Russia: Growth Model Under Pressure
We believe that the sharp slowdown in Russia's economic activity so far this year is structural and not cyclical in nature. This means that there are no easy fixes in sight, and that growth will remain subdued over the next few years, if no major reforms are implemented.
In short, we believe that private consumption, which is the main driver of growth, is poised for a slowdown, while investment is unlikely to pick up the slack.
Household consumption is coming under pressure on three main fronts: slowing income growth, slowing credit growth, and elevated inflation.
- Wages have been heavily reliant on rising state revenues from oil and gas exports, which would then trickle down in the form of higher salaries in the public sector and the broader economy. Oil prices will not be able to sustain the rise in incomes seen over the past decade for reasons that our Oil & Gas team have elaborated on elsewhere, but which basically amount to oil oversupply weighing on prices in the coming years.
- Credit growth is also poised for cooling, as banks are already retrenching from their over-exposure to the private sector over the past few years. Banks are starting to ramp up loan loss provisioning, meaning they are becoming increasingly concerned with non-performing loans. Meanwhile, the authorities are taking steps towards reining in unsecured household lending. As such, household credit growth to the tune of 40% y-o-y seen over the past few years is unsustainable, and is already beginning to slow.
- Inflation will remain elevated mainly on the back of structural rouble weakness going forward, which will keep import costs high. We are bearish towards the rouble on the back of a worsening trade balance, tepid demand for Russian financial (and real) assets, and a potential rate cut by the central bank in H1 2014. High inflation will continue to erode consumer purchasing power going forward.
The diminishing windfall from oil and energy prices will underscore the structural impediments to investment, such as corruption, grossly inefficient bureaucracy, poor property rights, and questionable independence of the judiciary among others. It was no surprise then that fixed investment continued to deteriorate in Q2 2013, with gross fixed capital formation contracting by 2.5% y-o-y in Q2 after posting double-digit growth rates in late 2011 to early 2012. Meanwhile, foreign direct investment (FDI) had fallen back to its 2006 level in H1 2013.
These factors will make it difficult for the Russian economy to rebalance away from its commodity dependence and its consumption focus, and towards an investment-oriented economy any time soon.
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