Just the threat of new “crushing” US sanctions that may be adopted in the autumn is already hurting the Russian economy in August. The Ministry of Economic development has already revised the 2018 full-year GDP growth to 1.9%, while the CBR expects GDP growth in the range of 1.5-2% for the full year.
Inflation has already ticked up to over 3%, partly due to the hike in VAT from 18% to 20% in July, which means the Central Bank of Russia (CBR) is almost certain to halt its easing cycle – and may even tighten slightly at one of the two policy meetings left this year – and the government is generally putting the economy on an “economic war” footing. The most obvious place this is to be seen is the Ministry of Finance decision to sell off three quarters of its US T bill holdings (a move mirrored by Turkey, which also got hit by Trump metal sanctions in August.)
At the end of August president Vladimir Putin also finally dealt with the huge disapproval to the government’s proposed pension reform launched in the midst of the World Cup. He reduced the proposed retirement age for women (which accounted for 61% of his votes in the presidential election in March): the original idea was to hike the female retirement age from 55 to 65 but Putin has cut it back to 63, and taken a few more years off for mums with more than three kids.
Putin’s popularity fell from over 80% into the 40s with this reform, but with the number of workers supporting each pensioner down from 2:1 to close to 1:1 there was no way of avoiding this reform. It remains to be seen how far the “good tsar” popularity recovers, but he clearly decided to spend some of political capital on this change and was correct to do it immediately after the presidential election to give the population the longest possible time to forget about the change before the next elections in 2024.
With GDP rising by 1.5% last year and up 1.8% in the second quarter, the Russian economy started to pull out of recession, albeit at a slower pace than many hoped.
The politics of sanctions are weighing on the recovery and life has been made more difficult by the fall of the ruble recently which has lost 17% YTD as of the end of August.
However, many of the other economic indicators are doing well. gross international reserves (GIR) have continued to rise and are just shy of $460bn, with the National Welfare Fund (NWF) adding nearly $10bn in two months to hit $77bn – the backstop against more budget problems in the future.
Industrial production also surprised on the upside increasing by 3.9% in July, lead by an uptick in manufacturing. The most rapidly growing sector of the Russian economy, and the one demonstrating the highest demand for credit, is transport and communications. During the first half of 2018, credit to the sector increased 20.8%, although the CBR does note that the substitution of ruble-denominated debt for foreign currency loans contributed noticeably to the high growth.
The budget is also now in surplus thanks to oil that has been averaging over $75 per barrel for the last three months, which is feeding both budget spending and the NWF.
Oil, but not only, has had a knock on effect to Russia’s balance of payments were the government is now running a healthy current account surplus of $28bn for the second quarter. It was only a year ago that Russia Inc ran a (small $300mn) current account surplus, but rising oil prices have come to the rescue. The oil price rose sharply in the second half of 2017 and the expected oil price this year will be substantially higher than assumed last autumn. The average oil price this year is $64–65 a barrel, 18% higher than last year.
Less encouragingly inflation broke above 3% for the first time in a year as the ruble devaluation and higher costs of petrol feed through. While CPI remains at historical lows, producer price index of inflation (PPI) jumped in the last two months to 16% on the back of those increasing fuel costs.
However, while the macro picture is mixed it remains broadly positive and although the US sanctions are causing problems, it is nothing the government can’t cope with.
On the policy front all efforts are being thrown into finding money to pay for Putin’s RUB8 trillion of new spending over the next six years on the social sector and infrastructure that are part of his May Decrees. While the MinFin continues to hone the tax service, this month there was a flap after presidential advisor Andrey Belousov suggested a super-tax of RUB500bn on the top 14 commodity producers, sparking a month of controversy. However, as August came to a close the oligarchs had agreed a deal whereby they will invest into specific projects rather than give money to the government – so perhaps Belousov’s proposal was just an opening gambit in a bid to force the oligarchs to increase their investments as part of the Kremlin’s general policy of raising gross capital formation to 25% of GDP, up from 21% in 2017.
The Kremlin is correct to identify the need for investment as the key issue facing the Russian economy – and was also right to identify the corporate’s reluctance to invest. However, it remains unclear how the government will be able to raise the approximately RUB2 trillion a year of extra spending Putin called for. All-in-all Putin’s target are probably designed to goad the government into action rather than being actual targets so if investments fall short no one will be too disappointed, as long as there was significant progress.
Fixed investment recovered last year, largely driven by investment in oil & gas production and pipeline transmission capacity by state-owned companies, but total fixed investment in 2017 only matched the levels of 2011 and 2008.
Fixed investment is expected to increase this year on the back of more state lead investments, lead by the programme to spend heavily on infrastructure projects. Rapid growth is not expected as the major investment phases of various large projects are already past and appetite for new investment is still limited by high real interest rates.
In the banking sector the CBR continues its clean up and the number of banks fell to 518 in August, down from just under 1,000 when CBR governor Elvira Nabiullina took over in 2013. She has been closing banks at the rate of a 100 per year regular as clockwork. Russia is on course to hit Putin’s de facto goal of about 300 banks in the next two years and in the meantime the CBR continues to improve the regulations and support. The sector is back in profit, although the vast majority of profits go to Sberbank. The CBR also launched its first effort to sell of one of the banks it took over during the mini-crisis last September.
Retail lending is booming, while corporate lending finally started to pick up. While household consumption began to recover last year, it was still at the 2012 level. Consumption was supported by a significant slowdown in inflation, higher wages and social payments to households, as well as increased borrowing and lower savings rates. However, other household income streams diminished, and real household incomes started to improve only during the first months of this year.
The growth of real wages and disposable income growth in July remained robust, with real wages up to 8% growth y/y, increasing from 7.2% in June. Real disposable incomes grew 2% y/y versus 0.7% y/y in June. But taken together with rising inflation and the slow pace of growth consumption is expected to rise fairly moderately in 2018.
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