Russian GDP growth slowed from 2.7% year on year in 4Q18 to just 0.5% y/y in 1Q19, well below expectations. Unlike most commentators, we attribute this slowdown to a pause in the state CAPEX rather than to the VAT hike. We also believe a policy response is more likely to come from the Finance Ministry rather than the Central Bank
1Q19 GDP growth well below expectations
The preliminary official estimate of Russian GDP growth for 1Q19 is 0.5% y/y, which is well below the 1.2% y/y consensus and our 1.1% y/y expectations. This also suggests a very material deceleration vs. the 2.7% y/y reported for 4Q18.
The two key questions are: 1) what caused this slowdown and 2) what would be the policy response. The initial market comments suggest that the slowdown is attributed primarily to a VAT hike-related hit to consumption, and a more aggressive key rate cut is believed to be the most likely response. We cannot fully subscribe to this view.
The slowdown reflects a halt in investment growth, as suggested by zero construction growth...
Regarding the causes of GDP slowdown, there will be no official breakdown until mid-June, however, some preliminary conclusions could now be made.
Retail trade, which is a proxy for household consumption (accounting for 50% of GDP), indeed showed deceleration from 2.8% y/y in 4Q18 to 1.8% y/y in 1Q19. This suggests, that the slowdown in household consumption could explain only around 0.5 percentage points out of 2.2 percentage point slowdown in the overall GDP growth in 1Q19.
We believe the bulk (1.7 pp out of 2.2 pp) of the slowdown is attributable to a drop in investments and inventories (accounting for c.25% of GDP) and stringent government consumption (c.15% of GDP), while the contribution of net exports remained flat. This view is supported by two key observations:
First, the growth in construction, which is a proxy for investment activity, slowed down materially from 4.1% y/y in 4Q18 to just 0.2% y/y in 1Q19; while industrial output, an indicator of producer activity also showed deceleration from 2.7% y/y to 2.1% y/y respectively. Also, according to the Ministry of Economic Development, the drop in imports of investment goods deepened from -3.2% y/y in 4Q18 to -6.2% y/y in 1Q19.
...amid a 20% y/y drop in the state investment spending
Second, according to recently revised data, the budget was executed with a large RUB666bn (2.7% GDP) surplus in 1Q19, as the modest 6% y/y expenditure growth was significantly below the 18% y/y increase in non-oil revenues and lower than the 9% y/y spending growth budgeted by the Finance Ministry for the full year. The key drag on the budget spending is the 20% y/y drop in the spending on 'National economy', which represents the state investments and other support to the industries.
GDP growth may pick up later, as 'National projects' gain momentum, budget policy - the key watch factor
The key takeaways:
Overall, we take the weak GDP data as confirmation of our below-consensus 1.0% GDP growth expectations for 2019. Our current year-end key rate forecast is 7.25%, suggesting two 25 basis point cuts amid gradual CPI deceleration to 4.6%. We continue to believe that within the economic policy framework the budget policy is running a higher risk of easing than monetary policy.