Vladimir Tikhomirov of UralSib -

New global trends...

Over the past few weeks, a number of significant new macroeconomic developments have begun to unfold both within and outside Russia. These developments include the recent rise in the cost of borrowing triggered by the US sub-prime mortgage crisis, a significant strengthening of global inflationary pressures, increased concerns over global economic growth prospects, the rapid depreciation of the US dollar, and rising volatility in currency exchange rates.

...have prompted us to revisit our macroeconomic forecasts

We expect these developments to have a major, long-lasting impact on Russia's economic growth prospects, and this has prompted us to review our short and medium-term macroeconomic forecasts. We now anticipate higher short- and medium-term inflation, more moderate industrial output and GDP growth rates, weaker private investment (but stronger public investment), lower real income growth and personal consumption rates, a stronger real ruble exchange rate, higher federal government spending and a lower budget surplus, and higher trade and current account surpluses as a result of stronger crude oil prices and slowing import growth.

Long-term economic stability assured

We remain confident that the new developments will not undermine the stability of Russia's economy and financial system, but nevertheless we now expect more modest economic growth than we had forecast earlier.

But growth drivers could change

Our new macroeconomic forecasts contain important implications for the equity market. Our macroeconomic scenario suggests possible problems in consumer-related themes, as we believe the growth prospects in these sectors may be constrained by lower consumer demand. While we generally retain a positive outlook on growth in the metals and engineering sectors, as growing domestic demand should offset potential downside from a global slowdown, we also believe companies likely to win large state contracts have significant potential. We are now more bullish on the long-term prospects for the oil price than before and believe this should lend considerable support to Russia's public finances; however, stronger oil prices are likely to have only a marginally positive impact on medium-term growth in the Russian energy sector, which will continue to operate under a heavy tax burden.

No global meltdown

We do not share the pessimism of some other economists that a widespread financial crisis and global market meltdown are inevitable. Nevertheless, we have clearly witnessed a number of new developments this year that are likely to define global development trends for the next few years at least.

But a sea change has taken place

In our view, the most important of the new developments are: -- Escalating inflationary pressure. The global economy has proven resilient to booming commodity prices for a surprisingly long period, but this resilience now appears to be finally coming to an end. Rising prices for energy and other basic commodities can no longer be offset by falling labour costs. Moreover, in light of mounting economic and political pressure on emerging market countries to appreciate their currencies, growing labour costs in these global sweatshops are likely to accelerate in the coming years. In addition, inflationary pressures are on the rise in the global agricultural sector, which until recently had to a large extent managed to absorb non-food commodity price hikes at the expense of lower margins. Inflation is becoming a global problem, meaning that attempts by any single government to protect its economy from inflation through the use of administrative controls are unlikely to succeed in the long run. Economies will have to adjust to higher global prices, but in countries where core inflation is running at a higher pace, such as Russia, this adjustment may prove far more painful and protracted.

--Higher liquidity costs. There are a limited number of ways in which monetary authorities worldwide can respond to rising inflation; certainly, raising interest rates is one of the most obvious. Over the past 2 1/2 months we have witnessed a substantial increase in the cost of borrowing, but this has been driven more by a correction of existing market imbalances (such as banks' exposure to the US sub-prime mortgage market) rather than by any concerted attempt to control the spread of inflation. However, we believe the ongoing global credit squeeze is unlikely to disappear anytime soon, as central banks all over the world are likely to support higher borrowing costs through higher interest rates as soon as the US subprime crisis begins to ease.

More expensive liquidity is clearly bad news for many countries - including many emerging market economies - that have come to rely on cheap foreign liquidity to fund growth. Rising interest rates could also have a major detrimental effect on the growth prospects of the developed economies, where a downturn in house prices and consumption levels could come as bad news for both domestic and global growth prospects.

--Global growth worries. This combination of higher inflation and more expensive credit is certain to act as a brake on global growth. We are not convinced by the argument that booming domestic growth in many emerging economies, such as China and India, can protect those countries from the effects of a global slowdown, as a large part of their wealth creation is directly dependent on exports to and consumption levels in the developed world. Indeed, it is hard to find an economy that would be immune from a global slowdown, and the BRIC economies would certainly not be among their number.

--Rise of protectionism. We believe increased global economic turbulence is likely to be accompanied by governments attempting to protect their economies from negative influences stemming from foreign markets. A rising protectionist trend has already become evident in many countries. The upshot could be greater use of administrative controls over domestic and foreign trade, increased currency rate manipulations, and growing state intervention in the economy and in investment. Higher inflation and liquidity woes could further increase the temptation to intervene in the economy, particularly in countries where the state has traditionally played a leading role, such as former communist societies. If these trends persist, they could halt the development of a global free trade system and even harm the financial stability of countries that are currently among the leaders in terms of international reserves.

Vladimir Tikhomirov is Chief Economist at UralSib in Russia

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