Russian growth is stymied by a crisis of confidence

Russian growth is stymied by a crisis of confidence
Uncertainty about the future is holding back Russia's economic development
By Ben Aris in Berlin August 8, 2018

Russia’s economy is doing fairly well but what is holding it back from faster growth is a crisis of confidence amongst its businessmen: corruption and red tape are problems, but it is the increasingly predatory nature of the state-owned enterprises that make some businessmen wary of taking the kind of risks needed to fuel faster growth. The default attitude is to make certain of your existing business and not stick your head above the parapet.

The Rosstat Business Confidence survey shows an aggregate improvement over the last two years as the economic recovery gets underway. The index has risen from a low of -5 index points in December 2017 to -2 in March where it has remained since then. The index averaged -3.23 from 2005 until 2018, reaching an all time high of 7 index points in the midst of the boom years in July 2007, but then fell to a record low of -20 in December 2008 during the global crash.

However, small businesses are more vulnerable and this is also the sector Russia’s growth should be coming from.

The sentiment index for small business measured by Alfa-Bank has fallen hard recently to -27 index points — on a par with its level in November 2016 in the midst of the “silent crisis.” The all time low for this index was set in November 2015 when Alfa’s SME confidence index fell to -38 index points.

This plunge in confidence is mirrored in the last industrial production and IHS Markit Russia Manufacturing Purchasing Managers (PMI) indices, which have also both been falling in the last three months, despite the rising incomes and moderate economic growth.

Most SMEs expect a deterioration in the economic situation in the country and predict a decline in the purchasing power of the population, Alfa Bank explains. The worries are prompted by the government’s recent decision to hike VAT from 18% to 20% — the first time the government of President Vladimir Putin has directly increased the burden on the population during his 18 years in office.

At the same time the Central Bank of Russia (CBR) focus on controlling inflation has made life for business harder too. Despite a string of cuts, the monetary policy rate remains very high at 7.25% and the central bank is expected to cut rates only one more time this year — if at all. Given inflation remains at record lows levels of 2.5% the CBR’s ultra conservative monetary policy means Russia has real interest rates of around 4%, which is extremely high by international standards and makes it expensive to borrow money.

The difficulty and reluctance to borrow are also visible in the banking statistics. Retail lending has taken off over the last year and has been growing so fast that the central bank recently moved to dampen the growth in consumer loans by increasing prudential restrictions. However, the same has not happened with corporate lending which has been stagnant for almost a year, although it has increased somewhat recently.

The small entrepreneurs that Alfa surveyed said the main problems they face are: high taxes (46%), demand reduction (39%) and lack of funds for development (37%). 

Business anxiety continues to grow against the background of increased tax and financial controls over small businesses and self-employed citizens, the study revealed. And there is an unspoken fear behind the practical worries: what will happen in 2024 when Putin is scheduled to step down, as he is barred from running for president again by the constitution? Many middle class Russians are making contingency plans, buying property abroad or making sure their kids can speak English in case things go badly wrong in the transition to post-Putin.

In the meantime 83% of Alfa’s respondents believe that the current economic situation in the country hinders business development, and half believe that the situation will worsen in the next six months. About half of enterprises record a decline in profits, and a third experienced a reduction in the number of customers and purchases. 

There may be something else at work here as at the aggregate level Russian businesses have been earning more profits this year than in the last two years, according to Rosstat figures. However, the aggregate is distorted by the large role oil and gas companies play in the economy, so it could well be that while the commodity producers are pulling the numbers up as oil prices rise, the SMEs are being left behind and under pressure from the greater austerity being imposed by the government.

The SME respondents themselves seem a bit confused as Alfa found they estimate their own business prospects more optimistically than the situation in the industry and the economy as a whole. Since the autumn of 2017, the number of companies and entrepreneurs has increased and they expect revenue growth: 22% of entrepreneurs call their business successful — a share that has not changed from the last survey. In the PMI survey too panellists were basically optimistic about their prospects for the rest of the year, despite the slowdown in orders and shrinking backlogs.

One of the changes that is affecting all businesses dealing with the consumer is the rapid expansion of e-commerce that is seeing more and more of Russia’s retail business go online. This year, the Watcom Shopping Index that measures sales at leading Moscow malls has under-performed all three of the previous years since the index was launched, despite the fact that retail turnover is expanding again after two years of contraction and real and real disposable incomes are rising again since the start of this year.

Olga Tretyakova, the head of the marketing department for mass business of Alfa Bank, says business has followed the interests of consumers who are moving to the sharing economy model. "People take a taxi instead of driving their car. They take delivery of food and other goods instead of going shopping… This model of consumption begins to penetrate deeper, covering more and more services, crowding traditional formats of trade," Tretyakova explains. That is good news for services and small business, which is the most flexible and fastest moving segment of the economy, as they are the first to respond to this request, sums up Tretyakova as cited by Vedomosti.

This shift to the service sector is also visible in the services PMI index, which, unlike the manufacturing PMI, continues to expand. What remains unresolved is if this shift to a more services orientated Russian economy is enough to drive economic growth going forward. According to Rosstat, the retail trade turnover in June 2018 increased by 3% over June last year, and the semi-annual growth was 2.6%.

The authors of the study believe it is possible: 60% of respondents to Alfa’s survey say they are ready to change their business model or activity to adapt to consumer behaviour. 

The state is also pushing for changes in entrepreneurship. The survey showed that 14% of entrepreneurs had to rebuild business processes, because of changes to the law that have resulted in a heavier tax burden and falling profits. Part of the rising tax burden that is the Ministry of Finance has revamped the tax service, which in turn has simply become a lot more efficient. For example, the “fly by night” shell companies scam — ephemeral legal companies set up to take a tax liability and then closed the day before payment comes due — has almost entirely disappeared in the last two years.

Separately, Alfa Bank drew attention to the first sharp deterioration in the mood in the IT sector, which has until now been the one truly dynamic part of the Russian economy. IT entrepreneurs are pessimistic about both the economy as a whole and the prospects of their own business. Traditionally, the IT industry differed from other industries in terms of its optimism and confidence, in addition, companies expected state investment in the development of the digital economy. 

Now IT representatives are increasingly mentioning sanctions among their problems. Russian IT is also one of the most multinational parts of the Russian economy, heavily dependent on western markets for sales, investment capital and potential exits.

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