The seasonally adjusted S&P Global Russia Services PMI Business Activity Index posted a very strong 57.6 in August, up sharply from 54.0 in July. (chart)

“The latest data signalled a sharp expansion in business activity across the Russian service sector, with firms often attributing the rise to stronger domestic client demand. The rate of growth in output was the second-fastest for three years and steeper than the series average,” S&P said in a press release on September 5.

The services PMI follows on from a strong S&P Global Russia Manufacturing Purchasing Managers’ Index, which was up slightly in August to 52.7 from the previous month’s 52.1 in July, “pointing to a solid strengthening of operating conditions that was more pronounced than seen in the previous survey period,” S&P said in a press release on September 1.

Taken together, the exceptional service index gain pushed up the Composite PMI output index to 55.9 in August, up from 53.3 in July. Anything above the 50 no-change benchmark is an expansion.

“August data signalled stronger demand conditions across the Russian service sector as output expanded at a sharper pace, according to the latest PMI survey from S&P Global,” the consultant said. “Growth in business activity was steep overall, and supported by the quickest rise in new orders for just over three years, which was often linked to a boost to domestic client demand. New export business also increased, albeit at only a marginal pace. Pressure on capacity following stronger new order growth led to a record rise in backlogs of work. Strain on capacity was felt despite a renewed increase in employment, with job creation solid overall.”

The Russian economy has done far better this year than expected, as the sanctions have largely failed to cut the Kremlin off from its sources of wealth: raw material exports. The Central Bank of Russia (CBR) is projecting a growth of 2% for this year, but other analysts such as Capital Economics have recently upgraded their forecasts even more to 2.3%.

However, the long-term effects of the sanctions coming from distortions imposed on the economy, which is increasingly being put on a military production basis, are starting to be visible as the economy comes off the boil; it is predicted to slow in 2024, with Capital Economics predicting growth of only 1.3%, whereas the official CBR forecast remains 2.5% at the upper end of its range. The central bank may change its outlook at the next monetary policy meeting in the middle of September as its forecast was issued before CBR governor Elvia Nabiullina was forced to put in a big 350bp rate hike on August 15 after the ruble sank to below RUB100 to the dollar.

Inflation is another problem that is starting to make itself visible. After falling to a post-Soviet low of 2.4% this summer, prices are creeping up again and consumer price inflation (CPI) topped 5% last month. The CBR expects inflation to continue to climb for the remainding months of this year to end at over 6%. Nabiullina said last week that there would be no more rate cuts this year, and analysts are expecting more pre-emptive rate hikes at the remaining monetary policy meetings this year.

“Service providers saw another marked increase in business expenses during August, as input prices rose at the joint steepest rate in a year. Some companies mentioned that greater wage bills drove cost inflation, whilst many others stated that the recent depreciation of the ruble had pushed supplier and imported goods prices, as well as transportation costs, up,” S&P said.

Demand conditions were conducive to firms being able to pass through higher costs to their clients via an uptick in selling prices in August. The rate of output charge inflation accelerated for the third month running to the fastest since May 2022.

S&P report that respondents to its survey said input prices rose markedly as unfavourable exchange rate movements pushed imported goods prices and transportation costs up. Demand conditions were accommodative to increased selling prices, however, as output charges rose at the fastest pace since May 2022.

But with the heavy state spending on military production there is liquidity in the system that has boosted demand. Rising nominal and real incomes, caused by the extremely tight labour market, is also contributing to a boost for consumption.

“Contributing to the upturn in output was a stronger increase in new business during August. The expansion was the seventh in as many months, with the pace of growth quickening to the fastest since July 2020. Greater customer interest was behind the sustained rise in new business, with firms also highlighting larger customer bases and a boost to domestic demand,” S&P said.

A rise in new export orders also supported greater business activity in August, S&P said. Following broadly unchanged levels of new business from abroad in July, firms recorded a marginal rise in foreign client demand.

Greater new business led firms to step up their hiring activity midway during the third quarter, which is contributing to the record low unemployment numbers. Service providers recorded a solid rise in workforce numbers, following broadly unchanged levels of employment in July. The rate of job creation was stronger than the series average as firms sought to expand capacity.

Nonetheless, backlogs of work returned to expansion during August. Service sector firms struggled to process incoming work in a timely manner, with the level of outstanding business rising at the sharpest pace on record (since October 2001).

Russian service providers were buoyed by greater client demand and a sustained rise in new orders, with expectations for the year ahead improving in August. The degree of confidence was the highest since September 2021, with firms boosted by stronger domestic demand conditions.