Fair weather for Russia's economy

By bne IntelliNews June 20, 2007

Graham Stack in Berlin -

Much of the data for Russia's economy in the first half of this year have been awful: oil prices fell, gas and oil production slumped, the ruble continues to appreciate, and imports are flooding in while exports are slowing. A nightmare for the Russian economy? Pinch yourself – economic growth is surging towards 8%.

GDP growth for the last quarter of 2006 hit a whopping 7.8%, and for the first quarter of 2007 topped even that to reach 7.9%, according to figures just published by Rosstat.

And this despite growth in exports dropping like a stone, to just 7% in Jan-April from 30% in the same period of 2006. At the same time, imports from outside the CIS were up by more than half to $56.5bn. Things like shoes and textiles were up a massive 90% in May as foreign-made goods turn up the temperature on domestic manufacturers. So is Russia finally shaking the commodity export habit?

The big change underlying the robust performance of the economy, despite the tightening competitive conditions, was this year's mild winter, the warmest for decades. Last year, the winter was so cold it made the Russians regret that no one was invading them.

Why does the weather matter so much? Because of the construction boom just getting off the ground in Russia. Construction is where the population’s growing income is most likely to hook up with local industry and suppliers. There is unquenchable demand for new housing and housing blocks, which unlike mobile phones can't easily be satisfied through imports.

So is the whole thing a statistical anomaly, caused by construction freezing one winter and then shooting up the next?

Not really. Construction growth in last quarter of 2006 and the first quarter of this year averaged 23.5%. And just over 45% more housing was built in the period Jan-April from a year ago.

The construction industry is not just about building sites, but also about the industrial sectors supplying them, so the economy is benefiting from the construction "trickle-down" effect. Production of window glass, cement, panels, steel piping and other metal products for construction all boomed. Production of cranes, bulldozers, lifts and excavators boasted growth rates between 20% and 70%. So construction is feeding Russian industrial output – which soared statistically during the warm winter.

The other half of the story is a strengthening in investment. The Russian government, and to a lesser extent the World Bank, have pointed enthusiastically to a sharp rise in domestic fixed-capital investment as driving growth in Russia.

After more than a decade of lacklustre 12% average growth, fixed investment surged by 19.9% in the first four months of 2007 and continued to rise this spring between March and April. This suggests, according to the World Bank, that investment growth in 2007 could beat the record of 17.4% set in the annus mirabilis of 2000 when Russia's GDP grew by an astronomical 10.4%. This result is all the more unexpected because 2007 is an election year – and political uncertainty should deter investment.

No one knows for sure what is driving the investment boom, and whether it will continue. The economy does appear to have reached a critical mass, but the tightening macroeconomic constraints could also easily take some of the shine off of recent results.

Finance Minister Alexei Kudrin said on Monday, June 18 that Russia's economy has now passed the pre-fall Soviet levels, but that investment is still not high enough to ensure Russia's long-term growth; so far this year total investment is 74% of the 1990 levels and the fixed investment shortfall is even greater.

However, domestic demand is continuing to grow rapidly, supported by aggressive retail banking and the state bumping up meagre loans and providing mortgage support. At the same time, a massive state spending programme on infrastructure that is already running into the hundreds of billions of dollars will give the economy a Keynesian shot in the arm.

The picture will become clearer in the second quarter. The results will not just be of interest to investors and economists. If these growth rates hold for the rest of the year, then Russia is looking at 7%-plus GDP growth for 2007 - a very convenient figure for the powers that be. For 7.2% is the magic number by which the economy must grow to meet Putin’s target of doubling by 2010. This is Putin’s final year in office. If his target is met, and the holy cow of diversification finally even appears on the horizon, then he will be able to leave office claiming mission accomplished - and usher in his successor.

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