Russia's consumption and investment motors stall

By bne IntelliNews November 26, 2014

bne IntelliNews -


Russia's economic growth has slowed to a crawl. The latest official forecast is 0.8% growth this year, but a range of analyst and international financial institutions are predicting growth will be lower and there could be no growth at all next year as Russia enters stagflation territory.

The fall of the ruble and the tumbling oil prices are partly to blame but more serious is the lack of domestic investment and the worsening position for Russia's shoppers as real incomes stagnate after almost a decade of strong gains.

The latest macro statistics for the first 10 months of this year continue to paint a picture of consumption-driven growth, with retail trade up 2.2% year-on-year and investment down 2.5% year-on-year for the period, reported Alfa Bank.

"However, we expect accelerating inflation, the risk of new rate hikes and the lack of aggressive social spending to weaken retail trade growth in 2015," Natalia Orlova, chief economist with the bank, said in her monthly economic wrap on November 25. "Meanwhile, no further need to accumulate FX will assist companies in redirecting financial flows to capex, thus supporting our more positive view on investment for next year."

Consumption has been the backbone of Russia's economic recovery in the last decade. Even during the crisis years after 2008 incomes continue to rise at about 10% a year. Meanwhile, companies are increasingly being squeezed between the rising cost of borrowing and lower sales. A drum-tight labour market, with unemployment at historic lows, means they had to continue to increase wages, but this situation is clearly unsustainable.

Retail trade growth stayed at 1.7% year-on-year in October, according to Rosstat, but the underlying fundamentals are deteriorating, said Orlova.

"While the market expected retail trade growth to decelerate to 1.2% year-on-year last month, in reality it was close to our more optimistic expectations, remaining at September's 1.7% year-on-year level, and in the first 10 months of this year growth stayed at 2.2% year-on-year," said Orlova. "The sources financing this growth continued to deteriorate, with unemployment spiking from 4.9% to 5.1%, and real wage growth reported at only 0.3% year-on-year in October versus 2.4% year-on-year in 9M14, which was also anticipated."

The way out of this mess is obvious: companies need to invest and build new production to sustain growth. However despite Russian President Vladimir Putin's success in moving Russia up the World Bank's Doing Business ranking, this hasn't translated into a more appealing investment environment. Business owners have simply suspended investment plans until there is some more clarity about the future.

The latest investment numbers disappointed yet again, despite strong industrial output growth at the start of the autumn. Industrial production soared by more than 5% month-on-month because the sanctions imposed on the European Union by the Kremlin stimulated a measure of import substitution. But economists say the bump is temporary and will not turn into a trend because  the constraints on international borrowing hinder any real expansion of industry. If anything the already bad situation with investment is getting worse.

"The investment trend surprised on the downside, decreasing 2.9% year-on-year in October and 2.5% year-on-year in the first two months of this year," says Orlova. "At the same time, the real [economic] sector kept industrial production growth strong at 2.9% year-on-year in October and 1.7% year-on-year in  the first 10 months, reflecting projects sponsored by the Russian military and pipeline construction in Siberia."

The outlook for consumption next year is bleak or poor because of the exceptionally high rate of inflation. The Central Bank of Russia (CBR) has been struggling to bring inflation down all year but is under pressure to cut interest rates.  While inflation was running around 8% until recently, the CBR  believes the core inflation was closer to 4%-5%.  But Putin has upset the economic balance of forces  with his punitive sanctions on EU agricultural imports imposed earlier this year.  That pushed food inflation into double digits, something that the central bank can do nothing about.

Then, after the oil price began to slide in September, sending the value of the ruble tumbling, the central bank was forced into hiking interest rates dramatically. That should have brought inflation down, but the rate hike failed to stop the devaluation of the ruble, which continued to slide and will stoke even more inflation. The forecast for this year now is more than 9%.  All of this is going to weigh heavily on consumption.

"Deteriorating household income supports our expectations of weaker consumption growth going forward," says Orlova. "The key concern is the above-expected inflation that is growing 0.3% week-on-week and is currently close to 9% year-on-year, and the recent ruble depreciation will likely push it to 12% year-on-year by mid-2015, limiting real income growth. A new round of rate hikes, which we now see as possible in  the first quarter of next year, will also lower households’ ability to boost leverage. Finally, the government’s intention to increase nominal social payments by only 5.5% year-on-year  next year underlines the lack of sources to finance retail trade growth, which we now see at 0.5% year-on-year  for 2015."

The only good news that Orlova has to offer is that investment might start to recover in 2015 as companies have built up sufficient reserves of hard currency – their main concern for the current quarter was to salt away enough FX reserves in their treasure chests to meet maturing debts.

"Corporate FX accounts with banks increased by $7bn in October and $24bn year-to-date; however, the CBR’s decision in November to introduce ruble free-float has apparently put an end to this process," says Orlova. "We believe that companies have sufficient FX for foreign debt redemption, allowing the real sector to finance more capex in 2015."






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