Is this the death of Russia's middle class?

Is this the death of Russia's middle class?
By Ben Aris December 22, 2015

For most of the last decade and half the Russia story has not been about its lakes of oil or caverns of gas. It has been about the emergence of its middle class. More attractive to foreign investors than Russia's minks, with real incomes falling heavily for the first time since Putin took over, is the shopaholic Russian consumer about to become an endangered species?

The economic data is not good. Alfa Bank released a report in December titled "Russia's consumer model is exhausted". And while the economy has a whole seems to have passed bottom around the summer of 2015, retail sales numbers continued to fall precipitously. "October's drop in retail sales was worse than anything seen in the 2009 crisis," Uralsib's Olga Sterina said in a note on December 16.


"Data published by Rosstat showed that most key economic indicators continued to improve in October … However, consumer demand continued to deteriorate, as retail trade dropped 11.7% y/y in October after falling 10.4% y/y in September. Real disposable incomes shrank 5.6% y/y in October versus 4% y/y in September, and real wages dropped 10.9% y/y in October versus 10.4% y/y a month earlier," Sterina said in a note.

Russians are now spending half their income on food alone, according to VTB Capital, up from an all time low of 25% set in 2007, and that could rise further in 2016. Russian consumers are going into survival mode.

The October contraction in retail sales was the deepest since 1998 – even deeper than anything seen in 2009. The bne IntelliNews despair index tells the same story, with despair in 2015 being slightly higher than that of 2008/09, but still a long way below the 1998/99 levels.

And analysts believe consumer demand will continue to deteriorate over the coming months, as the government does not have the money to support incomes in the same way as it did in 2009. Then the state poured money into public sector wages and invested in areas like infrastructure problems. But until 2014 Russia was still running a triple surplus – trade, current and federal budget account were all in the black – which meant the state had cash. With the federal budget expected to end 2015 with a 3% of GDP deficit, the government has no spare money to spend and is cutting everything it can – including politically sensitive payments like pensions.

On top of the cuts, the Central Bank of Russia (CBR) has clamped down on consumer borrowing in 2014 to prevent a consumer credit bubble getting out of hand, as consumers binged on expensive credits thanks to their constantly rising incomes. The Russian borrower has been deleveraging for over a year and with stores like electronics retailer M.Video making as much as one in three sales on the never-never, the disappearance of credit has also killed off big ticket purchases very effectively. And then the oil price collapsed in December 2015, leading to a heavy devaluation of the ruble, which made everything a lot worse.

"The contraction in consumer lending intensified in October, and the slump is only likely to get worse. The recent round of ruble depreciation and rising inflationary risks should also hurt consumer demand, which is already weaker than during the 2009 crisis. Demand is unlikely to improve until the second half of 2016, when the economy could show its first signs of recovery," says Sterina.

Russia's prosperity and its attractiveness as an investment destination have been predicated on its rapidly swelling middle class for most of the last decade. Per capita GDP soared to $12,800 in 2013 (over $21,000 on a ppp basis, which put Russia ahead of EU members like Portugal), but this has slumped to $8,644 in 2015. Even so, this still well ahead of everywhere else in the Commonwealth of Independent States (CIS).

No one is actually clear on how big the middle class is; it depends on whom you ask but the consensus is something on the order of 30%. But whatever the exact number is, it will be cut by a quarter in 2016, say experts.

Today, one in five Russians belongs to the middle class, according to criteria of the Russian Institute for Social Analysis and Forecasting (InSAP), reports Russian daily Vedomosti. A cited study titled "The middle classes at various stages of life" found too many Russian jobs are blue collar and don't require much expertise or training. The consultants go on to speculate that the current crisis will halve the size of the middle class to 15% of the population.

The first effects of this contraction has already appeared in the November unemployment figures that showed a small uptick of 0.2% from record lows to 5.8% (seasonally adjusted). This is a low number by any standards, but the increase in the jobless rate in the face of falling real incomes, down 9% in the first eleven months of this year, is a worrying sign.

The death of the middle class is also visible in the retail sales figures. While most leading macroeconomic indicators seemed to have passed bottom at the end of the summer, retail sales are still contracting painfully; the total sales volume was down by an unexpected 13.1% y/y in November an acceleration from the previous couple of months. Likewise retail lending is also still falling, down 6.2% y/y in the same month and adjusted for the devaluation effects, according to Rosstat. Most of this non-spending is happening in big ticket items like cars and furniture, where the collapse of sales has been far more dramatic than the headline numbers. Things got so bad in the automotive sector that many factories have put their workers on mandatory holidays and foreign manufacturers are already closing factories and laying off staff. If this hidden unemployment is added in then it could add as much as 10% to the headline figure, say analysts.

Still, the middle classes are resilient to change. One of the criteria is to have an income not lower than the average wage in the region, and as nominal wage increases are running at 4.6% y/y in November it will take several years to bring most salaries below this level.

Another criterion is to hold enough savings to be able to buy a car outright. But here too the picture is not too bad as consumers have finished paying off their debts built up during the consumer credit bubble that was popped in 2015 and retail bank deposits are rising again since the middle of this year.

The final criteria, based on a person’s socio-professional qualifications and experience, can never be undone. The National Census in 2010 found that 24% of the working population has a higher education. The InSAP researchers found that 22% of the population meets two out of three of the above criteria, but only 8.1% of the population has all three.

The speed of the shrinking of the middle class will be set in effect by the rate of inflation but the determining factor will be the speed real wages fall in 2016; the drop in real wages in October was the worst for 16 years, and the decline of retail turnover was worse than that seen in the 2009 crisis, according to the Economics Ministry.

The inflation outlook at least is positive: the CBR estimates the current 15.6% will fall into single digits next year. But there is no real consensus on wage growth and this will be entirely dependent on if the economy can return to growth, which is itself entirely dependent now on next year’s oil price. The official government forecast is for 0.7% growth in 2016, while most of the International Financial Institutions (IFIs) say there will be a 0.7% contraction.