Russia Country Report Dec22 - December, 2022

December 5, 2022

“The world is now at a historic crossroads, with the most dangerous and important decade since World War II looming,” Russian President Vladimir Putin said at the plenary session of the Valdai International Discussion Club on October 27. He is not wrong, but its dangerous because of his doing.

"We have arrived at a historic juncture. Perhaps, the most dangerous, unpredictable and, at the same time, the most important decade since the end of World War II lies ahead," he emphasised.

The war in Ukraine drags on with the frontline stabilising and now major offensives expected for the meantime. Russia intensified its attack on Ukraine’s power infrastructure that started in October as winter looms. Russia is also trying to secure its hold on the Donbas, but progress is very slow.

Notably in November there were growing calls for a start to be made on peace talks as it appears both sides are starting to realise that the war is probably unwinnable on the battlefield and that some sort of compromise will be needed. However, with Ukraine still backing in the euphoria of retaking Kherson from Russia there is no possibility for those talks now.

Russia’s economy will only fall by 3-3.5% this year despite the dire predictions at the start of the year. Earlier in November, First Deputy Prime Minister Andrei Belousov said that the GDP contraction would amount to 2.8–3% in 2022 and no more than 1% in 2023.

Russia’s economy has now officially gone into recession. Preliminary figures from the economic development ministry show Russian GDP contracted by 5% y/y in September, a slightly higher pace of decline than the 4% recorded for July and August. For the January-September period, the ministry estimates GDP shrank by 2% y/y. Russian GDP was still growing briskly in January and February prior to the invasion of Ukraine.

Russian President Vladimir Putin’s mobilisation caused a lot of anxiety in September and somewhere between 300,000 and a million Russian men left the country, but after the draft ended that anxiety faded away again. In general life in Russia goes on as normal with the majority of the people believing the Kremlin’s propaganda. There is very little signs of dissent or protest and as the economy is holding up well most Russian see the war as something happening “down there” and having little impact on their daily lives. Putin’s personal popularity remains high, above 80% as he is milking the surge in nationalism.

The parallel import mechanisms are functioning now so that many of the products that disappeared in the first months of the war are back on the shelves. Russian companies have largely found new suppliers or supply routes to get many of the products they imported before the sanctions, but the big exception is with technology and machinery.

But the war is slowly impacting the economy.

September deterioration was led by consumption as the volume of retail sales was down by about 10% y/y. Consumer demand was quelled by reduced purchasing power as real incomes shrunk by more than 3% y/y during July-September. Consumption was further depressed by the partial mobilization that started in late September.

The decline in industrial output deepened in September. Production of mining and quarrying industry contracted by 2% y/y. While crude oil output was up slightly, growth slowed to just 0.5% in September. Production of all other major mining products contracted. The drop was led by lower output of natural gas, which was down by 26% y/y (not including LNG). The drop in manufacturing output accelerated in September to 4%.

Agriculture and construction continued to prop up the economy in September. Agricultural output rose by 7% y/y, while construction, despite some cooling, was still up by 6% y/y in September. Housing construction activity, however, slipped into decline in September, falling by 8% y/y.

The partial mobilisation that started on September 21 has also hit the labour market with Russian company surveys from October revealing that about a third of respondents said that the mobilisation had affected their employees. An even larger share of firms said they expected the mobilisation to affect negatively the labour market and demand in coming months.

Spending on the war has also hit the budget where all the surplus of the first quarter has been used up although the budget remained in a small surplus in the first nine months of the year, but only after Gazprom was hit with a special tax worth over RUB400bn, otherwise it would have reported a small deficit. Oil and gas tax revenues rose significantly, even though the price of Urals oil was lower than a year earlier for the first time this year in September-October. But the increase was due to the tax payment collected from Gazprom, without which the drop in the budget's total revenues compared to the year before would have been down about 20%.

Russia remains on track to end the year with a mild 2% of GDP deficit that will be funded partly from the National Welfare Fund (NWF) and partly with new issues of Russian Finance Ministry’s OFZ treasury bills. The Ministry of Finance (MinFin) plans to issue something on the order of RUB2 trillion a year in OFZ going forward and tap the ample liquidity in the banking sector as a source of funding the budget going forward.

The EU's import ban on Russian crude oil is coming into force on December 5. The ban covers oil imported by sea. Crude oil is also brought from Russia to EU countries by pipeline. Germany and Poland, the biggest buyers of pipeline oil, have announced that they will stop importing pipeline oil at the same time. Progress to implement an oil price cap mechanism at the end of November was proving difficult as some countries wanted a low level of around $30 a barrel while others preferred levels over $65, above what Russia current sells oil for, including the discount. A compromise is likely to be found that will leave the oil price cap mechanism largely ineffective.

The EU has completely replaced Russian gas with liquefied natural gas (LNG) supplies and pipeline gas from other suppliers, European Commissioner for Energy Kadri Simson said on November 23 at a plenary session of the European Parliament, but at huge cost.

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