Russia in Global Context: Resilient to Shocks, But Growing Slowly

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( 13 mins read )

In recent weeks a flow of rather hot news was unable to ease the concerns about slowing economic growth worldwide, but Russia was not in the spotlight, as such issues as burning rainforests in Brazil, continuous attempts of the UK government to invent a new recipe of a Full English Brexit, the US government’s own ground-breaking ideas (buying Greenland is just one example) looked more important than Russia-related events.

The global economic recovery after the 2008–2009 economic crisis already looked fragile as it was based on monetary populism, which naturally limits the ability of the monetary authorities worldwide to provide more stimulus going forward. It now looks as though financial markets overall (and some countries as well) fully fit the concept of “too big to fail”.

In such an environment it would not be surprising to see the Russian government paying much more attention to domestic economic issues, where the picture does not look great.

  • Russia’s July statistics pointed to no change in trends, such as muddling through with the rate of economic growth between 1% and 2%. It was reported that the y-o-y GDP growth accelerated in 2Q19 to 0.9% from 0.5% in 1Q19 and is expected to be a bit higher for the full year.
  • Domestic private consumption remains sluggish as retail trade looks weakening having grown by a mere y-o-y 1.6% in 7M19 and 1.0% in July. So far it looks as though the y-o-y growth will not change much until year-end causing a further y-o-y deceleration on a cumulative basis.
  • A less hawkish macroeconomic policy, such as a moderate increase in government spending (assuming it is channeled to the right places and spent efficiently) and lower interest rates could break this negative trend.
  • One cannot rule out that the macro statistics, as well as some sectoral data, could be revised up this year as it looks rather strange that amid the aforementioned 0.5-0.9% reported GDP growth and decelerating inflation (having peaked at near 5.5% in 1Q19) the non-oil tax collection was up by an impressive 15.0% y-o-y in 7M19, which well exceeds the additional revenues originating from the increased VAT.
  • Of course, possible statistical revisions will not look ground-breaking, but they can support the view that Russia keeps muddling through on its own with the rate of GDP growth between 1.0% and 2.0%, being less dependent on the external environment.
  • A strong non-oil revenue flow will secure a big federal budget surplus this year despite the fact that Brent oil price fell from over $70/bbl in spring to below $60/bbl in August. Overall, Russia with its unimpressive economic performance but a low debt and a twin surplus looks less sensitive to external shocks than in the past.

As in recent weeks a flow of rather hot news was unable to ease the concerns about slowing economic growth worldwide, Russia was not in the spotlight. Indeed, such issues as burning rainforests in Brazil, continuous attempts by the UK government to invent a new recipe of a Full English Brexit, looked more important than Russia-related events. Hot news has been regularly coming from the other side of the Atlantic where the US government continued to generate its own ground-breaking ideas (buying Greenland and imposing new series of trade tariffs on China are just two of them). The world economic order started to crumble in recent years without Russia’s active involvement as in recent years a number of innovative “deals”, such as those related to the aforementioned trade disputes between the US and China or USMCA replacing NAFTA, have been put on the table to get rid of established arrangements. A new “better deal” was promised by the US to the UK once it leaves the EU.

The global economic recovery seen in the aftermath of the 2008–2009 economic crisis already looked fragile as it was based on monetary populism, increased debt levels and lower interest rates, which naturally limits the ability of the monetary authorities worldwide to provide more stimulus going forward. Increased wealth inequality was another side effect of the monetary populism in recent years. As a result, amid already inflated stock and bond prices investors of all sorts want to see more monetary stimulus. It now looks as though financial markets overall (and some countries as well) fully fit the concept of “too big to fail”, previously attributed to a limited number of financial institutions. Therefore, it looks increasingly likely that more stimulus will come – both from the Fed and the ECB. The US president has recently hinted that the Fed should cut the rate by another 100 bps. Meanwhile, bringing the US treasury yields closer to zero, issuing more debt and buying real assets, such as [Green]land, look very logical and straightforward trade ideas.

As it is known, the road to hell is paved with good intentions. It is not surprising that monetary populism which caused wealth inequality to increase became a fertile soil for populism in politics. However, the result was not in favor of traditional social-democratic and other parties with similar views, whose leaders still appeal to traditional working-class people, but in favor of some relatively new parties, such as AfD in Germany, while the electoral base of traditional left-wing parties shrank as the working class itself evolved amid changing economic landscape. Italy and France are other examples where traditional left-wing parties lost some support in recent years. These changes contribute to increased political risks worldwide.

In this regard it is worth quoting Goethe’s Faust (Vers 1336): “Faust: …Nun gut wer bist du denn? / Mephistopheles: Ein Teil von jener Kraft, die stets das Böse will und stets das Gute schafft”, which in English sound a bit less poetic “Faust: …Well, what are you then? / Mephistopheles: Part of the Power that always wills the Evil and always works the Good.” Looking at what happens these days worldwide it makes sense to rephrase Mephistopheles’ words in a different fashion: “(I’m) Part of the Power that always wills the Good, and always works the Evil”, or maybe not “always”, but quite often.

Indeed, the trade dispute between the US and China which stems from the populist concept “America First” (“America über alles,” as it would sound in German) will make good neither for US, not for China or Europe (the latter suffers from the weaker Chinese currency and reduced imports) as the Chinese current account has already shrank quite significantly in recent years and limiting Chinese exports to the US by higher tariffs eventually can only weaken the yuan further irrespective of whether China is labelled “currency manipulator” or not. A weaker currency will make Chinese goods cheaper and can be supportive to Chinese growth. Therefore, it is likely that the US-China trade dispute will be sorted out in not so distant future as it just makes little sense. Given that the current account in the EU19 (euro area) is strong, it would not be surprising to see trade disputes unfold between the US and Europe sooner rather than later.

Similarly, a “better deal” between the US and the UK, namely between the two twin deficit countries (current account and fiscal), on the back of the “America First” concept will most likely mean more US exports to the UK amid lower tariffs and a weaker pound. It cannot be ruled out that eventually the weaker pounds may also be supportive for the UK economic growth, but this effect can be seen only after the smoke coming from the kitchen where the Full English Brexit is being cooked has cleared.

Brazil’s similar approach “Brazil First” (i. e. chopping and burning the rainforest for the benefits of Brazilian mining and farming, causing an inevitable impact on climate change) could eventually reach a tipping point triggering more attention to such issues as climate change, environment protection and respective responsibility of nations with regard to these issues, which are closely tied to global trade. In recent years these issues have been overshadowed by populism and egoism of selected countries and no easy immediate solution can be found. Indeed, why the developed nations have the right to pressure the governments in developing countries and restrain their economic growth as the latter countries want to utilize their natural resources in full extent and in a similar way as developed countries did in the past having chopped their own forests in favor of shipbuilding and agriculture and not paying much attention to such issues as biodiversity? Nations have to agree on economically sensible terms to protect the nature of resource-rich countries from excessive use.

Unsurprisingly that even though Russia had its own wildfires in Siberia, the Russian affairs looked less important in such global context – if to consider economic and financial issues. One recent exemption was a rather useless debate among the G7 leaders on whether to invite Russia at some point to such a gathering or not, but it was not Russia’s initiative. There is no doubt that the Russian administration has made very obvious conclusions from the developments of recent years. As the country was labelled “an adversary” by the US lawmakers meaning that current (and forthcoming) sanctions will remain “perpetual”, while the EU no longer sees Russia as a strategic partner the Russian side can no longer rely on the West and trust it in the foreseeable future. President Trump rightly pointed out that even if Russia is invited to attend the G7 meeting in the US, there are no guarantees that it will accept the invitation.

Overall, it would not be surprising to see the Russian government paying much more attention to domestic economic issues, where the picture does not look great. The July statistics looked unimpressive and pointed to no change in trends, such as muddling through with the rate of economic growth between 1% and 2%. It was reported that the y-o-y GDP growth accelerated in 2Q19 to 0.9% from 0.5% in 1Q19 and is expected to be a bit higher for the full year. Previously, GKEM Analytica raised some concerns about the reliability of these data as performance of some sectors, such as wholesale trade, looked understated this year as it was overstated in 1Q18 having created a high base effect.

Such inconsistencies may emerge if the structure of industry undergoes some radical transformation during the calendar year as it has probably happened with the wholesale trade in 2018. Imports grew rapidly y-o-y in 1H18, but then started to contract, leaving more room for domestically produced goods to be traded on the local market. Similarly, it now looks that the construction sector performs better than the 0.1% y-o-y growth reported in 7M19. Indeed, even though production of bricks and some other building materials looks weak, production of cement, ready-to-pour concrete, asphalt mixes for road construction was up y-o-y by respective 10.2%, 20.8% and 7.3%. It looks as though road construction this year keeps growing fast, while housing construction lags behind. To some extent this situation looks similar to that of a year ago, when the weak construction activity data was suddenly and strongly revised up, bringing the GDP growth up to 2.3%, which was impossible to foresee until December 2018 on the basis of available data.

Therefore, one cannot rule out that the macro statistics, as well as some sectoral data, could be revised up this year as it looks rather strange that amid the aforementioned 0.5-0.9% reported GDP growth and decelerating inflation (having peaked at near 5.5% in 1Q19) the non-oil tax collection was up by an impressive 15.0% y-o-y in 7M19, which well exceeds the additional revenues originating from the increased VAT. Of course, possible statistical revisions will not look groundbreaking, but they can support the view that Russia keeps muddling through on its own with the rate of GDP growth between 1.0 and 2.0%. A strong non-oil revenue flow will secure a big federal budget surplus this year despite the fact that the Brent oil price fell from over $70/bbl in spring to below $60/bbl in August. Overall, Russia with its unimpressive economic performance but a low debt and a twin surplus looks less sensitive to external shocks than in the past.

At the same time domestic private consumption remains sluggish as retail trade looks weakening having grown by a mere y-o-y 1.6% in 7M19 and 1.0% in July. So far it looks as though the y-o-y growth will not change much until year-end causing a further y-o-y deceleration on a cumulative basis. So far, the existing trends point to no meaningful acceleration next year.

Russia in Global Context: Resilient to Shocks, But Growing Slowly 1

However, a less hawkish macroeconomic policy, such as a moderate increase in government spending (assuming it is channeled to the right places and spent efficiently) and lower interest rates could break this negative trend. The aggregate statistics on banks’ interest rates is lagging and only the June numbers are currently available, but there have been reports that some banks also cut mortgage rates in the aftermath of the CBR’s recent rate cut.

It is likely that the y-o-y inflation will fall close to 4.3% in August and well below 4.0% by year-end which will give the CBR a better opportunity to orchestrate more rate cuts going forward, especially given that more stimulating policy is expected from the Fed and later from the ECB as the inflation in Eurozone fell to 1.0% while Germany, Europe’s largest economy, is likely to enter a technical recession in 3Q19. In this environment the Russian Central bank can help the economy to muddle through by cutting the key rate by another 75bp by year-end to 6.5%. If it happens, then economic growth may be higher next year than in 2019. So far, however, trends in such important sectors as industry, agriculture and the aforementioned retail trade (chart above) point to a deceleration in 2020. As growth in agriculture is likely to accelerate this year and production will be strong, a deceleration would be natural next year. Construction can benefit from lower rates next year. It is expected to grow this year by around 1-2% (on the basis of currently available statistics), but next year this sector is expected to deliver a better performance.

Overall, amid weakening global economic growth Russia’s only chance to maintain its own growth at a reasonable rate is to pay more attention to domestic issues, including enabling household consumption to expand steadily.

Data provider: Cbonds

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