MOSCOW BLOG: Russia’s economy, finance ministries diverge on economic outlook

MOSCOW BLOG: Russia’s economy, finance ministries diverge on economic outlook
Minister of Economic Development Maxim Oreshkin
By Ben Aris in Berlin September 29, 2017

Russia’s Ministry of Economy is increasingly optimistic about the country’s economic outlook. The ministry expects the current positive trends in Russia’s economy to continue in the next few months, Minister of Economic Development Maxim Oreshkin told the Federation Council, the parliament’s upper house, on September 27.

Oreshkin has published a slew of results that would support an increase in state spending to boost growth, in contrast to the Ministry of Finance’s more prudent projections.

Russia watchers are listening closely to Oreshkin’s comments as he is seen as having President Vladimir Putin’s ear. Some believe he has become Putin’s key economic advisor and is de facto setting Russia’s economic policy. His counterpart, Finance Minister Anton Siluanov, is a very competent pair of hands, but belongs to the liberal economic faction in the Kremlin that are seen by Putin as technocrats in charge of their ministries but are not actively setting policy unless Putin gives it his personal backing.

“In the next quarters, we expect a further positive trend in Russia’s economy. What is it linked with? First, it is credit activity dynamics,” Oreshkin said, reports Prime, adding that mortgages could increase in volume this autumn. “Higher supply in the segment will directly lead to economic growth.”

Most of the good news is coming at the macroeconomic level, helped along by higher than expected oil average oil prices this year. The 2017 budget has an estimate of $46 per barrel this year, but YTD the price has been over $50.

Oreshkin raised his forecast for the federal budget deficit this year slightly to 2.18% of GDP from 2.09% earlier, but down on last year’s forecast for this year of -3.2%.

The MinEcon has also raised its net domestic borrowing plan from RUB1.05 trillion to RUB1.124 trillion. This is going in the opposite direction from the finance ministry, which recently cut its estimated domestic borrowing plans for this year from the RUB1.05 trillion that the MinEcon also started from, reducing it to RUB0.87 trillion as part of its prudential policy of getting Russia’s finances back into shape. Borrowing in the following years is still set at RUB1.2 trillion, which is enough to cover the projected deficits in those years.

Part of the reason for the discrepancy is that the MinFin is counting in RUB89bn of dividends from Rosneftegaz, the state-owned holding company that controls, among other things, the state’s shares in oil giant Rosneft. That is a big assumption as the holding paid nothing last year and its CEO Igor Sechin, one of the most powerful men in Russia, made it clear he wants special treatment. The MinFin is insisting all state-owned enterprises (SOEs) pay 50% of their IFRS profits out as dividends, but so far has been able to collect only about half this amount.

Maybe Oreshkin knows something that Siluanov doesn’t. The number he reduced his borrowing estimate by is exactly the amount he says the MinFin wants to collect from the Rosneftegaz dividend payment. Siluanov also said that the dividend money collected from Rosneftegaz would be largely spent on developing the aviation sector.

More investment or a balanced budget?

Oreshkin’s plan represents more spending than the MinFin’s. It is focused more on boosting growth than the MinFin’s approach of just trying to balance the books and keep the debt low. 

Despite Siluanov’s prudence, even the MinFin sees Russia’s borrowing growing over the coming years, with state debt rising from 13.4% of GDP projected this year to 16.2% in 2020. These are still risibly small amounts by western standards; many developed markets have debt of 90% of GDP or more, but for Russia they are high. In the boom years, debt was in the single digits, and while Russia can easily afford 16% of GDP plus of state debt, one of the hallmarks of Russia’s fiscal policy has always been to keep borrowing to an absolute minimum. This is one of the reasons the economy has been able to weather so well the perennial shocks it has faced over the last two decades. After each of the multiple shocks the economy has always bounced back amazingly fast.

The economy minister was explicit about the need to invest more, saying a total of RUB5 trillion every year needs to be invested to promote growth. That is four times more than the entire budget deficit is forecast to be this year and a massive amount of money, some $86bn.

However, in a concession to reality, Oreshkin admitted that the government’s current policies are still more about preparing for and preventing shocks to the economy than about driving growth. Russia creates its macroeconomic policy “to prepare for external shocks, including an inflation targeting policy of the central bank, the floating exchange rate of the ruble, and the budget aimed at readiness to contraction of oil prices to $40 per barrel and below,” he said at a recent conference.

Oreshkin’s focus on the need to boost investment strikes at the root of Russia’s economic problems today. In the Yeltsin era the focus was on trying to rein in the bloated deficit, but since Putin took over the government has slowly refocused on trying to boost investment — without much luck. Part of the reason was the high value of the ruble: it was easier and cheaper to import Camembert from France than to make expensive investments into equipment only to produce a lower quality but more expensive local version, so no one bothered to do it. 

Russia’s oil production is to blame for the high value of the ruble, the so-called Dutch disease. This equation has changed following the devaluation of the ruble in 2015, but investment is still way below what it should be. In China, by contrast, the government deliberately kept the yuan cheap and attracted a flood of inbound investors that used the country as a factory for the world, retooling the entire economy in the process – exactly the opposite of what happened in Russia.  

“Investment activity contracted significantly at the end of 2014 and in 2015, but has returned to positive dynamics since the middle of last year. We see recovery here. It is very important for us to move further so that investment growth becomes stronger and the amount of projects implemented in the Russian economy rises,” Oreshkin said at a conference, reports Prime. “Our estimates show that we need to add about RUB5 trillion of investment each year so that the growth dynamics of the Russian economy rise above the average world figures for 2016.”

There is no way Russia can raise this kind of money while the sanctions regime remains in place. Currently foreign direct investment (FDI) is running at about $20bn a year, down from a peak of over $70bn in the boom years, but the bulk of Russia’s true FDI is simply the foreign companies that already set up shop in the boom years ploughing profits back into their existing operations, which brings little economic benefit for the rest of the economy.

A gradual revival 

Oreshkin’s estimates of the nominal value of the economy have been rising too, from RUB89.5 trillion to the new estimate of RUB92.2 trillion, or $1.58 trillion at current exchange rates. That is up from the recent crisis nadir of $1.2 trillion set in 2015, but still off the $2.1 trillion high Russia reached just before oil prices collapsed three years ago.

The minister said that the ruble is close to its fair value and that doesn’t expect any serious fluctuations in the near future. “On the back of a tangible drop in the ruble rate in real terms this April we believe that the rate has reached a more or less fundamentally fair level and project no significant fluctuations,” he said.

In September, the ministry affirmed its 2017 average ruble forecast at RUB59.4 against the dollar. However, economists at the investment banks expect the ruble to strengthen against the dollar in the rest of the year and some are putting the exchange rate’s upper band at RUB50 to the dollar by the end of the year.

Crucially for the government as it prepares for the 2018 presidential election, real wages are starting to rise again. While the macroeconomic performance has been better than expected this year, this has yet to trickle down to the man in the street, although that is starting to change now.

But Oreshkin said that it will take several years for incomes to regain the ground lost in 2014-2015. What growth there is currently in incomes, Oreshkin believes is connected with increasing labour efficiency and not oil price dynamics. Real wages will rise 3% over 2017 and 4% in 2018, the minster predicted.

Still, on the income front the outlook for next year is brighter than this year. The Ministry of Finance forecasts the growth in wages in 2018 in real terms at 4.1%, including by indexing the salaries of state employees, up from the current 3% growth this year.

"Beginning in 2018, the … decree on increasing the salaries of employees in the public sector will be fully implemented. Naturally, we are sure that there will be an increase in the quality of the services provided," Siluanov said.

In mid-September, Rosstat said that the real disposable money income of Russians in January-August 2017 decreased by 1.2% compared to the same period in 2016. At the same time, in August real incomes dropped by 0.3% after falling by 1% in July, growth of 0.2% in June and 0.1% in May.