Russia’s economic results for 2020 were encouragingly good. The acceleration of the covid-19 pandemic in Russia during the second half of 2020 reduced economic activity due to such factors as restrictions on personal movement.
There is clear evidence that economic recovery has started. The January data should be treated as a clear proof of major improvements in Russia’s economic performance. This is especially important because in the larger part of the country quarantine restrictions were still in place while base factor was not supportive for y/y comparisons.
The Markit IHS purchasing managers’ indices (PMIs) for Russia illustrate this current improving sentiment. More importantly, they augur a gradual return of economic confidence in Russia. The readings for the manufacturing PMI (50.9) and services PMI (52.7) both exceeded a neutral reading of 50 points in January and February, thus indicating increasing business activity. The last time both indices were above 50 points was in September 2020. Confidence about the future in services rose sharply to a level last seen in October 2019.
On the manufacturing side, seasonally adjusted production has grown nearly uninterrupted since last summer, but was still down from 2019 by 2.5% in the fourth quarter of 2020 (the on-year change in December was -0.2%). The production ceilings on crude oil output under the OPEC+ agreement continued to depress the mineral extraction sector, but manufacturing output increased by an impressive 4.4% y/y in December (2.9% in November).
In the fourth quarter of 2020, production of services fell by 13% y/y. Services output collapsed by nearly 40% in spring and the subsequent recovery has taken time. The construction sector last year managed to preserve production levels under exceptionally trying conditions. In the fourth quarter, construction grew by 0.8% y/y.
Russia’s sector activity data for January showed that industry came off the boil at the start of the year while activity in the retail sector picked up strongly as the effects of the coronacrisis start to fade, Capital Economics said in a note on February 18.
“The fall in virus cases and relaxation of some restrictions should support the economy in Q1, but the painfully slow vaccine rollout adds to the headwinds further ahead,” Liam Peach, an economist with Capital Economics, wrote.
Industrial production softened at the start of this year after picking up in the last quarter of 2020.
“It is becoming increasingly difficult to make sense of the first release of industrial production figures in Russia given the major revisions made by Rosstat after the full survey data become available. But for what it’s worth, the 0.2% y/y fall in December was revised to growth of 2.1% y/y and, in January, production fell by 2.5% y/y,” said Peach.
Manufacturing growth slipped from an upwardly-revised +7.9% y/y in December to -1.0% y/y in January.
“This partly reflected calendar effects as there were fewer working days in January 2021 than in 2020 but, even in seasonally-adjusted terms, output fell by 4% m/m, which more than reversed the 3.4% m/m rise in December,” reports Peach. “Meanwhile, the mining sector continued its steady recovery as oil production rose further, with mining output growth edging up from -7.5% y/y in December to -7.1% y/y in January.”
The figures also showed that the contraction in retail sales eased from -3.6% y/y in December to -0.1% y/y in January – a lot better than the consensus expectation of a -3.0% year-on-year contraction.
“This was broad-based among food (-4.5% y/y to -1.0% y/y) and non-food (-2.6% y/y to +0.9% y/y) categories and may partly reflect the easing of some virus restrictions in major cities as well as the relatively high level of social transfers from the government,” said Peach.
Overall, Capital Economics’ GDP Tracker suggests that growth in Russia broadly stagnated at -3 to -4% y/y at the start of 2021, but like most observers, Capital Economics expects Russia’s economy to rebound strongly this year from the second quarter onwards to end the year with about 3% growth.
“Russia has come through its second virus wave relatively well compared to many other countries, but the recovery is lacking momentum. With the vaccine rollout looking like it will take months to pick up pace, the downside risks to our GDP growth forecast of 3.5% this year are mounting,” said Peach.
Growth risks in 2021 are on the upside with little downside. A combination of factors is likely to combine to accelerate growth.
BCS GM base case scenario continues to forecast FY21 GDP growth at 3.3% – even despite a lower than expected decline in GDP in 2020.
The likelihood of weaker growth in 2021 is low in BCS GM’s view – such a scenario is possible in the event of a new global financial crisis (for example, a debt crisis triggered by an increase in inflation and rates) and / or in the event of escalated geopolitical risks and a plunge in commodity prices.
However, at the same time, the bank sees more risks that the Russian economy may grow faster.
Potential new catalysts include higher oil prices (BCS GM forecast for average 2021 Brent price is $51.3/bbl), as well as rising government social spending, which, together with the post-crisis economic recovery, could provide a more significant increase in real income than we forecast (0.4% y/y).
Government-funded (or funded by state-owned companies) investment can also play an important role in post-crisis economic recovery, though there is little clarity in this area. The government has been discussing ways and means of accelerating economic growth for several years now, however we still expect no breakthroughs in the near future in our base case scenario. Under a bullish scenario of high oil prices and outperforming growth in domestic demand, Russia's GDP growth in 2021 could reach 4% y/y or higher.
Elevated budget spending in January and rumoured plans of a social spending package this year worth an additional 0.5% of GDP, support our take that this year's budget fulfilment may be softer than initially guided by the government. However, that does not contradict the general course for consolidation.
According to preliminary estimates, January's federal budget was fulfilled with a RUB185bn deficit vs. our expectations of a small surplus of RUB50-100bn. At the same time, Reuters has recently reported on the rumoured intention to boost this year's social spending plan by 0.5% GDP, or RUB500-600bn.
Budget revenues remained strong in January, in line with expectations, with non-fuel revenues up 7% year-on-year, including a 39% y/y increase in local VAT, partially due to the scheduled tightening in tax collection regulations. Other consumption-related tax items were up 15-30% y/y. Fuel revenues improved from -34% y/y in December 2020 to -20% y/y in January 2021 thanks to the higher Urals price and easing in OPEC+ restrictions.
Budget expenditures were higher than expected, posting a 3% y/y increase from a high base (January 2020 spending was up 45% y/y, FY20 increase was 25% y/y). This increase challenges the current official plan to make a 6% y/y cut in nominal federal spending this year.
Normally, January is a month of restrained spending, accounting for 4-6% of the annual spending. January 2021 spending accounts for 7.6% of the annual spending plan, up from 7.1% seen in January 2020. The key drivers of the spending increase are transfers to the state Pension Fund (Jan-21 spending was 7.2% of the official FY21 plan vs. 6.0% of FY20 spending seen in Jan-20) and transfers to other social benefits (18.1% vs. 8.8%, respectively). Meanwhile, the intensity of non-social spending, including internal security, industrial support, education, and healthcare, declined.
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