Russia Country Report Mar19 - March, 2019

March 4, 2019

Russia’s economy put in a modest 0.7% growth in January y/y, as expectations for this year remain subdued, despite a controversial upgrade to 2.3% growth by Rosstat for the whole of 2018.

Russia’s economy is growing again, but that growth is way below potential. The forecast for growth in 2019 is 1.3-1.8% and the same again for 2020 before growth starts to respond to the extra RUB2 trillion of spending a year being invested as part of president Vladimir Putin May Decrees spending programme on infrastructure and the social sphere that is supposed to “transform” Russia. Analyst say that even 3% growth in 2021 is a “very ambitious” target.

But growth has not been the Kremlin’s priority. With new US “crushing” looming, the Kremlin has focused sanction-proofing the Russian economy.

External debt has been driven down to 15% of GDP, one of the lowest levels of any major economy in the world. The central bank sold off its US treasury bills holds and has been stockpiling gold since 2007 (so it’s reserves can’t be seized). A payment system has been set up (ot counter the threat of cutting Russia off from SWIFT). A crackdown on corruption and improvements to tax collection system has seen the tax take soar by 20% in 2018, while the tax burden stayed the same saw the breakeven price of oil needed to balance the budget tumble from $115 in 2008 to $49 now – less than the $65 average price of oil in 2018. And a tax hike to VAT went into effect in January while retirement ages will be raised to further shore up the government finances (so Russia doesn't need international investors to buy its bonds).

This campaign continues. This spring the Russian government is experimenting with setting up its own Internet in case it gets cut off from the global one. The Kremlin has already insulated Russia to the point the where there is very little the US sanctions can do to hurt Russia’s economy.

But this has come at the cost of stifling growth. Investment, both domestic and inbound, remains very low. Russia’s should be using its rock solid fundamentals to boost growth rather than build a financial fortress. While the corporate and banking sectors are back in profit real incomes fell again in 2018 for the fifth year in a row.

The plan is to use the surplus and go it alone in the form of massive investment as part of the May Decrees and under the 12 national projects.

The discontent from the Kremlin’s fortress mentality and the falling living standards it has caused has lead to growing discontent and falling popularity ratings for Putin personally, which threatens him politically.

Putin attempted address these concerns during his state of the nation speech in February announcing a Santa’s sack list of social spending increases that are designed to make people’s lives feel better and head off social unrest. Of all the initiatives he announced, across the board public sector wage increases are probably going to have the biggest effect has half the population are either directly or indirectly benefiting from budget spending.

The speech also represented a major shift in the Kremlin’s thinking, away from modernising the army and back to towards creating more prosperity for the Russian people. While military reforms needed to be able to face down Nato will continue, between 2012 and 2018 the budget was wholly focused on military modernisation at the cost of the public’s standard of living. Putin clearly thinks that the external threats have been countered and it’s time to switch back to deal with the internal political threats to his rule.

But the jury is still out if the Kremlin can lift Russia up by its bootstraps.

Minister of Economy Maxim Oreshkin admitted in February that the 2.3% GDP growth result for 2018 – a six year high —was “not sustainable” and “due to one-off factors.”

The macroeconomic results from the start of this year were poor. Industrial production was down from 2.3% in 2018 to 1.1% in January. The PMI manufacturing index fell again to 50.1 from 50.9 in December to just above the 50 no-change mark.

Retail sales growth slowed to 1.6% y/y from 2.9% in 2018. This was tied in with nominal wage growth easing to 5.2% y/y in January from 7.3% in December, and partly caused by an increase in inflation to 5% from 4.3% over the period. Indeed inflation is going to be a key number in 2019. After it fell to a post-Soviet record low of 2.3% in the middle of 2018 it finished the year at 4.3%, above the Central Bank of Russia (CBR) target rate of 4%, and is expected to rise to around 5-6% in the middle of this year, before falling off again in the second half of the year.

But despite this slowdown Russia is running a triple surplus again in the trade, current account and federal budget accounts – the budget and current account surpluses are currently at record highs – which gives it some wiggle room. Oil prices are expected to average $65 this year and there is a key OPEC meeting in April where the production cuts to keep oil prices at this level are almost certainly going to be prolonged.

This year will see the launch of many of the 12 national programmes as the government starts to push some flesh on the bones of the plan. Putin mandated RUB25.7 trillion ($390bn) of investments planned for the 12 national projects and named a handful of infrastructure modernisation programmes to be implemented during 2019–2024, although infrastructure will account for a third of the overall spending. The twelve national priority areas comprise 69 federal-level projects that will cost approximately 4.5% of 2018 GDP. While 70% of funding is supposed to come from budget, it is still unclear how much of an increase in budget spending, if any, will be required to cover the costs.

Geopolitically the big event will be the completion of a series of new big gas pipelines: the Power of Siberia pipe linking Russia to China is finished; Nord Stream 2 pipeline linking Russia to Germany is ahead of schedule and will be completed in the fourth quarter; and Turk Stream linking Russia to Turkey and on to southern Europe is well underway and should be finished next year. This trident of pipes will improve Russia’s cash flow and its geopolitical capital.
The bottom line is even if the Kremlin misses all the ambitious goals laid out in the May Decrees (as seems likely) Russia’s economy remains in an extremely robust state and it will continue to muddle through and make progress. The danger is that growth falls below the global rate of growth and that the economy slowly, but inexorably, falls behind the rest of the world in a Brezhnev-esque slow-moving stagnation.

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