Russian companies earn strong profits but economic recovery remains over the horizon

Russian companies earn strong profits but economic recovery remains over the horizon
Russian companies are earning their best profits in years.
By Ben Aris in Berlin July 29, 2016

Russian firms are making strong profits thanks to the devaluation of the ruble and the economic recession, data from Rosstat shows, but this feel good factor is not yet enough to feed through to the rest of the economy and kick start a general economic recovery. 

"Profit data is based on Rosstat figures that aggregate firm-level numbers determined according to Russian bookkeeping standards. By that measure, profits have risen to levels not seen since 2012-13," the Bank of Finland Institute for Economies in Transition (BOFIT) said in a note.

"The surge in profit this year reflects another slide in the ruble's exchange rate. The ruble fell rather continuously from summer 2015 to early 2016, which fuelled profits of export firms, in particular. The largest sums of profits were seen in almost all of the same branches as in early 2015, i.e. oil production, metal refining, chemical production and wholesale activities. Food industry profits were also up. Not surprisingly, these fields are also among the most profitable in Russia," BOFIT said.

However, the profits are very patchy. Companies concentrated on the domestic market do not enjoy the benefits of ruble devaluation and those that rely on imports like clothes, footwear, apparel and white goods have been badly wounded. Retail turnover continues to shrink, contracting by 5.8% in June y/y even after a jump in nominal wages of 9% the same month, putting real wage growth back into positive territory. Consumer confidence is starting to pick up, according to recent surveys, but it still far too early for the lighting of the pall hanging over consumption to translate into expanding retail sales.

Indeed, it seems that the increases in wages, such as they are, are concentrated and that while nominal wages are rising, so is the poverty level and proportion of the population struggling to make ends meet as income inequality expands.

The Russian car industry in particular is in a world of pain: the maker of the Lada, Avtovaz, saw its losses balloon to RUB4bn ($6bn) in the first half of this year as revenues fell another 5% in the period y/y. And the company's debt is creeping up: net debt stood at RUB97bn ($1.4bn) verses RUB 89bn at the end of 2015 and RUB 80bn at the end of the first half of 2015.

The upshot is higher corporate profits have yet to induce a recovery in domestic investment. Even if far less than in previous years, flows of outbound corporate sector assets have remained quite notable this year and last.

The net outflow of capital by banks and enterprises in the first half of this year was nearly five-times lower than in the first half of 2015: despite the net private capital outflow in the first quarter being upgraded from $7bn to $8.2bn, the end figure of $10.5bn was still a marked improvement on the $51.5bn outflow in the first quarter of last year.

The silver lining is that companies have been using their increased profits to pay down international debt and that process of deleveraging is now coming to an end. Firms concentrated on paying down foreign debt in the first half of 2015 but in the second the focus changed to building up reserves at banks. The theme of the first half of 2016 changed again to reducing indebtedness to domestic banks, with companies now net lenders to banks.

The end of foreign debt deleveraging means banks' and companies' foreign debt was unchanged at $477bn through the first half of this year - and the best companies actually managed to borrow some $9bn abroad - while it had accounted for $548bn at the beginning of 2015.

While the business environment is improving, the next stage will be to kickstart investment and businesses are still not willing to go there. The Central Bank of Russia (CBR) kept interest rates on hold at 10.5% at its meeting on July 28, which means the cost of capital is still high. Inflation fell dramatically in the first six months of this year, but plateaued at around 7.3% in the last four months, leading to the decision not to cut by the CBR. For investment to start the CBR needs to cut its rates again in the three policy meetings it has left this year, but unless inflation begins to fall again this remains unlikely, putting off a real economic recovery to next year.