Earlier today I gave a brief presentation on the topic of the Recent Developments in Russian Economy. Here are my speaking notes:
Economic growth in Russia was running at
+0.8% y/y in Q2 2014 versus 0.9% y/y in Q1 2014.
At the same time, GDP shrank 0.2% y/y in
July 2014 and 0% y/y in August 2014.
Taken against the consensus forecast for
growth at 0.5% for the full year 2014, this suggests geo-political risks-induced
slowdown in the economy of some 0.3-0.4% to-date.
Russia's economic outlook for 2014 and
2015-2015 continues to trend down, driven by two core factors:
- Geopolitical risks of the Ukrainian
conflict, and
- Structural weaknesses in the economy.
The first factor is responsible for the
expected actual output growth falling below down-trending potential output
growth in 2014 and 2015.
The second factor is driving down potential
output growth in 2015-2016 and beyond.
How dramatic were the growth forecasts
revisions so far?
Take IMF: IMF is about to publish its
October World Economic Outlook forecasts revisions.
In October 2013, IMF forecast real GDP
growth in Russia to run at 3.0% in 2014, 3.5% in 2015 and 3.5% in 2016. So 3.5%
average over 2015-2016.
In April 2014, IMF forecasts were running
at 1.33% in 2014, 2.3% in 2015 and 2.5% in 2016, respectively. 2015-2016
average of 2.4% down 1.1 ppt on previous.
We have no forecasts for October, yet, but consider
IMF's 'twin' organisation, the World Bank. The WB expect growth of around 0.5%
pa on average over 2014-2016, broken down into 0.5% in 2014, 0.3% in 2015 and
0.4% in 2016. Average growth of just 0.35% in 2015-2016 down massive 3.15 ppt
on a year ago!
Russian Government official forecasts are
for growth of 0.5% in 2014, 1.2% in 2015 and 2% in 2016, so average 2015-2016
growth of 1.6% or 1.25 ppt above World Bank forecasts.
Taken against CIS growth rates, the official
sector revisions suggest that about 1/2 of the total downside in growth
expectations is down to Ukrainian crisis and the rest are structural.
Based on World Bank forecasts, slowdown in
domestic investment and consumption will be the main drag on the structural
side of growth.
Private sector analysts forecasts are even
worse than those from the IMF and the World Bank. For example, Danske forecast
for GDP growth is -0.3% in 2014, -1.9% in 2015 and +0.5% in 2016. These are
driven by expected private consumption growth going from 1.2% in 2014 to -2.2%
in 2015 and rising to +2.2% in 2016, Fixed investment falling 3.7% in 2014, 3%
in 2015 and growing by only 0.3% in 2016.
Morgan Stanley cut its 2014 forecast for
Russian economy from +0.8% growth to -1.5% recession earlier this month.
BOFIT forecast estimates growth of 0% in
2014, +0.5% in 2015 and +1.7% in 2016, or an average rate of growth of 1.1% in
2015-2016. These are more in line with official forecasts and are less gloomy
than World Bank outlook and Danske outlook. I tend to err on their side,
although my expectation is that 2015 growth will be above 0.5% and 2016 will be
slightly shy of 1.7%, but the average of 1-1.1% for 2015-2016 looks about
right, assuming no major rapid changes to the Ukrainian situation.
All in, there is huge uncertainty as to
what we can expect from the Russian economy in 2015-2016.
The slowdown in investment is driven by a
number of factors, such as:
- Capital outflows and high interest rates (in part related to the
Ukrainian crisis, but also linked to stubbornly high inflation and the Central
Bank move to free floating ruble). Policy interest rates currently stand at 8%
and are expected to rise to 8.5% by the end of 2014-beginning of 2015.
Currently, EUR/RUB exchange rate is at 50.22 and 12month forward contracts
imply the rate of 53.65, while USD/Ruble rate is at 38.8 currently and 12
months forward markets pricing implies the rate of 41.18. Much of this is down
to the expected revaluation of the dollar and the strong euro vis-a-vis
majority of the emerging markets currencies. But some is down to expected
structural weaknesses in the Russian economy. Weaker ruble implying higher cost
of imported capital goods and technology.
- Weaknesses in the banking sector (exacerbated by the impact on the
banks' access to global funding markets arising from Western sanctions) relate
to continued sector consolidations (Central Bank has shut down more banks in
2014 so far than in 2010-2011 combined) and sector deleveraging (with credit
supply growth falling dramatically over the last 12 months).
- Tight fiscal policy: Russia's draft federal budget approved by the
cabinet on September 18, upholds the budget rule adopted in 2012 that says the
deficit may not exceed 1% of GDP. Spending composition changed to allow higher allocations
to defence and national security, as well as to boost certain sectors of the
economy. Much of the spending in the latter will go to building new production
or expand existing capacity to substitute for imports, especially in the
defence and agriculture sectors. The measures are part of Russia’s new emphasis
on economic self-sufficiency. New funding was allocated also to Crimea and the
Far East region development, and to large infrastructure projects such as
Moscow’s new ring road. Per BOFIT: “The government sees giant state-funded
infrastructure projects as a way to revive economic growth”. But big
infrastructure investments are not identical in terms of their future
productive capacity as business investment in new technology and capital goods.
As Brazil example shows, infrastructure uplifts based on public funding are
virtually one-shot game when it comes to funding growth.
On the budgetary policy side:
- The Government refrained from new tax hikes and shelved the proposal
for sales-tax. VAT remained unchanged at 18%. This is a major net positive for
domestic demand.
- Another positive on domestic demand side, but presenting new risks
on long term macroeconomic sustainability front, the new budget includes
decision to raise revenue by transferring federal budget pensions contributions
for 2015 into general budget, same as in 2014. Under 2002 pensions reform,
Russian pension system moved from pure pay-as-you-go system to partially funded
system. Under the 2002 reformed system, a share of pensions contributions
collected by the federal authorities went to fund current pensions obligations,
while the balance was invested in long-term instruments to help fund future
pensions provisions. Since 2014 and now into 2015, the second part of
contributions will be diverted to general budget.
As mentioned above, Russia is moving toward
a greater degree of economic self-sufficiency in two key areas: defense
industry and agriculture. While the former is likely to be a drag on
general investment, the latter presents opportunities for Irish exporters and
is likely to lead to some economic grains in Russia.
Russian agriculture is in a desperate need
of investment. I wrote about this on my blog
http://trueeconomics.blogspot.ie/2014/09/892014-russias-agrifood-sector-in-need.html
on September 8th - a post that I shared with you on the IRBA Linkedin page. To summarise my findings, modernisation of
Russian agriculture and food sectors will require annual investments in the
region of USD10.7-11.7 billion per annum. Agriculture Ministry requested a 50%
increase in annual farm subsidies from EUR4.2 billion in 2014 to EUR6.3 billion
in 2015.
These investments will have to cover:
- -
Agricultural production,
especially in dairy, fisheries, beef and fruit and vegetables sectors,
including staples, like potatoes;
- Supply Chain Management and
Logistics, especially in storage and transportation relating to fruit and vegetables
sectors;
- Food processing sectors,
especially relating to dairy and fishing sub-sectors.
We can expect significant
uplift in investment support schemes in beef and poultry sectors, as well as in
pork production. So far, draft 2015 Budget provides only 20% of the funds
requested for this purpose. The hope is that the bumper crop of cereals this
year is going to provide off-setting breathing space for investment: Russia
expects grains harvest in 2014 to hit 104-106 million tons, just shy of the
all-time record of 108 million tons achieved in 2008 and well above the 84
million tons average for the last 10 years.
Overall, most acute risks to the
Russian economy are geopolitical, with sanctions escalation on September
12-18th resulting in more severe pressures on the banks for funding, as well as
increased pressure on oil producers. So far, the sanctions war has been
escalating despite the ceasefire in Ukraine holding and this suggests that we
cannot expect lifting of the sanctions before the end of 2014 even under the
most optimistic scenarios.
Credit supply from euro and dollar funding
has fallen to zero for all Russian companies in July 2014.
The second immediate risk is that of
declines in oil prices. Russian economy is more sensitive to changes in oil
prices than to gas prices and the fact that oil is currently down some 16% on
its June 2014 highs and is trading closer to USD95-96/bbl presents a major
threat to the economy. Should oil prices fall below USD90/bbl, federal budget
will require major tightening to keep the Government within targeted 1% deficit
rule.
The third risk is to the investment side
from the monetary policy: stubbornly rising and high CPI - currently running at
around 7.9% against CBR and Government targets of 5.5-6%, and devaluation of
the ruble, plus rapid outflows of capital from Russia - all are implying future
potential tightening of interest rates policy. This, if it were to pass, will
push even further down the already poor investment performance.
On the positive side, even with sanctions
tightening, we are seeing some recovery in producer and consumer confidence, as
signaled by PMIs and consumer surveys. But the recovery is fragile and
uncertain in terms of future prospects. We need to see confirmation of the stronger
PMIs trend in September figures, due to be released this week.
If we are to look at the demand side for
exporters into Russian markets, things are tough. Russian imports have already fallen in
2014, driven by depreciation of the ruble more than by anything else. Imports declines contributed +6.5% to
Russian GDP growth in 2009, but rebounded relatively strongly in 2010 and 2011,
erasing the 2009 contraction. Imports shrinkage is likely to contribute some 1%
to GDP growth in 2014, 0% to 2015 growth and -0.3% in 2015, so expected rebound
to the current imports drop is likely to be less swift and longer-drawn out.
Surprisingly, imports slowdown and
sanctions did not hurt, to-date, bilateral trade in goods between Russia and
Ireland. In the first seven months of 2014, compared to the same period of
2013, Irish exports to Russia rose from EUR397 million to EUR509 million - an
uplift of 28% y/y. Our trade balance in goods with Russia improved from a
surplus of EUR301 million in January-July 2013 to a surplus of EUR353 million
in January-July 2014. If in 2013 exports to Russia accounted for
3.67% of our goods exports ex-EU and USA, in 2014 so far it is accounting for
4.31% of our goods exports ex-EU and USA.
Keep in mind: in national accounts, net
trade (trade balance) is what counts as additive to national income and GDP. In
these terms, for the first 7 months of 2014, our surplus vis-a-vis Russia (at
EUR353 million) is much more to our GDP and GNP than our trade deficit with China of
EUR478 million.
While we do not have detailed breakdown of
July trade flows, comparing H1 2014 against H1 2013, noticeable increases in
Irish exports to Russia were recorded in:
- Coffee, tea, cocoa, spices and
manufactures thereof
- Miscellaneous edible products and
preparations
- Essential oils; perfume materials; toilet
and cleansing preps
- Chemical materials and products nes
- Photographic apparatus; optical goods;
watches and clocks
- Miscellaneous manufactured articles
Noticeable decreases were recorded in:
- Live animals
- Meat and meat preparations
- Metalliferous ores and metal scrap
- Organic chemicals
- Medical and pharmaceutical products
- Office machines and automatic data
processing machines
Opportunity space for Irish exporters in
Russia remains wide open in areas not impacted by sanctions, e.g. outside
immediate supply of some food and agricultural products. And new opportunities
should open up in the areas relating to agricultural production, food
processing, storage and transportation. In addition, there is renewed scope for
investment in Russia in the above areas and in areas relating to technological
innovation and modernisation in a wide range of sectors.
However, to facilitate this, it would be
positive if Russian authorities were to accelerate policy efforts directed at
attracting foreign investors into the country, especially in areas linked to
investor protection and regulatory and tax facilitation. There is also a need
for assuring investors that ruble valuations are going to become less erratic
and the global rates divergence is not going to precipitate dramatic further
drops in currency values. Key here is Euro/Ruble pair, rather than Dollar/Ruble
one. Access to trade finance and insurance are also a major bottleneck.
While over the next 1-2 years we can expect
more uncertainty and risks to materialise, including the risk of significant
further devaluation of the ruble valuation, taking a longer-term horizon of 5-10 years,
these factors are likely to be replaced by more positive growth momentum and
improved returns on foreign investment.
