Alexei Moisseev of Renaissance Capital -
In recent months, numerous prophets of doom have emerged to call an imminent apocalypse for the global economy. Many have focused on some of its weakest links, with Russia - having two consecutive quarters of approximate -10% GDP contraction under its belt - being cited among the key suspects.
As time has progressed, the reality, as always, has proven much more complex, with most global economies showing a mix of positive and negative data. Somehow, the focus in Russia's case has been more on the negatives, which may be understandable given investors' disappointment with the former star performer falling so far, so quickly. However, a significant proportion of recent data suggests things are finally turning around. In this report, we set out our view of the key positive signals (often referred to these days as green shoots), and assess the mechanics of the severe economic contraction witnessed in Russia over the first quarter. We start with the latter.
Green shoots are visible, when should we expect them to bear fruit? We believe the data presented in this report demonstrate that even in the harsh economic conditions facing countries such as Russia, green shoots have found fertile soil and are now clearly visible. However, the northern spring is notoriously unstable, and green shoots can be wiped out with the return of the frost. Looking at Russia today, we think a recovery, as it stands, has been largely enabled by a rebound in world commodity prices and the abundance of money globally - with these two factors perhaps not entirely independent of each other. If either turns - with commodity prices falling back, or global central banks reining-in monetary policy slack sooner rather than later - Russia will probably enter a prolonged period of stagnation. However, neither event informs our base-case scenario: we expect that, once the unfavourable base effect is behind us - perhaps in the fourth quarter, and certainly in the first of 2010 - Russia will start to post solid, single-digit growth rates.
We have previously argued that the main reason for Russia's GDP declining by a far greater degree than that of its peers was the planned devaluation of the rouble. As we have repeatedly noted, this resulted in the cost of money going through the roof at a time when capital markets were completely shut. Rosstat has now published data indicating that very expensive money resulted in massive de-stocking - partially, we note, due to a very aggressive build-up of inventories in the first half of 2008. Indeed, the Russian economy started to experience a crisis of overproduction as early as 1Q08, at which point inventories stood at about 150% of their 1Q07 level. The trend was maintained over 2Q08-3Q08 (in fact, in 2Q08, inventories grew at double the rate of 2Q07). Therefore, it was only natural for widespread de-stocking to begin in 4Q08 (reaching double the scale of the seasonal de-stocking recorded in 2007). The trend intensified in 1Q09, with the negative contribution to GDP in this quarter exceeding 7 ppts of a total decline of 9.8%, on our estimates. Figure 1 presents a comparison of the headline GDP figures with our estimate of what the GDP growth rates would have been had inventories remained stable. We conclude from this that:
1) Some of the damage done to the economy has resulted from overheating in 1H08
2) Some of the damage will be easy to recover
Unfortunately, Rosstat releases inventory statistics with a significant delay, so we have no way of knowing what has been happening since, but historical experience suggests de-stocking cannot last for longer than two-to-three quarters. Furthermore, money has become more available to the real sector over the summer, so we expect some re-stocking in 3Q09 to contribute positively to GDP growth.
Real performance vs base effect
Looking at GDP, industrial production and other figures coming out of Russia, we note a host of double-digit declines. However, a closer look reveals that most, if not all of these took place in 4Q08-1Q09, while 2Q09 and more recent releases look dreadful simply because of the base effect. For example, YoY industrial production data for July 2009 compare this July's production with the pre-crisis July 2008. This clearly reflects that, in the winter of 2008-2009, the economy fell off a cliff. However, what the numbers might suggest is that this fall continued into 2Q09. The fact that GDP fell 10.4% in 2Q does not mean it continued to decline; rather it simply means it is still being compared with the pre-crisis level. In fact as Figure 2 indicates, GDP has clearly bottomed out, and 2Q has even shown a pick-up (although largely seasonal) relative to 1Q09.
This picture is even clearer if one looks at industrial production figures. On a seasonally adjusted basis, the resumption of growth coincided with a decline in interest rates in May, and picked up in earnest in June, and in particular July (see Figure 3).
Furthermore, some sectors that we regard as particularly indicative have started to report improving figures. We note the rail sector, which is responsible for 60% of total non-pipeline cargo transportation in Russia, and which we regard as a good proxy for the level of non-oil and gas economic activity; the metals sector, which, arguably, was the worst hit globally; besides, perhaps, the financial services and the natural gas sectors, which were very badly hit early this year. Furthermore, some sectors that we regard as particularly indicative have started to report improving figures. We note the rail sector, which is responsible for 60% of total non-pipeline cargo transportation in Russia, and which we regard as a good proxy for the level of non-oil and gas economic activity; the metals sector, which, arguably, was the worst hit globally; besides, perhaps, the financial services and the natural gas sectors, which were very badly hit early this year.
Rail cargo loadings slumped by one-third YoY in January, but there has since emerged a clear trend of improvement. Even though the base effect is still unfavourable - and we expect it to remain so until 4Q09 - the rapidly declining rate of YoY contraction implies a de facto positive trend (see Figure 4).
The metals sector experienced a trough around Dec 2008-Jan 2009, but has since shown a clear rebound - both in terms of capacity utilisation, which has demonstrated a near-linear pick-up, and production, which has been showing positive (seasonally adjusted) MoM growth rates since April (see Figure 5).
Furthermore, gas production by Gazprom was badly hit at the beginning of this year by two important, but technical and temporary, factors: the annual transit conflict with Ukraine, and the phenomenon of spot gas prices in Europe being much lower than the formula prices embedded in Gazprom's long-term supply contracts with European offtakers. The transit conflict has been resolved, and Ukraine is now actively stocking up on its inventory in underground storage, which must ensure uninterrupted flow to Europe until at least the year-end. The long-term pricing premium has almost been eliminated since the oil-price collapse is now in the relatively distant past - enough to accommodate the correction in the formula that includes a six-to-nine-month lag to spot prices. With both factors removed, gas production is also recovering very quickly (see Figure 6).
Consumer hit but maybe not as hard as it seems
The other side of the supply and demand equation, the consumer, has also been perceived as having been hit very hard. Indeed, this was the case at the beginning of this year, but we saw a fairly quick recovery as the government stepped up social spending, in particular, having:
--Increased unemployment benefits 60%
--Increased military salaries 18%
--Increased pensions 8.5% as of 1 Mar
--Increased public sector salaries by a total of 30% in three tranches - in January, May and a final planned step in September
All these measures contributed to a recovery in the real disposable incomes index, which will be further enhanced by a planned 26.5% increase in pensions as of 1 Dec. These steps also proved instrumental in allowing avoiding a significant meltdown in real wages. As a result, retail sales, while still stagnating in seasonally adjusted terms, at least stopped falling in May following more than half a year of uninterrupted decline (see Figure 7).
The final cheerful piece of macro data we note is the unemployment rate, which seems to have shown some material reduction in recent months. We suggest a number of reasons for such a performance. One important factor is the combination of increased benefits (see above) and efforts by the authorities - de-jure unemployment has moved closer to de-facto unemployment. During all 18 transition years, Russian employers favoured stopping salaries or obliging employees to take unpaid leave, rather than making them redundant. Both President Dmitry Medvedev and Prime Minister Vladimir Putin moved decisively to stop this practice earlier this year, while a slightly more meaningful level of benefits increased workers' incentive to leave their jobs if wages were not being paid. While this is really the reason behind a sharp spike in unemployment, we think the reduction in unemployment is mainly related to the fact that - as per anecdotal evidence in sectors such as metals and financial services - initial redundancies were excessive, and some of these jobs have returned.
Finance turning corner
After a nine-month lending contraction in the Russian banking system, July finally brought some signs of reversal of this negative trend. Although we believe it is still too early to forecast loan market expansion rates to return anywhere close to pre-crisis levels, we think the turning point has most likely been passed. We also expect that towards the end of 2009, banks will gradually expand their credit exposure to the real economy (via loans and capital market instruments). The following key points summarise why we remain optimistic about the banking system's propensity to lend to the real economy.
VTB reported a sharp (+8%, [$2.7bn]) monthly increase in its corporate loan book in July. Apparently, such significant growth was largely driven by Putin's request to the state-owned banks to increase the amount of resources provided to the real economy by up to RUB500bn over three months. According to press reports and VTB management comments, most of the loans which contributed to a significant portfolio growth in July were granted to some of the largest Russian corporate borrowers. Unlike VTB, Sberbank reported a RUB32bn loan book decrease for July.
However, according to management, this largely reflects large-ticket loan repayments by Transneft, which recently received a significant cash injection from Chinese lenders. At the same time, according to the largest lender's balance-sheet data, the bank has significantly accelerated new loan originations in July and, according to management, has continued this policy into August. Therefore, we believe it is reasonable to expect Sberbank's loan book to resume growth in the coming months.
Alexei Moisseev, chief economist, Renaissance Capital
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