Russia’s economy returned to growth again in the fourth quarter of 2016 ending seven consecutive quarters of recession. Revised data upgraded growth to a meager 0.3% of growth in the last quarter from a 0.4% contraction in the third quarter.
Manufacturing has been driving growth but the recovery remains fragile. Although manufacturing was strong in February with the Markit PMI still over the 50 “no change” market coming in at 52.4, slightly down from 52.5 the month before, manufacturing shrank in the fourth quarter and industrial production over all is still not expanding strongly.
The sectors that are doing the best are still agricultural, which is basking in the sun of a bumper harvest in 2016 and on course for another good year this year, and utilities. The power sector is in an interesting place at the moment as most of the planned capex is finished at power companies are starting to generate free cash that they are sharing with investors, leading to the whole utilities sector being the best performing on the stock market last year.
In general the stock market did very well in 2016 up over 50% for the whole year. The bond market has also done well and this year the state plans to double its issuance to RUB1,200 trillion, up from a record RUB500bn in 2016, to finance a modest budget deficit on the order of 1.5%-2% of GDP depending on what happens to oil prices.
The outlook for the stock market is for a 15%-20% gain in 2017, but both the dollar denominated Russia Trading System (RTS) and ruble denominated Moscow Interbank Currency Exchange (MICEX) sold off by about 10% in the first quarter thanks to a drop in oil prices and profit taking. The end of the “Trump bump” also contributed as it became clear that the newly installed US president would not take US sanctions – including the all important financial sanctions – off Russia quickly as some had speculated.
Likewise, the ruble is doing very well and was amongst the best performing currencies in the world in the first quarter, up some 7% in the first two months of this year. The outlook for the currency is uncertain as a strong ruble will reduce the deficit but the Kremlin has said it would prefer a weaker ruble to bolster economic growth. The Central Bank of Russia (CBR) has said that it will get back into the market with interventions in 2017 to manage the rate again to some extent.
On the macroeconomic front the big story was the ongoing success the CBR is having at bringing down inflation, which dropped below 5% for the first time since the fall of the Soviet Union in 1991 this February. The CBR is on course to hit its 4% target, possibly before the end of this year. The plan seems to be to bring this crucial number down to a “normal country” level so that the cost of borrowing falls to “normal” levels and the entire economy transforms to that of a “normal” country that will kick start a new virtuous cycle of spending/profit/wage increases/investment.
The fight against inflation is already going well enough that the CBR surprised Russia-watchers by cutting the monetary policy rate to 9.75% at its March meeting that will support growth. But along with the 4% inflation target this has to be followed by reducing the overnight rates to something sensible if this plan is going to work and clearly that will take several years.
In the meantime the Russian people are continuing to suffer. The macroeconomics maybe recovering but the benefits have yet to trickle down to the man on the street. Wage increases have gone back into the black, thanks to the falling inflation (something Russians are extremely sensitive to) but after a spike in February thanks to a one-off payment to pensioners -- real disposable incomes went back to contracting in March, albeit at a constantly slower pace.
Disposable incomes are falling and retail sales have been contracting for over two years. The Watcom shopping index bne carries was off its worst start in three years in 2017 and this index measures shopping volumes in Moscow, which are well ahead of the national average.
This tension spilled over on March 26 when anti-corruption blogger and opposition leader Alexei Navalny organized country-wide protests that saw demonstrators hit the streets in 87 cities and towns across the country. Previous demonstrations have been limited to the middle-class capitals of Moscow and St Petersburg but these demonstrations were in the heartland where president Vladimir Putin core supporters live. Moreover the age of the protestors was a decade younger. While Russia has historically low unemployment the prospects for Russia’s youth is not good and youth unemployment is rising.
This is all potentially explosive given there are crucial presidential elections in 2018 (Putin’s last). As the government has the least control over the youth who don't watch state sponsored TV and don't remember the Soviet Union commentators are predicting a further tightening of control by the authorities and possible outright oppression before the vote.
Russia’s politics is turning into a race against time. The Kremlin needs to produce more robust recovery to ease these pressures but certainly won’t achieve that before the 2018 elections so will try and spend its way out of the hole.
Finally, the liberals in charge of the reform plan, lead by former Finance Minister and co-head of the presidential council Alexei Kudrin, are holding out for a structural reform recovery that is driven by less corruption and more productivity. There is another faction lead by presidential Ombudsman for Business Boris Titov that would prefer a Keynesian debt-funded-spending plan to stimulate the economy, but for the moment the prudential team headed by Kudrin hold the reigns. The trouble with Kudrin’s plan is it takes longer and is less splashy.
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