Forecasting Russia – Reconcile the Incompatible

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( 12 mins read )

The recently released set of Russia’s monthly statistics produced a mixed impression, not only because some segments of the economy performed quite well while others lagged behind, but also due to the fact that some statistical data look puzzling and are not immune from mutual contradictions. The latter complicates forecasting and at a glance it remains unclear where the overall economy is heading, as trends in some segments look upward while others indicators point downward. There are reasons to believe that once again the official statistics was unable to capture structural changes occurring in some segments of the economy, such as retail and construction.

All in all, recent statistical numbers and some of the logical inconsistencies between them raise doubts about whether Russia’s growth was so poor in 1H19, as quarterly and monthly statistics looks unusually volatile and inconsistent. The recent statistical releases support GKEM Analytica’s earlier view that the annual growth this year will be better than many forecasts suggest, while in 2018 the GDP growth was probably a bit slower than the official 2.3%. It looks as though the Russian economy is still drifting sideways rather than decelerating.

  • Rosstat reported that industrial production was up 3.0% y-o-y in September and 2.7% in 9M19, which clearly pointed to an acceleration. An accelerating trend was seen in case of agriculture (up 5.6% and 3.6% in September and 9M19, respectively). The basic sectors output (an aggregate measure of output in industry, trade, agriculture, construction and transport which is often considered as a monthly proxy for GDP) was up 2.9% and 1.8% over the same periods.
  • Meanwhile the retail sales y-o-y growth reportedly decelerated from 1.9% in 1Q19 to 1.6% in 2Q19 and to 0.8% in 3Q19. Consumer services, which is another essential part of household consumption, were steadily down yo-y, namely by 0.6%, 1.0% and 0.4% in 1Q19 to 3Q19, respectively. At the same time Rosstat recently released its first estimate of the 2Q19 GDP by end use and, surprisingly, the reported rate of household consumption growth rapidly accelerated in the second quarter – to 2.8% y-o-y, and was in stark contrast to a poor performance of retail trade and consumer services.
  • Based on the available statistics and observations, the economic growth in the year 2019 can be forecast between the 1.5% and 2.0%. The currently available statistics and greater public spending in 2H19 allow to anticipate a GDP growth close to 1.5% (as the y-o-y growth in 3Q19 and 4Q19 may eventually exceed 2.0%). However, once the 1Q19 and 2Q19 GDP numbers are revised up, which GKEM Analytica expects to happen at some point, then full year’s growth in 2019 may be closer to 2%. A similar rate of growth can be expected next year as well.

As it often happens, the recently released set of Russia’s monthly statistics produced a mixed impression, not only because some segments of the economy performed quite well while others lagged behind, but also due to the fact that some statistical data look puzzling and are not immune from mutual contradictions. The latter complicates forecasting and it remains unclear where the overall economy is heading, as trends in some segments look upward while others indicators point downward.

Rosstat reported that industrial production was up 3.0% y-o-y in September and 2.7% in 9M19, which clearly pointed to acceleration. The same accelerating trend was seen in case of agriculture (up 5.6% and 3.6% in September and 9M19, respectively) and real wages (2.4% and 2.2%). The basic sectors output (an aggregate measure of output in industry, trade, agriculture, construction and transport which is often considered as a monthly proxy for GDP) was up 2.9% and 1.8% over the same periods. Statistically strong growth in the five basic sectors was also supported by a kind of recovery of the yo-y growth in the wholesale trade segment, which was reportedly down 6.3% y-o-y in 1Q19, 1.8% in 2Q and up 3.8% in 3Q19 (4.6% in September alone). GKEM Analytica previously broached this issue and concluded that wholesale statistics had been incorrect in 2018 and in 1H19 as it had been distorted by base effects. Hence GKEM Analytica expects 2H19 wholesale data to become much stronger (and later on, say, at some point in mid-2020 the 1Q19 numbers are expected to be revised along with the GDP statistics as well).

From the very start of the year Rosstat reported that the retail sales y-o-y growth steadily decelerated from 1.9% in 1Q19 to 1.6% in 2Q19 and to 0.8% in 3Q19 (and was reported even weaker in September alone – just 0.7%). Strangely, this deceleration of real growth occurred on the back of a rapidly decelerating inflation. Consumer services, which is another essential part of household consumption, were steadily down y-o-y, namely by 0.6%, 1.0% and 0.4% in 1Q19 to 3Q19, respectively. These two indicators (retail trade and services) represent the bulk of household consumption and they account for roughly 75% and 25% of its combined volume in nominal terms, respectively. Therefore, an aggregate household consumption as a category of national accounts, which is a major component of the end-use GDP structure, should generally drift at a rate roughly equal to the weighted average growth of the former two indicators.

Rosstat recently released its first estimate of the 2Q19 GDP by end use (see table below) and, surprisingly, the reported rate of household consumption growth rapidly accelerated in the second quarter – to 2.8% y-o-y and performed much better than retail trade and consumer services. Generally, retail sales in Russia can be viewed as a decent proxy of domestic consumption of goods – in contrast to smaller countries with a strong tourism business where retail is very seasonal – going up in high season and down in the low season, and breaking this trend in some years either due to politics, or climate, or whatever reasons. This is definitely not applicable in Russia’s case – also not least because the aforementioned numbers are y-o-y. Also, domestic household consumption as a category of national accounts includes consumption in kind, such as home-grown fruits and vegetables, but a second quarter is clearly not a harvesting season in Russia, and therefore this idea cannot help resolve the aforementioned puzzle.

Forecasting Russia - Reconcile the Incompatible 1

Hence the question – is Russia’s household consumption decelerating or accelerating? Unfortunately, official statistics does not give a clear and convincing answer so that loading these data in some model to derive a 2020 forecast could get it stuck as its equations may have no solutions. Note that even though household consumption as part of GDP is not that high in Russia as in the US, it makes up around half of Russia’s GDP, and so it is still important to understand whether (and how) it changes direction. Therefore, it is highly desirable to find at least some explanation of why the aforementioned puzzle appeared and what the reality may look like.

Meanwhile, as the official Rosstat 3Q19 GDP figures are not available yet, the Economy Ministry released its own GDP growth estimate of 1.9%, pointing to a clear acceleration. If so, then it should probably imply a rather strong growth of household consumption in 3Q19 as well and thus a widening gap between consumption and decelerating retail.

The charts below illustrate that even though the rate of household consumption growth in recent years was normally somewhere between the rates of growth of retail trade and consumer services, which looks logical, there are some unexplainable exemptions. In 2017, for instance, there was an unexplainable acceleration of consumption growth while retail and services lagged far behind (more clearly seen on the right chart). A minor mismatch was seen in some quarters of 2018 as well. On top of that, there was too deep a fall of retail in 4Q16, which also does not match the household consumption number.\

Forecasting Russia - Reconcile the Incompatible 2

To seek some explanations of those inconsistencies, it makes sense to look at some other data and check how consumption matches production – for example, in the case of food products. The chart below shows the most recent trends in food retail sales and production of foodstuffs as reported by Rosstat. As seen from the chart, food production has clearly accelerated since the start of 2018, while food sales have been decelerating steadily. Even though food production has been rather volatile in 2019 it has been growing much faster than food retail sales since 2018. Russia increased exports of food in recent years, but not much enough to explain the gap between domestic sales and production.

Forecasting Russia - Reconcile the Incompatible 3

A very likely and at least partial explanation can be that the official statistics is often simply unable to capture rapid structural changes occurring in the economy. Last year, GKEM Analytica pointed to similar problems with construction statistics which reported sluggish growth in 2018, while production of major construction materials strongly increased (Rosstat revised construction statistics up later). Same problems are seen this year as well, as despite strong growth of production of various construction materials, such as ready-mix concrete, which is up 16.1% y-o-y in 9M19, construction activity is reportedly sluggish (just 0.3% growth over the same period). It looks as though this year Rosstat is unable to capture a kind of structural change within the construction sector, such as faster growth of road construction (production of asphalt mixes was up y-o-y by 7.4% in 9M19). This issue was also discussed a few months ago in one of the previous GKEM Analytica reports.

Investment statistics is now published on a quarterly basis only and with some lag. According to Rosstat, investment in production capacity was seemingly down in 1H19 (as it was down 2.6% y-o-y in 1Q19 and up 1.0% in 2Q19), as the chart below demonstrates. However, these numbers cannot be taken easily as well, i. e. without questions and reservations, as it looks very unusual that the y-o-y investment in production capacity was very low both in 4Q17 and 4Q18, especially because it was reported in the aftermath of a rather strong growth in all previous quarters of those years.

Forecasting Russia - Reconcile the Incompatible 4

Now it looks as though the retail sector were underestimated as it is also going through structural changes – increasingly more food delivery by online orders which is the case of ready-made food and basic food products as well. On top of that, the structure of food consumption may be changing as well. According to statistics, production of bread and cereals was down 1.6% and 1.5% y-o-y in 9M19, respectively, while meat production (not frozen) was up 7.7% At the same time, poultry production was down 3.1% y-o-y over the same period. The roots of this problem may stem from the exaggerated decline in food retail in 2015-2016 (reportedly, it was much deeper than in 2012, which looks rather strange), as Rosstat may have not been able to capture the structural changes in the sector properly, namely booming production of local food products amid declining imports.

Similar questions can be raised about non-food retail and production (adjusted to imports). However, this short note does not aim to come up with an accurate alternative estimate of construction activity or retail sales. It aims to draw attention to such issues and the headline numbers circulating in the media. Another objective is to understand Russia’s general macro trends more clearly by looking beyond the macro data.

Coming back to the table on the second page, it is worth mentioning that public consumption remained quite sluggish in 1H19, growing 0.2% y-o-y. This figure generally matches the federal budget expenditure growth over the same period (by around 5.1% y-o-y) as the difference between the nominal growth of expenditures and the real growth of public consumption is consistent with the reported inflation. However, public spending is set to grow by the end of the year to reach the budgeted 9.5% full-year increase. Public spending has already increased in recent months, which somehow supported GDP growth in 3Q19 and will support it in 4Q19.

All in all, recent statistical numbers and some of the aforementioned logical inconsistencies between them raise doubts about whether Russia’s growth was so poor in 1H19, as quarterly and monthly statistics looks unusually volatile and inconsistent. The recent statistical releases support GKEM Analytica’s earlier view that the annual growth this year will be better than many forecasts suggest while in 2018 the GDP growth was probably a bit slower than the official 2.3%. It looks as though the Russian economy is still drifting sideways rather than decelerating.

Based on the available statistics and observations, the economic growth in the year 2019 can be forecast between the 1.5% and 2.0%. The currently available statistics and greater public spending in 2H19 allow to anticipate a GDP growth close to 1.5% (as the y-o-y growth in 3Q19 and 4Q19 may eventually exceed 2.0%). However, once the 1Q19 and 2Q19 GDP numbers are revised up, which GKEM Analytica expects to happen at some point, then full year’s growth in 2019 may be closer to 2%. A similar rate of growth can be expected next year as well.

Detailed macroeconomic forecasts with quarterly upgrades by GKEM Analytica will be available by subscription.

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