Russia Country Report Aug21 - August, 2021

August 3, 2021

Summary:

The Russian economy surpassed pre-COVID-19 levels in 2Q21, with the country’s 1H21 growth estimated at 4.6% YoY and its 2Q21 growth at 10.1% YoY, according to the Ministry of Economic Development.

While some sectors have experienced constraints (e.g. OPEC+ and COVID-19-related restrictions), the growth in non-constrained sectors points to a moderation in growth rates. The momentum from stronger production and consumption has translated into higher incomes and lower unemployment. We expect the momentum to fade in 2H21 as consumption stabilizes following the spending of excess savings, as well as due to lower loan growth.

The good news is that Russia’s economy continues to grow faster than expected. Russia’s Economic Development Ministry has upgraded its growth forecast for this year to 3.8% from 2.8%, the ministry said on July 9.

“The estimate for Russia’s 2021 GDP growth is 3.8% against 2.9%. The reason for the increase of the GDP forecast for 2021 is better dynamics of consumer and investment demand,” a spokesperson for the ministry told reporters.

The GDP growth forecasts for 2022 and 2023–2024 were maintained at 3.2% and 3%, respectively. Russia’s industrial output will still rise by 2% this year, but the forecast for 2022 was improved to 3.6% from 3.4%. The processing industries will expand by 2.4% this year and by 2.5% next year, while the mining industry will grow by 0.7% this year and 5.9% next year.

The bad news is that inflation is also accelerating faster than expected. Despite repeated big rate hikes by the Central Bank of Russia (CBR) since the start of this year – March (25bp), April (50bp) and June (50bp) – inflation has continued to climb from 5.2% in January to 7% in June.

CBR governor Elvira Nabiullina has blamed the increases on a variety of factors including soaring food prices, rising commodity prices and broken supply chains, which is creating “demand inflation” as opposed to the regular monetary supply inflation.

The problem with demand inflation as it is not caused by an excess of cash chasing too few goods rate hikes have little to no effect on inflation. Basically there is little the CBR can do to bring inflation down other than wait for the supply chains to be repaired and for the economy to rebalance, which is likely to take around six months.

At the same time the broken supply chains has driven producer price index of inflation (PPI) up even faster than consumer price inflation (CPI), which is running at an astonishing 35% year-on-year – its highest level ever.

On top of these problems the CBR has asked if the structure of the economy has not been fundamentally changed by the events of the last year. Shopping and increasingly business has gone online, labour has become remote and more flexible, and production has become geographically diverse. The CBR is studying what all this means for its assumptions and targets.

The upshot of these problems is the economic recover began to splutter in June. Russia’s seasonally adjusted IHS Markit Russia Services Business Activity Index registered 56.5 in June, down from 57.5 in May, but still well above the 50 no-change mark, as services continue to recover from last year’s annus horribilis. The manufacturing PMI contracted slightly in June, but over all business is still growing strongly.

Business optimism also cooled somewhat in June as a result, but it still remains at historic highs not seen for at least eight years.

Russia’s labour market further extended its gains in May, as unemployment declined to 4.9% and industrial production soared in May by 11.8% from 7.6% in April, which was also revised up from the previous result of 7.2%, Rosstat said on June 24. The economy is on the mend and will return to the pre-crisis level in July, the spokesperson said.

Going forward the challenges for the Kremlin in the medium term remain reversing the decline in real income levels that are really hurting business climate and also pose a political danger, especially with the Duma elections looming in September. As the budget has returned to profit far faster than anyone expected, thanks to $75 oil, there is plenty of money to stimulate the economy and spending ahead of the elections can be expected. Putin has already promised to spend an additional RUB400bn ($5.4bn) on the social sphere on top of spending slated in the budget. And the spending on the 12 national projects should also feed through into a recovery of incomes in the latter part of this year, as it briefly did in the last quarter of 2019.

The ministry maintained its estimate for Russians’ real disposable income growth this year at 3%, while the forecast for real wages increase was raised to 3.2% from 2% due to a faster than expected recovery of the labour market.

That will feed through to the retail sector, which is another engine of growth. The retail turnover growth estimate was also improved last month to 6.9% in 2021 from 5.1%, to 3% in 2022 from 2.9%, and to 2.9% per year in 2023–2024 from 2.8%, according to the Economics Ministry’s update forecasts.

The other major problem is the low levels of investment, which has plagued the Kremlin for years and is the main thing holding back faster growth. Russia fixed capital formation is running at 20%, when it needs to be at least 25% to create sustained economic growth and remains behind the 30% that many Central European countries have maintained for years.

Elections loom, repressions ramped up

Politically the Duma elections are already starting to overshadow domestic politics. The state is on the one hand trying to battle the coronavirus (COVID-19) pandemic and has taken drastic and unpopular actions including a mandatory vaccination rule that has sent vaccination rate up from 13% of the population to 17% in a month. But on the other hand the state is trying to minimise the political damage of these moves and has left the coronavirus restrictions relatively loose. It seems most Russians are ignoring them anyway.

The most ominous affect of the looming elections is the way the Kremlin has taken off the gloves and is now simply crushing the opposition and the free press. Anti-corruption activist and opposition politician Alexei Navalny’s organisation has been outlawed and other opposition figures persecuted to the point where some of them have fled abroad.

And opposition press, and even simply liberal press that dare to be critical of the government, have been listed as “foreign agents” or just banned. Putin’s government has operated what bne IntelliNews columnist Mark Galeotti dubbed “repression-lite” for most of the last two decades, but now its has been scaled up to flat out repression.

Internationally things are going better. Following the summit between Putin and US president Joe Biden in Geneva on June 16 the first practical steps have been taken to build a new “stable” relation. US Special Presidential Envoy for Climate John Kerry was in Moscow to meet Russian foreign minister Sergei Lavrov in July to kick off climate cooperation and Putin has called for the issue to be “depoliticised.”

On the more difficult politicised issues like Ukraine and Nord Stream 2 less progress has been made, but its seems while the west is trying to thrash out a unified position, the negotiations are still hard as everyone’s agendas are different. Germany in particular has insisted on the Nord Stream 2 pipeline’s completion because it is a “commercial project”, despite Berlin’s active support of Ukraine, “political project.” It is this conflicted stance where political and commercial goals cause internal contradiction that stymie a unified stance on Russia. And this balance of politics and commerce is weighed different for each of the EU members.

The position of the US is clearer and as it has little direct trade or investment business with Russia it can be more aggressive and decisive. But Washington’s position is also complicated by its desire to repair the damage Trump did to transatlantic relations and so it must take the EU’s desires into account.

As Biden has clearly downgraded the importance of the “Russian problem,” as he has upgraded the “China problem,” this plays to the Kremlin’s advantage as it has made it easier to find compromises with the White House. For his part Putin also wants to downgrade the tensions (and stop new sanctions being imposed) as he also wants to focus more on dealing with his domestic problems.

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