July 25, 2019

Economy: Making Russia Safe Again

BY Alexander Kudrin, Evgeny Gavrilenkov

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( 10 mins)

The CBR can support consumer demand by gradually bringing its key rate closer to more comfortable levels, where the word “comfortable” means comfort not to the foreign buyers of the government bonds and not to local banks, but to local consumers and producers. Amid the recent hunt for yields a twin-surplus Russia is seen as kind of a relatively safe place compared to its peers. For ordinary Russians the country’s surpluses are of lesser importance, as economic “safety” means a stable and reasonably high rate of growth of their income (and the economy as well).

As the y-o-y inflation decelerated sharply in June and it is likely to fluctuate between 4.5% and 4.7% in 3Q19 before falling further in October December, it cannot be ruled out that the CBR may cut the rate on July 26 which should be supportive for domestic demand. Another measure of inflation, such as the annualized 6M moving average, a more forward-looking measure than the y-o-y inflation, will be already well below 4% in July (in fact it will get closer to 3%) which will mean that the gap between the 7.5% key rate and this measure of “current” inflation will widen significantly. Cutting the key rate by another 50 bps by year-end now cannot be ruled out. Hence if Russia enters the year 2020 with a key rate of 6.75% and inflation of around 4%, then the real rate will be even a bit higher than it was in the early 2019.

  • Rosstat preliminary report on the 1H19 economic situation in Russia was mixed. Such sectors as industry demonstrated some acceleration of the y-o-y growth in 2Q19 relative to the previous quarter, while some other sectors, such as retail, continued to decelerate.
  • What can be derived from Rosstat 1H19 statistics is that domestic consumer demand is gradually weakening as retail expanded by 2.8% in 2018, decelerated in 1Q19 to 1.9% y-o-y and was up only by 1.5% y-o-y in 2Q19. However, some improvement can be expected in 2H19 as decelerating inflation is gradually pushing up real wage growth and to some extent real income.
  • As of June 1, 2019, ruble consumer loans exceeded R16.0 trln, having grown by around R1.2trln (8.2%) since the start of the year. The average monthly consumer lending increases were around R240 bln in nominal terms. Rough calculations show that, assuming an average consumer loan rate is now 13 – 14%, households have to pay back to banks some R2.2 trln per year, or around R180 bln a month. This situation to some extent resembles what happened in 2012-2013 when consumer debt servicing also suppressed domestic demand. However back then the case was more extreme as by around 2013 the average monthly increase of nominal consumer debt became roughly equal to interest payments.
  • Therefore, rate cuts are inevitable as the country needs to test all possible tools that could bring GDP growth rate closer to 3-4%, i. e. comparable to global average (or even higher than that) as it is what can secure the country’s economic safety in the long run.

Rosstat preliminary report on the 1H19 economic situation in Russia was mixed. Such sectors as industry demonstrated some acceleration of the y-o-y growth in 2Q19 relative to the previous quarter, while some other sectors, such as retail, continued to decelerate. It looks as though the industrial growth is slowly gathering pace after a rapid deceleration to 2.1% y-o-y in 1Q19, as it reached 3.0% y-o-y in 2Q19, which is more or less on a par with its rate in 2018 (2.9% for the full year). As a result, industry expanded by 2.6% y-o-y in 1H19 with prospects of some acceleration in 2H19 so that industrial growth may again be around 3% for the whole 2019.

The y-o-y growth in the mining segment decelerated to 3.3% in 2Q19 from 4.7% y-o-y in 1Q19, while in manufacturing it accelerated from 1.3% to 2.4% y-o-y over the same periods. There were strong base effects in the mining segment, such as acceleration of growth in 1H18, so that mining will continue to decelerate, while manufacturing can continue its upward trend. Manufacturing production was rather uneven across various segments. There was rather strong growth in 1H19 in such segments as food (by 3.8% y-o-y), wood working (8.3%), metal working other than production of machines and equipment (6.0%), while in other sectors, such as production of cars, growth almost stagnated (0.8%). Meanwhile car production contracted in June by 5.1% y-o-y. Some other smaller segments of manufacturing even posted a y-o-y contraction in 1H19.

Overall both mining and manufacturing are expected to expand by around the aforementioned 3% in 2019 as a whole, while in 1H19 growth in mining was stronger (4.0% y-o-y) than in manufacturing (1.9%). Given that industry represents around 29.9% of GDP in nominal 2018 prices and 26.7% of gross value added, which differs from GDP by net taxes on products, industrial growth can make quite a positive contribution to overall economic growth in 2019.

Agriculture expanded by 1.2% y-o-y in 1H19, cargo transportation turnover was up by 1.7%. Even retail, which demonstrated some deceleration, was up by 1.6%. Retail trade in June expanded by a mere 1.4% y-o-y. Even though these 1H19 numbers do not impress compared to faster growing Asian economies, they look far better than the officially reported Russia’s 0.5% y-o-y GDP growth in 1Q19. One of the previous GKEM Analytica reports mentioned that the economic growth was probably underestimated in the early year due to a rather questionable accounting of the wholesale trade, which represents quite a meaningful part of GDP. It can well be the case that the 1Q19 GDP growth is set to be revised upward and be a bit closer to 1.0%.

What can be derived from Rosstat 1H19 statistics is that domestic consumer demand is gradually weakening as retail expanded by 2.8% in 2018, decelerated in 1Q19 to 1.9% y-o-y and was up only by 1.5% y-o-y in 2Q19. However, some improvement can be expected in 2H19 as decelerating inflation is gradually pushing up real wage growth and to some extent real incomes. Real wage growth decelerated sharply in the early 2019 not only as a result of accelerated inflation, but also due to a deceleration of nominal wage growth. Real wages increased by 4.1% y-o-y in 4Q18 (and growth was even stronger in the previous periods) and then the growth rate decelerated to just 1.3% y-o-y in 1Q19 but reached 2.3% in 2Q19. According to Rosstat, real income contracted by 2.5% y-o-y in 1Q19, but almost stopped falling in 2Q19 as inflation decelerated (a minor y-o-y contraction by 0.2% was recorded).

As in June inflation decelerated to 4.7% y-o-y (i. e. well below the CBR expectations which were revealed in the early 2019) it is quite likely that it will continue decelerating and the most visible y-o-y deceleration will be seen in 4Q19 so that by year end it may even fall to below 4%. Hence consumer demand is expected to strengthen by year-end.

As the y-o-y inflation decelerated sharply in June and it is likely to fluctuate between 4.5% and 4.7% in 3Q19 before falling further in October – December, it cannot be ruled out that the CBR may cut the rate on July 26 which should be also supportive for domestic demand. As one of the recent reports of this series mentioned, another measure of inflation, such as the annualized 6M moving average, which is a more forward looking measure than the y-o-y inflation, will be already well below

4% in July (in fact it will get closer to 3%) which meanы that the gap between the 7.5% key rate and this measure of “current” inflation will widen significantly. Cutting the key rate by another 50 bps by year-end now cannot be ruled out. Hence if Russia enters the year 2020 with a key rate of 6.75% and inflation of around 4%, then the real rate will be even a bit higher than it was in the early 2019.

The chart below illustrates that even though consumer lending rates decreased since January 2017 they still remain high, especially given that the nominal wage growth decelerated from double-digit levels in 2018 to around 7% in 1H19. The latest available month is May 2019 as the CBR statistics on rates and credit volumes is lagging, but it is clearly seen that as inflation started to accelerate at the end of 2018 short-term consumer lending rates (up to 1 year) increased. An upward trend continued in January – May 2019, and these rates are likely to go down in 2H19, but probably not much faster than the CBR is going to cut its benchmark rate.

Economy: Making Russia Safe Again 1

Lending rates for “longer-term” credits which involve car loans and mortgages also increased in the second quarter. As of June 1, 2019, ruble consumer loans exceeded R16.0 trln, having grown by around R1.2 trln (8.2%) since the start of the year. The average monthly consumer lending increases were around R240 bln in nominal terms. Rough calculations show that if to assume that an average consumer loan rate is now 13 – 14% (as seen from the chart above) then the annual costs of servicing this debt can be estimated at R2.2 trln, implying that households have to return to banks around R180 bln a month.

This situation to some extent resembles what happened in 2012-2013. However back then the case was more extreme as by around 2013 the average monthly increase of nominal consumer debt became roughly equal to interest payments. Hence on aggregate consumer lending stopped making contribution to economic growth beyond the banking sector, while production of goods slowed.

This time the difference between monthly increase of consumer lending and debt servicing is still positive. However, it is not surprising that amid a 0.5% y-o-y GDP growth in 1Q19 the financial sector posted the fastest growth among other sectors – 7.6%. The same happened in 2018 as the sector grew 6.2% while the GDP added just 2.3%. Again, this situation is very similar to what was seen some six or seven years ago.

There is quite a popular point of view that the CBR cannot cut the rate because some economic variable, called potential output, which cannot be measured directly, is very low in Russia (its proponents say that lowering rates will imply higher inflation). Leaving aside comments on potential output, one can conclude from the above observations that the CBR can support consumer demand to some extent by gradually bringing the rates closer to more comfortable levels.

In this context the word “comfortable” means comfort not to the foreign buyers of the government bonds and not to local banks, but to local consumers and producers. Amid the recent hunt for yields a twin-surplus Russia, which enjoys a very strong current account surplus, a low level of government debt and a federal budget surplus of around 2-3% of GDP (it was 2.7% last year and will be close to 2% this year) is seen as kind of a relatively safe place compared to its peers. For ordinary Russians these parameters are of lesser importance, as economic “safety” means a stable and reasonably high rate of growth of their income (and the economy as well). It looks as though a GDP growth rate of 3-4%, i. e. comparable to global average (or even higher than that) is what can make the country economically safe in the long run.

Data provider: Cbonds

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