Russia Country Report Sep17 - September, 2017

September 7, 2017

Russia’s economy continued to expand thanks to investment, which is mainly a function of continued infrastructure spending by exporters and the state, which, however, is not enough to offset weakness in other GDP components, most notably consumption and public spending. Therefore, analysts  remain cautious on Russia's growth prospects this year, despite the strong performance seen in 2Q17.

Growth over the first half of the year had already started to slow again by August as the economy ran up against its structural limitations that caused the economy to start slowing in 2013. The chances of the deep structural reforms starting before the presidential elections in September 2018 remain very small.

Economic growth decelerated sharply from 2.9% y/y in June to 1.5% y/y in July, according to the Economy Ministry. Given the previously reported modest 1.1% y/y industrial production growth, analysts do not see this deceleration as surprising and view it as a return to normal levels after the unusually high 2.5% y/y increase reported in 2Q17 due to weather factors and a one-off boost to investments. Alfa Bank target 1.2% y/y growth for 3Q17 and forecast 1.4% y/y for 2017.
 
In July the construction industry – a proxy of investment – demonstrated the strongest dynamic out of all the key segments of the economy: construction volumes increased by 7.1% y/y after a rise by 5.3% in June and 3.8% in May. Fixed investment rose by 4.8% y/y in 1H17, which means that in 2Q17, investment rose by more than 7% y/y (vs 2.3% in 1Q17), the highest growth rate in 5 years.

At the same time, the picture in all the other segments remained fairly bleak, e.g., growth in retail sales slowed to 1% y/y (from 1.2% in June), the slump in agriculture deepened to -2.9% y/y (-1.3% in June), volumes of paid services for the population declined by 0.8% y/y (-1% in June), while contraction in the volumes of residential construction continued (-5.4% y/y vs -6.6% in June).

After posting zero y/y growth in June, real disposable incomes fell again in July (-0.9% y/y), despite some acceleration seen in real wage growth (4.6% y/y vs 3.9% in June). The unemployment rate remained stable at the low level of 5.1%.

One-off factors that boosted output in 2Q17 – such as calendar and weather factors – are no longer at play. The ruble's long run toward appreciation also ended 3 months ago, which means that the recent spike in consumption that it had supported could soon be coming to an end.

On a positive note, the low inflation environment and falling cost of borrowing will continue to offer the economy and the population support in the coming months, which means that investment will remain the prime driver of economic growth.

However, analysts say the chances of a significant acceleration in the growth dynamic will remain slim – this year, Russia's GDP is unlikely to significantly exceed the growth rate seen in 1H17 (1.5% y/y).

The ministry  lowered the forecast for annual inflation in December 2017 to 3.7% from 3.8% in its updated macroeconomic forecast on August 31. At the same time, the ministry retained its forecast for inflation at the end of 2018, 2019 and 2020 at the level of 4%.

The Ministry of Economic Development also raised the GDP forecast in 2017 in the baseline scenario to 2.1% from 2% and in 2018 to 2.1% from 1.5%. The ministry increased its forecast for GDP growth in 2019 to 2.2% from 1.5%, and in 2020 to 2.3% from 1.5%.

In addition, the agency raised the forecast for investment growth in Russia in 2017 to 4.1% from 2%, and in 2018 to 4.7% from 2.2%, as well as improving the forecast for growth in investment in the baseline scenario in 2019 to 5.6% from 2% and in 2020 to 5.7% from 2.1%.

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