An unexpected surge in public spending and private investment cushioned Russia’s economy from the widely expected sharp economic fall in 2022, government statistics released this week show. However, the economy continues to reel from further sanction shocks after a new embargo on oil products was put in place in February. The outlook for this year remains uncertain, but the authorities are at this point confident that Russian President Vladimir Putin’s Fiscal Fortress is robust enough to cope with the new sanctions.
The Russian statistical authority RosStat published the first estimate of the GDP development of the entire last year in the last week of February that showed Russia's GDP shrank by 2.1% compared to the previous year, the Bank of Finland institute for Emerging Economies (BOFIT) reports in its weekly update.
“The better-than-anticipated development surprised almost all parties following the Russian economy. The contraction of the economy was slightly smaller than even the authorities' expectations, e.g. the Russian central bank predicted just a week earlier that the GDP had contracted by 2.5% from a year ago,” BOFIT said. “Back in November, the central bank predicted that the economy would contract by 3.3%, and the average of international investment banks' forecasts for Russia was -4.2%.”
The first estimate of year-on-year changes is usually not consistent with quarterly statistics, BOFIT says, “so an accurate picture of the last quarter's growth is not yet available.” In the past RosStat has made major revisions to the GDP result after it has dug more deeply into the data.
And it has been accused of massaging the data to throw Russia’s economic performance into a more favourable light. However, despite the occasional anomalies, economists on the whole trust RosStat’s data as largely accurate.
“The data will certainly still [need to] be clarified, but based on the figures published now, the contraction of the economy would have stopped already in early autumn,” BOFIT said.
BOFIT is treating the results with caution. In addition to the growth spurt at the end of the year, RosStat's first assessment of the development of items in the supply balance (i.e. the total supply and demand of the economy) is difficult to interpret, says BOFIT, partly due to the fact that the Russian government stopped publishing a lot of key data, such as trade and banking sector results, immediately after the start of the war.
“Estimates of the amount of total export and import are not published, but based on other items, the amount of net export last year would have been around zero,” says BOFIT. “This again does not fit well with the available data on the development of the value of foreign trade.”
Economists have been forced to look at the publicly available customs data of Russia’s partner countries in order to work out what is happening to Russia’s trade.
Based on this data, the preliminary balance of payments data suggests that the value of total imports decreased by 9% and the value of total exports increased by 14% from a year ago, BOFIT reports. The value of Russia's goods imports calculated from mirror statistics decreased by 23% and the value of goods exports grew by 23% compared to the previous year.
Rosstat’s data also paints a mixed picture on consumption, which has not fallen as far as might be expected given the size of the economic shock caused by the imposition of a “massive package” of sanctions immediately after the war in Ukraine started.
According to published data on the maintenance balance, private consumption shrank by 1.8% from a year ago, but public consumption grew by 2.8%.
“The contraction of private consumption is in line with the development of real incomes (-1% from a year ago), on the other hand, the contraction of retail turnover (-6.7%) would have predicted an even bigger drop,” BOFIT said. “The picture will certainly become clearer as long as the figures for the last quarter of 2022 are published.”
As bne IntelliNews has reported, the economy has held up much better than was initially expected. In the first months of the war even the Central Bank of Russia (CBR) monthly survey of professional economists predicted a 15% contraction in the Russian economy, which failed to appear. One of the factors holding up growth was a surge of both public and private investment; the state poured money into putting Russia’s economy on a war footing, which resulted in companies accelerating their investment programmes to cope with the shock to supplies and markets caused by the wide-ranging sanctions.
Companies big and small spent to replace foreign equipment and software or channelled money into building new supply chains to reach alternative markets. Facing initial forecasts for a decline of up to 20% in capital expenditure, Russia instead saw it increase 6% in 2022.
Despite the early evidence that defence spending was driving a surge of activity in the first half of 2022, the RosStat data tells a slightly different story. Over 56% of all business capex was self-funded last year, a reflection of the fact that the systemic lack of aggregate demand, lack of predictability and dependence on export sectors encourages firms to defensively accumulate reserves rather than invest steadily.
Total fixed asset investment – money sunk into building factories, offices, various sources of productive capacity – hit RUB16.4 trillion ($217bn) in 2022, RUB12.8 trillion of which came from big business, which is the more useful figure structurally as SMEs accounted for only about one-fifth of GDP pre-invasion.
Nearly half of investment went towards construction and a third of spending went towards procuring equipment and machinery. Of all big business investment, only 17.8% came from government funds or support programmes. Resource extraction, namely oil and gas, accounted for about 20% of all investment and pipelines of various kinds accounted for an additional 10%. By comparison, net investment into value-added production and manufacturing actually declined slightly y/y, falling to about RUB2.1 trillion ($27bn).
“The nominal growth of public spending (according to preliminary data, more than 20%) was exceptionally high last year. This means that public spending grew by almost 10% in real terms. Expenditures in the federal budget grew particularly strongly (+25%). The increase in public expenditures was partly driven by the increase in public consumption and partly in public investments,” says BOFIT.
As a whole, the gross capital formation recorded in the maintenance balance decreased by 3.2% from the previous year. The contraction was solely due to a huge drop in inventories, BOFIT reports.
“The uncertainty brought by the war, the sanctions and the reorganisation of the logistics chains practically emptied the stocks of the companies. On the other hand, investments in fixed capital according to the maintenance balance definition grew surprisingly strongly (5.2%),” BOFIT says.
The increase in investments is largely explained by investment projects started before 2022, supported by the public sector, and the state's own investments. For example, budget funding for state-supported national projects increased by 29% last year. The largest of these are related to the construction of transport infrastructure. In addition, many acquisitions made for warfare are recorded in investments.
In the most recent manifestation of this ongoing investment into transport infrastructure Russian President Vladimir Putin this week opened the new $6.6bn “Big Circle” line of the legendary Moscow metro system to much public fanfare as part of the ongoing development of Moscow's transport system.
The effects of the war year can be seen on the production side of GDP as a very uneven development. The agricultural value added increased by 8% from the previous year, boosted by a good harvest year. There was no growth at all in the extractive industry (+0.4%), and the processing industry shrank by -2.4% on average. Sectoral variations were very large. Sectors that serve domestic demand and warfare such as the pharmaceutical industry (+ 8.5%) and the manufacture of metal products (+ 6%) grew rapidly.
On the other hand, the wood processing industry (-12.8%) and the automotive industry (-45%) which were affected by the sanctions, shrank significantly.
The growth of public investments was reflected in construction, whose value added increased by 5%. General administration grew by 4% from a year ago.
“RosStat's data on January's economic development do not point to a quick turnaround. Compared to a year ago, the retail trade continued to contract clearly (-6.6%), but the monthly change was positive in January after the drop in December,” BOFIT said. “On the other hand, the indicators describing the demand for household services (e.g. hotel, tourism and restaurant services) continued their strong growth that started last year.”
In January, the production of the processing industry shrank by 2% from a year earlier, and the production of the extractive industry by as much as 3%. In particular, natural gas production (-14%) and LNG production (-13%) shrank sharply. In January, crude oil production was 1% lower than a year earlier.
One of the biggest causes for concern was the collapse of budget revenues in January, driven by a 46% fall in oil and gas receipts, coupled with a very big surge in spending, that left the budget with a RUB1.76 deficit – its biggest deficit since 1998 and more than half the expected deficit for the full year.
Analysts say the situation is likely to rapidly improve in the coming months as the spending surge was a one-off after the Ministry of Finance (MinFin) frontloaded some of the year’s spending, instead of putting it off to the end of the year as is usual. Also there were changes to the tax code that also affected income. However, the fall in oil and gas revenues is real and likely caused by a shock to the energy market caused by a new EU embargo on Russian oil products that came into effect on February 5. Analysts say that if the energy market had the same evolution to a similar shock in the first months of the war a year ago, when Western traders abruptly stop buying Russia’s Urals blend of oil, then oil and gas revenues should recover in the next few months as the market finds a new equilibrium. Nevertheless, S&P reports that the export of Russian oil products slumped in February as the new shock arrived.
“In January, the income of the federal budget fell drastically from a year ago. The increase in spending accelerated even more (to almost 60% from a year ago). The deficit of the federal budget was 64% of the deficit estimate of the budget approved for this year as a whole, which indicates a significantly larger deficit for the whole than budgeted (2%).
Despite the terrible January budget results, MinFin is sticking to its 2% of GDP deficit forecast – the same as last year’s – and appears to be confident that the events of last year will repeat themselves and the effects of the oil product embargo will be short-lived. As it transpired, MinFin's prediction of a 2% of GDP (RUB3 trillion) deficit turned out to be more or less correct and Russia ended 2022 with a 2.3% deficit, with almost all the negative results coming in December alone. However, if the deficit trends in January persist then experts have said the deficit could come in at between RUB6 trillion to RUB9 trillion.
Even in the worst-case scenario MinFin would be able to finance a RUB9 trillion deficit in 2023 with the RUB6.6 trillion in the National Welfare Fund (NWF) plus the planned RUB3.5 trillion issue of Russian Finance Ministry’s OFZ treasury bills that will tap liquidity pools in the Russian banking sector, but such enormous spending would exhaust Russia’s reserves and probably lead to a financial and economic crisis in 2024.
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