Growth Model Under Pressure

BMI View: We continue to forecast a slowdown in Russian economic growth, which should arrive at 2.0% in 2013, down from 3.4% in 2012, with a slight acceleration to 2.5% expected in 2014.As households come under pressure from slowing credit growth and incomes, we are sceptical that investment is able to pick up the slack any time soon, hampered by the structural inefficiencies of the economy.

We have grown progressively bearish towards the Russian economy, as we believe the sharp economic slowdown year-to-date has come on the back of growing pressure on the country's economic growth model. Over the past decade, Russia's economy has been heavily dependent on rising state revenues from oil and commodity exports, which have trickled down to wages in the public sector and the broader economy. With our Oil & Gas team forecasting the price for oil to average below the break-even price for Russia of US$110/bbl (the price at which the budget is balanced) over the next few years, incomes are unlikely to grow at the pace seen over recent years.

Furthermore, even if oil prices exceed our forecasts, it would be hard to imagine oil price growth at a pace necessary to maintain the rise in real incomes from the past decade, in the context of stubbornly high inflation and slower lending growth we expect to see over the next two years. The diminishing windfall from oil and commodity prices will also put into sharper relief the structural impediments to investment, such as corruption, grossly inefficient bureaucracy, poor property rights and questionable independence of the judiciary among others. These will make it difficult for the economy to rebalance away from its commodity dependence and its consumption focus, and towards an investment-oriented economy.

Low Growth Rates For The Foreseeable Future
Russia - Real GDP By Expenditure, Selected Components, % chg y-o-y

BMI View: We continue to forecast a slowdown in Russian economic growth, which should arrive at 2.0% in 2013, down from 3.4% in 2012, with a slight acceleration to 2.5% expected in 2014.As households come under pressure from slowing credit growth and incomes, we are sceptical that investment is able to pick up the slack any time soon, hampered by the structural inefficiencies of the economy.

We have grown progressively bearish towards the Russian economy, as we believe the sharp economic slowdown year-to-date has come on the back of growing pressure on the country's economic growth model. Over the past decade, Russia's economy has been heavily dependent on rising state revenues from oil and commodity exports, which have trickled down to wages in the public sector and the broader economy. With our Oil & Gas team forecasting the price for oil to average below the break-even price for Russia of US$110/bbl (the price at which the budget is balanced) over the next few years, incomes are unlikely to grow at the pace seen over recent years.

Furthermore, even if oil prices exceed our forecasts, it would be hard to imagine oil price growth at a pace necessary to maintain the rise in real incomes from the past decade, in the context of stubbornly high inflation and slower lending growth we expect to see over the next two years. The diminishing windfall from oil and commodity prices will also put into sharper relief the structural impediments to investment, such as corruption, grossly inefficient bureaucracy, poor property rights and questionable independence of the judiciary among others. These will make it difficult for the economy to rebalance away from its commodity dependence and its consumption focus, and towards an investment-oriented economy.

Low Growth Rates For The Foreseeable Future
Russia - Real GDP By Expenditure, Selected Components, % chg y-o-y

Admittedly, the government has shown awareness of the necessity to ramp up investment and attract foreign direct investment, as it plans to decrease operational costs for businesses in 2014. However, we believe these steps are insufficient, and unless we see strong moves towards liberalisation of the economy, we remain sceptical that investment could pick up the slack any time soon. Nevertheless, on the back of the government's plans we forecast of 2.5% growth in 2014, up from 2.0% in 2013, lower than the 3.4% result in 2012.

Household Consumption: After private consumption expanded by 6.8% in 2012, we now forecast it to slow down to 4.0% in 2013 and 3.8% in 2013. Credit growth, in our view, is past its peak, as banks are ramping up loan loss provisioning and the authorities are taking steps to rein in unsecured household lending. This will translate in lower growth rates for household spending for the foreseeable future than those seen in previous years. In addition, we expect inflation to remain elevated above the central bank's target of 5.0% in 2014 on the back of rouble weakness keeping the import bill elevated. This will keep a lid on more robust growth rates in household spending. It is not surprising therefore, that consumer sentiment in the economy has darkened, as measured by various gauges by the Federal State Statistics Service.

Structural Headwinds Overshadow Consumption Sentiment
Russia - Selected Consumer Confidence Indicators

Government Consumption: We forecast modest public consumption growth of 1.0% in 2013 and 1.3% in 2014. Underlying our conservative outlook on public expenditure is the rule that ties spending to the price of urals (Russia's equivalent brent crude benchmark). With our Oil & Gas team currently forecasting US$106/bbl for 2013 and US$102/bbl for 2014, and declining prices for the foreseeable future, we do not expect the government to ramp up spending any time soon. Furthermore, on September 19, the government announced across-the-board budgetary cuts, such as freezing military salaries for 2014, underpinning a broader policy shift towards public belt tightening and reining in inflation.

Gross Fixed Capital Formation: Fixed investment has continued to deteriorate in Q213, with fixed gross capital formation contracting by 2.5% y-o-y in Q213 from posting double-digit growth rates in late 2011-early 2012. Real industrial output, at 0.3% y-o-y in September, has kept its stall-speed growth trajectory since the beginning of 2013. Similarly, monthly investment in production capacity has been in negative growth territory year-to-date. Looking forward, the central bank's recent hawkish turn means that elevated borrowing costs will continue to dampen businesses' demand for credit for the foreseeable future. Overall, we forecast fixed investment to grow by 2.0% y-o-y in 2013, and by 3.0% in 2014, on the back of the recent government plan to freeze utility prices in 2014, whereby relieving operational costs for this year.

Investment Weak Link In The Chain
Russia - Real Industrial Production and Investment In Production Capacity, % chg y-o-y

Net Exports: Although exports have posted 4.1% y-o-y real growth in Q214, up from 0.4% in Q113, we remain doubtful of more robust growth rates over the next two years. Although recovery is taking place in Europe, demand for Russian exports will remain subdued by end-2013. As such, we forecast exports to grow by 1.5% in 2013 and by 2.8% in 2014, and we do not see exports to grow by more than 5.0% for the next decade in contrast to double-digit growth from the past decade. The main reason is that Russia's traditional and biggest export destination, Europe, and especially Eastern Europe, is looking to diversify away from its dependence on Russian energy ( see 'European Energy Grip Loosening' 17 October).

We expect imports to finish the year at 5.0% and 2014 at 6.5%. Consumption growth, although more tepid than in recent years, will continue to sustain solid import growth rates over the next decade of on average 6.5%. As such, imports are likely to catch up with exports as a share of GDP by the end of the decade.

Read the full article

This article is tagged to:
Sector: Country Risk
Geography: Russia
×

Enter your details to read the full article

By submitting this form you are acknowledging that you have read and understood our Privacy Policy.