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Russia Economy – May 2012

Source: OPEC 6/9/2012, Location: Asia

In his speech to parliament on 11 April, Vladimir Putin set out the priorities for his new presidential term: halting the decline in Russia's population; developing the Russian Far East; and creating 25 million high-skilled jobs. He announced that the federal budget would be in balance by 2015. The use of any windfalls from oil and gas revenue would be restricted under new fiscal rules. Noting that, among the G8 economies, Russia had the fastest growth rate and was the only one not running a budget deficit, he predicted that Russia would become one of the world's five largest economies, measured at purchasing power parities, in two or three years.

However, real GDP growth slowed to 3.2% in March, down from 4.8% in February and 3.9% in January. Other recent economic data also point to weakening growth momentum. Export demand remains weak and investment growth has slowed, reflecting weak construction activity. Investment spending growth slowed to 4.9% year-on-year in March, from an average of 15% in the first two months of the year (EIU, May 2012).

It seems that high oil prices have reduced the motivation for reform in Russia. On the one hand, Russia is set to join the World Trade Organization (WTO) in 2012, and there have been some promises of reforms, and, on the other hand, a vision set out by Mr Putin endorses state capitalism, citing China and South Korea as examples.

Although he has defended the state corporations created under his rule, however, Mr Putin has also supported policies such as privatization, WTO entry, improving the business climate and pension reform. The budget's reliance on oil has increased greatly. From 3.6% of GDP in 2007, the non-oil budget deficit widened to 13.9% of GDP in 2009 and has since narrowed only modestly. Additional expenditure on defence, public-sector workers' pay and pensions means that Russia would require oil price of about $120/b to balance its budget in 2012, up from only $55/b in 2007.

The original 2011 budget plan expected a deficit of nearly 4% of GDP, but high oil prices boosted tax revenue well above the budget forecast. The price of Urals Blend crude averaged $109.5/barrel in 2011, well above the budget assumption of $75/b. This helped the budget to return to a surplus, at 0.8% of GDP. The government boosted spending pledges in the run-up to the presidential election. According to official medium-term fiscal projections, the non-oil deficit is expected to be about 10% of GDP over the coming three years.

According to estimates from the Ministry of Economic Development, annual real GDP growth slowed in March to 3.2%, from 4.8% in February and 3.9% in January. On a seasonally adjusted basis, monthly GDP fell by 0.6% in March, after increasing by 0.5% in February. Other recent economic data also points to weakening growth momentum.

Export demand remains weak and investment growth has slowed markedly, reflecting weak construction activity. Investment spending growth slowed to 4.9% year on-year in March, compared with average growth of 15% in the first two months of the year. The volume of seasonally adjusted retail sales in March remained unchanged from February, and retail sales for the first quarter were flat, compared with the final quarter of 2011. Growth in real household incomes was stagnant in the first quarter. Year-on-year industrial output growth fell to 2% in March from 6.5% in February.

In March, there was a seasonally adjusted decline of 1.2% on the previous month. Manufacturing output growth fell to the lowest rate for over 12 months, rising by just 2.4% year on year. It should be noted, however, that the extent of the apparent slowdown in March has been slightly exaggerated by the fact that output in February was boosted by an extra working day caused by the leap year, while, in March, there was one less working day, compared with the same month in 2011.

In December 2011, the Russian Central Bank (RCB) cut the refinancing rate from 8.25% to 8%. At the same time, the repo rate, which is the key rate for providing liquidity to the banking system, remained unchanged at 5.25%. As inflation has decelerated, the RCB's concerns have shifted towards risks to growth.

However, the RCB seems committed to its 2012 inflation target of 5–6%, and inflationary risks stem from a tight labour market. The decline in inflation is thus unlikely to lead to near-term cuts in interest rates. The RCB left base rates unchanged at its meetings in February, March and April. It sees the recent decline in inflation as being the result of delays in increasing regulated tariffs until July (instead of January, as usual), as well as a rouble appreciation. The RCB is also cautious because consumer lending is expanding.

The growth prospects for the Russian economy will remain dependent on international commodity prices. The economy expanded robustly in 2011, driven by strong private consumption growth. Real GDP rose by 4.2, well below rates before the recession of 2009. It is estimated that economic growth will decelerate in 2012 to a forecast 3.7%, as global economic growth slows.

Part of the reason for the relatively robust GDP growth in 2011 was strong growth in agricultural output. However, this was a recovery from a poor performance in 2010. Also global financial turbulence is expected to affect investment and consumer expectations in Russia. The share of fixed investment in GDP is much lower than in many emerging markets. Impediments to faster growth include a relatively weak banking sector, the economy's high and growing dependence on natural resource sectors and manifold institutional weaknesses. Energy output growth will remain sluggish, with oil companies struggling to increase production as existing fields are depleted and recovery becomes more difficult (EIU, May 2012).

Despite the weakening of the rouble, inflation decelerated in late 2011, mainly because of falling food prices. Year-on-year consumer price inflation fell to 6% at the end of 2011 (although the annual average inflation, at 8.4%, was higher than in 2010). Russia, like other emerging economies, experienced a weakening of its currency in reaction to the uncertain global outlook and flight from risk. At the end of 2011, the value of the rouble against its euro/US dollar currency basket was down by nearly 4%, compared with the start of the year.

The low point was in early October, when the rouble was 14% below its 2011 peak, which was reached in July. In 2011, Russia recorded a trade surplus of $198.4 bn, which helped push the current account surplus above $100 bn. This was the result mainly of a 34% increase in exports of oil and gas, although other exports rose by nearly 24% year-on-year. In contrast to the improving trade in goods balance, trade in services moved deeper into deficit, with payments for services approaching $100 bn. The rapid growth in transactions on the services account testifies to the increasing openness in the economy, although Russia pays nearly twice as much for services as it earns.

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