Russia’s Growth: Walking with Hurdles

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( 11 mins read )

Rosstat recently published some data which looked both disappointing and encouraging. On the one hand, it reported that Russia’s GDP grew just 0.5% in 1Q19, which was well below all expectations. On the other hand, April statistics surprisingly looked much more encouraging, i. e. well above what could have been expected amid the suddenly decelerated GDP growth in the first quarter.

As in the years to come the regulatory environment is likely to remain unchanged in Russia, its economic growth may be partially supported by some improvements in the macroeconomic policy.

In addition to the CBR’s potential lowering of the key rate Minfin can also make its own contribution to the simplification and long-term stability of the financial system if it decides to stop depositing money with banks and to reduce its role as a major liquidity regulator via quantitative measures. Such actions by Minfin would also help reduce interest rates for borrowers other than financial institutions and support economic growth.

  • It looks as though a kind of consensus has emerged among pessimists in the government circles at the St. Petersburg Economic Forum that the economy cannot grow fast enough and the key issue now is how to avoid recession and secure a rate of growth between 1% and 2%.
  • The April statistics, however, looked brighter than the data published for 1Q19. It was reported that industry expanded y-o-y by 4.6% in April and by 2.8% in 4M19. Agriculture expanded by 1.4% and 1.2% over the same periods, cargo turnover increased by 2.3% in both periods. The retail sector grew by 1.2% and 1.7% which, by the way, pointed to some deceleration last month.
  • Even though these numbers leave a mixed impression, they do not match the sluggish 0.5% y-o-y GDP growth, as they suggest that either something extraordinary suddenly happened in several segments of the economy so that it rapidly accelerated in April or something remained unaccounted for in 1Q19.
  • The CBR may consider cutting the key rate already in summer. It is not falling inflation alone which may encourage the CBR to act, but the need to gradually eliminate some distortions which stem from a too peculiar combination of a too tight budgetary and monetary policies, which negatively affect economic growth.

Growth may be not as bad as it was reported…

In the past several weeks Rosstat published some data which looked both disappointing and encouraging. On the one hand, it reported that Russia’s GDP grew just 0.5% in 1Q19, which was well below all expectations. On the other hand, April statistics surprisingly looked much more encouraging, i.e. well above what could have been expected amid the suddenly decelerated GDP growth in the first quarter – even adjusting for an additional working day in April 2019 (relative to April 2018). This GDP growth figure was well below those for 3Q18 (2.2%) and 4Q18 (2.7%) and was only slightly higher than in 4Q17 when the economy expanded by a mere 0.3% y-o-y. Russia exited recession in mid-2016 as the y-o-y GDP growth turned positive in 2Q16 and reached 0.3% and remained at the same level in 3Q16, which is illustrated by the chart below.

Russia’s Growth: Walking with Hurdles 1

At the same time this chart illustrates that, for some reason, the quarterly y-o-y growth has become more volatile since 2017 relative to what was observed in 2015-2016. This chart shows the data starting from 2015: a comment on the Rosstat website suggests that the GDP growth data since 2015 have been revised and are now incompatible with the data published earlier. Hence referring to seasonally adjusted figures does not look pertinent as the timeframe from 1Q15 to 4Q18 seems too short (Rosstat itself provides these data available from 1Q14, but has not yet published the 1Q19 detailed national accounts stats).

These observations may suggest that something is not right with the published data and that revisions are likely to happen in the future. In particular, something looks unclear with the wholesale trade statistics, which looks unexpectedly volatile and this volatility lacks any reasonable economic explanation. Several weeks ago this issue was broached in a report of these series which suggested that a shift in the structure of the wholesale trade might have occurred during the year that had not been properly reflected in the data (wholesale companies started to trade more domestic goods and less imported goods on the market).

As said, April statistics looked brighter than what the above chart showed for 1Q19. It was reported that industry expanded y-o-y by 4.6% in April and by 2.8% in 4M19. Agriculture expanded by 1.4% and 1.2% over the same periods, cargo turnover increased by 2.3% in both periods. The retail sector grew by 1.2% and 1.7% which, by the way, pointed to some deceleration last month.

In any case these numbers do not match the sluggish 0.5% y-o-y GDP growth, as they suggest that either something extraordinary suddenly happened in several segments of the economy so that it rapidly accelerated in April (well above what one additional working day could have added to general trends) or something remained unaccounted for in 1Q19, such as strange “statistical” contraction in the wholesale trade segment which according to official data contracted by 7.7% y-o-y in 1Q19, by 3.7% in April and by 6.6% in 4M19. Clearly these declines do not correlate with the reported growth in production of goods in major segments of the economy, such as industry and agriculture.

Meanwhile, Rosstat reported that output in the five basic sectors (industry, agriculture, transport, trade, construction) expanded by 2.7% y-o-y in April and by 1.3% in 4M19, which still does not look great as construction was reportedly flat y-o-y (due to the base effect stemming from the unprecedented upward revisions of construction activity in 2018), but much better than the officially reported sluggish y-o-y GDP growth in 1Q19. It can be expected that the May data will not look as good as April’s, but it should generally look better than the sluggish 1Q19 performance.

… but it still looks unimpressive

One of the issues discussed at the St. Petersburg Economic Forum was related to growth and the officials were not as optimistic as they had been a year before. It looks as though their sentiment had been affected by the poor economic performance in 1Q19. The Economy minister Maxim Oreshkin even suggested that Russia could enter another recession in 2021 if consumer lending continues to grow as fast as in the past couple years. Interestingly, the debates on particular policies which could enable Russia to achieve growth rate above the world average seemed overshadowed by the unimpressive 1Q19 GDP data.

It looks as though a kind of consensus has emerged among pessimists in the government circles that the economy cannot grow fast enough and the key issue now is how to avoid recession and secure a rate of growth between 1% and 2%. It is not easy to argue with these expectations as the overregulated economy with the increasing role of the state sector is unlikely to suddenly change the trajectory which it has followed since 2012-2013. According to Russia’s business ombudsman Boris Titov, the fines paid by businesses totaled 179 bln rubles in 2018, which was higher than in 2017 as businesses have to comply with too many regulations.

Coming back to economic growth and a risk of recession as was suggested by the Economics minister, it is worth to mention that even though consumer lending resumed growing since 2017 after years of stagnation, it still remains below 15% of GDP, which is not high by international standards. What really looks too high is lending rates even though they are well below those seen in 2014-2015. At that time consumer lending rates were within a 20–30% range (depending on maturity), while these days the average lending rate for loans with maturity up to one year has fallen below 15% and is fluctuating around 13% for longer loans. As of April 1, 2019, the total stock of consumer credits in rubles reached R15.4 trln, i.e. was around the aforementioned 15% of GDP implying that debt servicing pressure on the household sector has somewhat decreased and that it may be premature to predict recession to be caused by a too fast expansion of consumer lending.

However, it goes without saying that these interest rates look too high in the environment when inflation is set to fall below 5% already in June, while the nominal wage growth rate is somewhere within 6-7%. Therefore, it is more likely that the economic growth will remain unimpressive in the years to come and household consumption will muddle through pressured by the debt servicing costs.

As regulations are unlikely to change, more business-friendly macroeconomic policy may help

As in the years to come regulatory environment is likely to remain unchanged in Russia, economic growth may be partially supported by some improvements in the macroeconomic policy. GKEM Analytica’s previous reports mentioned that the CBR may consider cutting the key rate already in summer. It is not falling inflation which may encourage the CBR to act, but the need to gradually eliminate some distortions which stem from a too peculiar combination of a too tight budgetary and monetary policies. The chart below illustrates that as the budget surplus increased last year while the key rate remained elevated money supply growth started to slow. It slowed from 12-13% y-o-y in mid-2018 to below 8% in April 2019. Slowing money supply growth is well in line with slower economic growth and higher y-o-y OFZ yields.

Russia’s Growth: Walking with Hurdles 2

As a result of strong liquidity sterilization by Minfin via the fiscal surplus the ministry now holds an equivalent of 10-11 trln rubles at the accounts with the CBR, i.e. out of the commercial banking sector. Note that the total money supply (M2, national definition) accounted for R46,4 trln as of May 1, 2019. Apart from FX purchases in line with the fiscal rule the ministry partially returns this liquidity to the banking sector by opening deposits of various maturities with banks. The average volume of such deposits has recently fluctuated around R1.3 trln recently and the interest rate is defined as RUONIA with some discount which is derived from reservation requirements.

However, the Central bank is eager to sterilize this liquidity by offering its own bonds to banks (the rate is equal to the key rate) and deposits as well. For instance, the amount of the bonds offered by the CBR to banks fluctuated recently around R1.6 trln. As RUONIA fell below the key rate in 2Q17, i.e. when the Finance Ministry started buying FX, banks got an opportunity to generate risk-free positive returns acting as intermediaries between the Minfin and the CBR by pumping money from one entity to another. It obviously made the banks less willing to lend money to companies and individuals, and it mostly affected not the volumes of lending but the interest rates which still stay higher than they could have been. The real economy does not seem to need such flow of money from Minfin to the CBR and back that much, and the only beneficiaries of these transactions are banks (mostly state owned).

Therefore, in addition to the CBR’s potential lowering of the key rate Minfin can also make its own contribution to the simplification and long-term stability of the financial system if it decides to stop depositing money with banks and to reduce its role as a major liquidity regulator via quantitative measures. Such actions by Minfin would also help reduce interest rates for borrowers other than financial institutions and support economic growth.

Data provider: Cbonds

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