Tim Gosling in Moscow -

The record-breaking heat wave that afflicted Russia this summer has hurt the economy and the effects have already spilled over to the rest of the world by sending food prices soaring.

Russia was on course to become one of the world's biggest exporters of grain, already claiming third place in 2009. But with more than half the farmland in the country damaged by wildfires in the first half of August, according to some estimates, expectations for this year's crop has plummeted to about 60m tonnes from the 97m tonnes harvested in 2009.

International grain prices have already more than doubled after Prime Minister Vladimir Putin announced a ban on exports in mid-August, which sent global wheat markets spiralling. Russia may even be forced to import grain this year, and that would only send international food prices yet higher, although officials from the Agricultural Ministry deny the possibility.

Moreover, as the fires have delayed the planting of Russia's winter crop - which produces one and half times more than the summer crop - production is expected to fall further, raising the possibility of a repeat of the food price shock that hurt economies around the world in the summer of 2008. However, the jury is still out on what the full effect of the drought will be on the country's economy; that will only become apparent as we head towards the end of the year.

Rebuilding

In the short term, the Russian state faces a big bill to repair the damage. The government has promised to rebuild, at public expense, the houses and associated infrastructure that burnt down (causing a few unscrupulous people to torch their homes). The total repair and compensation bill is an estimated RUB12bn ($400m), Emergencies Minister Sergei Shoigu announced on August 19.

Such costs are dwarfed, however, by analyst estimates that the heatwave could shave up to 1% off GDP this year - a loss of $15bn for the economy - as companies cut work hours and freeze investment plans. And farmers, already reeling from a collapse in demand caused by the economic crisis, now find themselves deeper in debt due to the catastrophe. Analysts estimate that as much as RUB127bn (€3.25bn) of agricultural credits - 15% of total banking sector credits - will need to be restructured, with state-owned Sberbank and agricultural specialist Rosselkhosbank bearing the brunt. The state has already said it plans to offer a RUB10.5bn to subsidize interest rates to farmers in 2010-11. Russia's nascent livestock farming segment will be another victim as the cost of feedstock soars. Russia has only recently become self-sufficient in chicken meat, but pork and beef farming is still being developed. The price of meat, eggs and milk are all likely to rise significantly in the wake of the catastrophe.

Food producers and retailers look set to find themselves stuck between the devil and the deep-blue sea then, as they attempt to balance higher prices from suppliers with a government desperately trying to keep a lid on inflation. Several flour mills and bakeries are already being prosecuted for price gouging, whilst supermarket chain Seventh Continent and dairy producer Wimm-Bill-Dann are in a spat over prices.

Russian shipping and transport companies will also feel the summer's heat if grain exports cease. With exports apparently finished for the year, the total volume shipped (mostly to the Middle East) is unlikely to top 4.5m tonnes in 2010 compared with 21.5m tonnes last year.

Overall, the heatwave has jarred a fragile economic recovery that was just getting underway. In July, industrial production was up 5.9% year on year, with fixed investment also in positive territory at 0.8%, but both indicators fell 10% compared with June. Olga Sterina at Russian investment bank Uralsib worries that, "investments fell more than anticipated [and] the August data may also be weaker."

While analysts hope the economic shock will be temporary, the fear is that soaring food prices will fuel inflation and wreck Russia's chances of accelerated growth. The silver lining to the global economic crisis for Russia was to bring the state's two-decade-long battle against inflation to an end after rates fell to nearly zero by August on the back of the economic slowdown. However, rapidly rising food prices have caused most analysts to increase their inflation forecasts, some by as much as 3% over and above the government's official prediction for 2010 of a maximum of 7% - which was the lowest for years.

The return of inflation will come as a big blow after June saw interest rates finally turn real - ie. higher than inflation - making the economy "normal" for the first time since the fall of the Soviet Union. If rates stay real, the Central Bank of Russia gains sorely-missed efficient levers to control the economy; however, the prize was gone as quickly as it appeared, with negative rates back already in July. The worry is that as the full effects of the heatwave unfold in the autumn, the return of real interest rates may look increasingly distant.