MACRO ADVISER: Winter debates that will shape the Russian economy and (maybe) politics

MACRO ADVISER: Winter debates that will shape the Russian economy and (maybe) politics
The debates amongst senior Russian government officials over what should be done to boost activity are intensifying.
By Chris Weafer of Macro-Advisory September 19, 2019

Against the backdrop of still weak economic indicators and deteriorating public confidence in the Russian government’s management of the economy, the debates amongst senior government officials over what should be done to boost activity are intensifying. If current relatively weak conditions persist, expect the debates to gain intensity and the pressure to “do something” to grow through the remainder of this year and up to next spring. 

The protagonists in these increasingly lively debates include the First Deputy Prime Minister and Finance Minister Anton Siluanov, the governor of the Central Bank of Russia (CBR) Elvira Nabiullina, Economy Minister Maxim Oreshkin and the head of the Audit Chamber and former long-time finance minister, Alexey Kudrin. The central bank has cut its forecast range for headline growth for this year from 1.0-1.5% to 0.8-1.3% and said it now expects the economy to reach 3.0% growth only at the end of 2021 rather than at the end of next year. The economy ministry maintains its position that growth will pick up in the second half to at least 1.6% and result in full-year growth of 1.3%. But it has scaled back expected growth for next year to 1.7% (from 2.0%) and is sticking with full year growth at 3.1% for 2021. However, Oreshkin issued a report warning that unless the central bank reins in high lending growth then growth may collapse into recession in 2021. 

While the ministers and officials debate each other, President Vladimir Putin is losing patience with the weak conditions and is undoubtedly concerned about the impact on public opinion and support for his administration. He said last month that “the pace [of economic growth] is certainly positive but the overall dynamic cannot be satisfactory for us. We need to make economic growth more sustainable and dynamic”. By “we”, of course he meant “government ministers”. Given that the president has declared, and promised to deliver, very ambitious economic and social targets by the end of his term, one can expect to hear more criticism from him if the data does not start to improve between now and next spring.

Of course, nobody believes that the targets set as part of the national projects programme can be achieved within the five-year timeframe. Given the scale and scope of the 13 separate project categories, this is more likely to be a seven to 10-year programme. The main objective appears to be for the president to be able to show credible evidence that real progress is being achieved by mid-way through his term, i.e. by spring 2021, and then to be able to say that the programme will “eventually” deliver on all of the ambitious objectives.  That would likely be enough to create a more comfortable macro, social and political backdrop for the second half of his term and allow for a less pressured succession process. 

But the economy needs to be on a sustainably stronger track, national projects need to be showing some results and, crucially, people’s incomes need to be again growing in real terms after the past six years of decline. While the Federal Statistics Service is revising the methodology and no longer reports the data on real incomes each month, the Audit Chamber recently reported that it calculates real incomes fell by 1.3% in 1H19. The economy ministry, which remains optimistic about recovery in 2H19, cut its forecast for real income growth this year from 1.0% to 0.1%. That is still quite an optimistic number based on the Audit Chamber’s report. President Putin also highlighted real incomes as one of the key measures that need to improve. Politicians the world over understand the correlation between people’s satisfaction with government and the amount of money in their pocket. 

The key issues in the debate, if not battle, between the various government agencies and ministries are:

  • Whether there should be extra budget spending and in what format?
  • How to avoid a potential debt crisis for households?
  • How to accelerate the national projects programme?

Russia has a strong balance sheet, with plenty of liquid cash and low overall debt and low debt service costs. The total value of the central bank’s FX reserves, at end August, was just under $530bn with $110bn of this in gold. The finance ministry said that liquid financial resources, as of August 1 (excluding long-terms loans to state companies and investments in projects, etc.) was $267bn. On the same date, the value of state, regional and municipal debt was only $246bn. The budget is also on course for another big surplus this year, a figure that will only rise after the oil price spiked as a reaction to the attack against Saudi oil installations. The value of the National Wealth Fund (NWF) is expected to reach 7% of GDP (approx. $140bn) within a few months.

So, does the country need to hoard so much cash, especially at a time when the economy needs a growth stimulus? Most international financial agencies think not and are urging the government to spend more. The finance minister said that extra spending is planned for 2020 ($28bn) and 2021 ($65bn), but that most will go to fund major infrastructure projects in the energy sector, such as helping to build the Yamal LNG-2 project and facilities at Ust-Luga for Gazprom. The governor of the central bank is openly opposed to that as it would benefit only one area of the economy and would be inflationary. Her proposal is to increase the breakeven oil price in the budget, from $41.6 per barrel to $46 per barrel and to add an additional RUB750bn ($11.5bn) to annual spending across the economy. 

One the one hand, the good news is that the debate is about how to spend a growing financial surplus rather than how to make current spending more effective and where to cut. But, on the other hand, that debate has, historically at least, led to inefficient spending decisions and created only short-term fixes. 

Another of the debates is between the economy minister and the central bank over the rising level of retail debt, especially in unsecured lending. Oreshkin is very optimistic that the pace of economic growth will recover by end-year and strengthen into 2020 and 2021, i.e. by the middle of Putin’s term and ahead of the autumn 2021 Duma elections. His concern is that should the growth rate in high interest-bearing unsecured lending continue unchecked, it could lead to a major debt crisis in mid-2021 and instead of 3.1% growth, which he expects that year, the economy could be pulled into a 0.6% contraction. In a recent report, he said that consumer spending could collapse by 4.6% in 2021 if banks are forced into a lending “hard-stop” and have to force borrowers to repay outstanding debt faster. 

The central bank’s position is that this is an exaggerated view and that overall debt in the economy (household debt to GDP is only at 17%) is manageable and the percentage of non-performing debt is only at 5%. Also, as of October, the central bank will introduce a new requirement for banks whereby they will have to more critically assess the financial position of clients, especially their ability to service debt, before extending any new loans. The expectation is that this will cut the annual rate of retail lending growth from 22-23% to 15-16%.

The third major debate is over national projects. The Audit Chamber has reported that only 32.5% of the full year aggregate allocation to the projects had been spent in the first half of 2019 and only three of the projects reported spending over 40% of the full-year total. This will undoubtedly lead to demands from the presidential administration to accelerate spending later this year and in early 2020. But the fact that spending is starting only slowly should neither be a surprise nor a cause for concern. This is a major change of direction for the economy and is huge in scale. All such projects start slowly and take longer to deliver the expected results. This is normal. Forcing a pick-up in the pace risks a loss of efficiency, misspent funds and a failure to deliver the results. 

The good news is that monetary flexibility and fiscal discipline in recent years, plus the relatively high average oil price, mean that Russia is in a strong and stable financial position. The critical question now, and the subject of the policy debates, is how to convert financial strength into growth and, just as crucially, into a recovery in public trust in the government. 

Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise and focus on underlying trends, real political risks, and opportunities in Russia/CIS, the Eurasia Union, and Mongolia. Follow him on @ChrisWeafer.