Has the dramatic devaluation of the ruble killed off the Russian retail sector? It seems not – more foreign retailers opened new stores this year than last, according to a recent report by real estate consultancy Knight Frank.
Since the start of this year, 32 foreign brands have opened their first stores in Russia, with two-thirds targeting the middle classes and almost half of them (14) opening in the summer months between July to September. This is two more than the number of newcomers that arrived in the same period a year earlier, according to the report.
The openenings come despite an almost halving of the ruble/dollar exchange rate, the first fall in real incomes since President Vladimir Putin took office in 2000, and a deep economic recession that could see Russia’s economy contract by as much as 4% this year, according to the most pessimistic forecasts.
There is no doubt that the retail sector has been badly damaged by the economic storm. Foot traffic in Russian shopping malls was down 20% on year at the last peak Christmas shopping period and was down by 30% in September, another back-to-school peak shopping period, according to Watcom’s Shopping Index.
At the same time, sales of clothing and shoes stores fell by 19% in the first quarter of this year compared with the same period in 2014, according to the Russian textile association Soyuzlegprom. Between 5% and 7% of all clothes and shoe shops – a lot of which is imported – have shut down this year. “In big Russian cities, and most notably in Moscow, the number of shops has fallen by at least 5-7% [this year],” Igor Ulyanov, director of Soyuzlegprom, told Moskva, the city's official news agency.
Nevertheless, Knight Frank expects at least 12 more new foreign brands to enter the Russian market by the end of 2015, including KidZania, the famous children's edutainment chain.
So what is going on? Why would foreign retailers even contemplate moving into the Russian market if things are so bad? The answer is that while retail margins have fallen and the value of Russian sales are depressed by the devaluation of the ruble, the costs of setting up retail operations and the cost of Russian labour has also plunged, offsetting the negative factors.
Shopping swings and roundabouts
The attractions of Russian retail has now become the subject of a complicated interaction between the 'swings' of the value of the currency and falling volume of sales versus the 'roundabouts' of the falling cost of labour and tumbling retail space rental rates.
Headline Russian retail sales have been hurt by Russia’s economic downturn, but surprisingly they started to bounce back in the last two months – especially non-food sales – as the population adjusts to the new realities. Retail turnover was 9.1% lower in August than in the same month last year, according to the Rosstat state statistics service, but analysts say the rate it was contracting at slowed noticeably in the summer months.
However, the “new normal” is clearly below the previous oil-fuelled shopping binge that Russia enjoyed pre-crisis. The overall volume of retail sales has fallen from a peak of about $660bn set in 2012 to the $400bn expected by the end of the year. But that still makes Russia a top three European consumer market and profits vary in each of the retail subsectors. For example, while the luxury car manufacturers are scaling back their operations, both Ford and Volkswagen have announced new investments into their Russian production, and the German discount supermarket chain Euroshop announced it will enter the market this year.
The lower sales are offset by much lower costs: rents are down 20-40% after a record volume of high-end shopping space came on the market this year; projects started during the relatively benign 2011 and 2012 period came online in the first half of this year, adding 342,000 square metres (sqm) of new mall space to Moscow, up 41% from the same period a year earlier, to make Russia the fastest growing market in Europe in terms of new retail space added. The acres of empty space is a gift for would-be new store owners.
“The real estate sector is searching for a new equilibrium, after the artificial demand spikes in 2014, slide in real consumption and the recent thaw in mortgage origination,” says Maria Kolbina, an analyst with VTB Capital.
Average incomes were falling at the fastest rate in eight months this August, dropping by 6% alone from the pervious month – the steepest decline since the start of the year – to RUB31,870 ($485) per month. Pre-crisis, the average Russian was taking home about $850 a month in dollar terms. But salaries in ruble terms have fallen by far less: adjusted for inflation (currently 15.8% in annualized terms), the average wage in August was worth just 9.8% less than in the same month in 2014.
Given that Russians are easily the wealthiest citizens in the former Soviet bloc and actually better off than the average Portuguese pre-crisis, their ability to absorb the recent falls is much greater than many in the region; the change is not the binary “wealth to poverty” of the 1998 crisis, but more a question of becoming more budget-conscious and trimming little luxuries and foreign holidays from the household spending.
For the foreign retailer the falling labour costs in dollar terms has probably made the biggest difference: the average Russian employee now costs less than the average Chinese to employ for the first time ever.
Ruble exchange rate dynamics hurts trade and imports
The situation is also less dramatic when you dig into the exchange rate dynamics. Adding to everyone’s headaches, the ruble exchange rates against the dollar and euro have been extremely volatile in recent months due to the yo-yoing of the oil price. However, the value of the ruble has fallen a lot less against the euro than it has against the dollar – and Europe is the source of the bulk of Russia’s imports.
A big part of the ruble’s fall against the dollar has been due to the rapid strengthening of the dollar this year. The ruble’s weakening against the euro has been a lot milder: the real effective ruble rate against the Central Bank of Russia (CBR) basket of currencies weakened by a headline 18.6% on year in January-August compared with the same period of 2014, but it only weakened by 14.5% to the euro while plunging by 30% against the dollar. The fall in the cost of rent and labour almost entirely offsets the losses from the exchange rate.
The upshot of these dynamics is that the Russian retail market remains a viable concern for most retailers, but the focus has clearly changed from high-end luxury goods to cheap mass-market products.
The change in the value of the ruble is also visible in Russia’s trade dynamics, but these have conspired to leave Russia Inc as a profitable business, if viewed purely in terms of the cash the country earns. That means unemployment has stayed at historical lows of under 6% and people are still being paid, albeit in less valuable rubles, which makes it much easier to weather the storm. Indeed, over the first seven months of this year unemployment has been falling, not rising.
Despite the near halving of oil prices, Russia is still running a trade surplus, which should result in a current account surplus of at least $60bn (down from over $120bn in 2014). However, as a lot less money is flowing into the economy, the decade of double-digit wage growth is clearly over.
While exports declined by 10% on month in July to $27bn as oil prices fell again, imports to Russia posted a 2.4% year-on-year increase to $15.6bn. “Imports in July showed an unexpected m/m increase for the second month in a row, which can be attributed to 3.6% month-on-month growth in imports of chemicals and chemical products,” Alfa Bank’s chief economist Natalia Orlova said in a note in September, citing the about-face in import declines as another piece of evidence that the economy may have turned in the summer.
Of course, a big part of the gains in the summer are due to low base effects, as trade has been walloped by the devaluation of the ruble and Russia’s counter-sanctions on European food imports. The overall trade surplus was down by 16.8% in the first seven months of this year on year, with exports down by 30.3% and imports down even more by 39% to $103.9bn in the same period (largely driven by falling food imports from Europe). This compares with a foreign total trade turnover decline of 6.9% in 2014 to $804.7bn, according to Alfa Bank.
So in this environment Russian retail is not for everyone, but ultimately Russia’s 143mn strong population makes it the biggest market in Europe and its people still need toilet paper, clothes and cars. Given the economic situation in many Western European countries is little better than Russia at the moment, for many retailers they have little other choice if they are still looking to expand.