every quarter since  2Q 2016.

3/8/17: BRIC Services PMI: July

Having covered BRIC Manufacturing PMIs in the previous post (http://trueeconomics.blogspot.com/2017/08/3817-bric-manufacturing-pmis-july.html), here is the analysis of the Services Sector PMIs.

Brazil Services PMI continued trending below 50.0 mark for the third month in a row, hitting 48.8 in July, after reaching 47.4 in June. While the rate of contraction in the sector slowed down, it remains statistically significant. This puts an end to the hope for a recovery in the sector, with Brazil Services PMIs now posting only two above-50 (nominal, one statistically) readings since October 2014.

Russian Services PMI also moderated in July, although the reading remains statistically above 50.0. July reading of 52.6 signals slower growth than 55.5 reading in June. The Services sector PMIs are now 18 months above 50.0 marker, continuing to confirm relatively sustained and robust (compared to Manufacturing sector) expansion.

China Services PMI remained in the statistical doldrums, posting 51.5 in July gayer 51.6 in June. The indicator has never reached below 50.0 in nominal terms in its history, so 51.5 reading is statistically not significant, given PMIs volatility and positive skew. Overall, this is second consecutive month of PMIs falling below statical significance marker, implying ongoing weakness in the Services economy in China.

India’s Services PMIs followed Manufacturing sector indicator and tanked in July, hitting 45.9 (sharp contraction), having previous posted statistically significant reading for expansion at 53.1 in June. Volatility in India’s Services indicator is striking.

Table and chart below summarise short term movements:

Looking at quarterly comparatives, July was a poor month for Brazil Services sector, with July reading of 48.8 coming in weaker than already poor 49.0 indicator for 2Q 2017. In Brazil’s case, current recession in Services is now reaching into 12th consecutive quarter in nominal terms and into 15ht consecutive quarter in statistical terms. Russia Services PMI also moderated at the start of 3Q 2017 (52.6 in July) having posted average 2Q 2017 PMI of 56.0. Russia Services sector expansion is now into its 6th consecutive quarter (statistically) and seventh consecutive quarter nominally. The same, albeit less pronounced, trend is also evident in China (July PMI at 51.5 against 2Q 2017 PMI of 52.0). India Services PMI was under water in 4Q 2016, followed by weak (zero statistically) growth in 1Q 2017 and somewhat stronger growth in 2Q 2017. The start of 3Q 2017 has been marked by a sharp, statistically significant negative growth signal.

With Global Services PMI hitting 53.7 in July, against 53.8 average for 2Q 2017 and 53.6 average in 1Q 2017, BRIC economies overall are severely underperforming global growth conditions (BRIC Services PMI is now below Global Services PMI in 3 quarters running and this trend is confirmed at the start of 3Q 2017).

3/8/17: BRIC Manufacturing PMIs: July

BRIC PMIs for July 2017 are out, so here are the headline numbers and some analysis. 

Top level summary of monthly readings for BRIC Manufacturing PMIs is provided in the Table below:

Of interest here are:

• Changes in Brazil Manufacturing PMI signalled weakening in the economy in June that was sustained into July. Manufacturing PMI for Brazil has now fallen from 52.0 in May to 50.5 in June and to 50.0 in July. This suggests that any recovery momentum was short lived. 
• Russian Manufacturing PMI, meanwhile, powered up to 52.7 in July from 50.3 in June, rising to the highest level in 6 months. Good news: Russian manufacturing sector has now posted above-50 nominal readings in 12 consecutive months. Less bright news: Russian Manufacturing PMIs have signalled weak rate of recovery in 5 months to July and July reading was not quite as impressive as for the period of November 2016 - January 2017. Nonetheless, if confirmed in August-September, slight acceleration in Manufacturing sector can provide upward support for the economy in 3Q 2017, support that will be critical as to whether the economy will meet Government expectations for ~2% full year economic expansion.
• Chinese manufacturing PMI gained slightly in July (51.1) compared to weak May (49.6) and June (504.), but growth remains weak. Last time Chinese Manufacturing posted PMI statistically above 50.0 (zero growth) marker was January 2013. This flies in the face of official growth figures coming from China.
• India’s Manufacturing PMI fell off the cliff in July (47.9) compered to already weak growth recorded in June (50.9). Over the last 3 months, India’s Manufacturing sector has gone from weak growth, to statistically zero growth to an outright contraction.

Overall, GDP-weighted BRIC Manufacturing PMI stood at extremely weak 50.4 in July 2017, down from equally weak 50.6 in 2Q 2017. In both periods, BRIC Manufacturing sector grossly underperformed Global Manufacturing PMI dynamics (52.7 in July and 52.6 in 2Q 2017). Russia is the only country in the BRIC group with Manufacturing PMI matching Global Manufacturing PMI performance in July. Russian Manufacturing PMI was below Global Manufacturing PMI in 2Q 2017.

Net outrun: BRIC Manufacturing sector currently acts as a drag on global manufacturing growth, with both India and Brazil providing momentum to the downside for the BRIC Manufacturing PMIs.

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