Following weaker performance at the end of last year, the Russian economy appeared to get back to the track of slow growth in the first two months of this year. The engine of recovery seems to have shifted from last year’s primary production to a broader base, but the development is still shaky.
Retail sales rose by 2% y/y in January-February. This represented a slight slowdown from the end of last year, even if real wages rose by over 10% y/y. The spurt appears to have come largely from certain public sector wage hikes prescribed by president Putin back in 2012 released ahead of the presidential elections on March 18. Notably public sector wage hikes were limited and one-offs so they will not support consumption this year, usually a major economic driver.
Real incomes, however, still contracted by nearly 1% y/y, although the last year’s point of reference is raised by the RUB5,000 one-time pay-outs to most pensioners (if the pay-out is ignored, real incomes rose by 2.5% y/y).
In 2017, household consumption was an important driver of economic growth. Sberbank analysts expect it to continue growing 1-2 pp faster than GDP in the coming years, driven by a recovery in real disposable income and a reduction in inequality.
In contrast, growth in industrial output accelerated in the first two months of the year, mainly thanks to support from manufacturing.
Manufacturing recovered briskly in January-February, rising 3% y/y. Metal fabrication and the car industry were among the main growth drivers. Growth in output of extractive industries slowed to under 1%, with oil & gas production levels declining from a year earlier. Pipeline transmission volumes also fell, weighing on growth of the entire transport sector. Construction activity remained unchanged from a year earlier in January-February, mainly on strong growth in housing construction. And the outlook for agriculture is good. While Russia is unlikely to beat last year’s all time high record harvest result, it will probably bring in a big harvest above trend and should earn at least $20bn from grain exports again.
Politics remain fraught. At the end of March nearly 30 countries followed the UK in expelling over 100 Russian diplomats from their countries. Many countries assess Russia to be responsible for the nerve agent attack in England in early March. While the coordinated expulsion of diplomats sent a powerful political signal, Russian market reactions were limited. The ruble-dollar rate depreciated by 0.4% in the beginning of this week and the Moscow exchange’s RTS index fell by about 1%. In the same week as the expulsions were announced Russia raised $3.75bn on London’s capital market and German gave full construction permits to the Nord Stream II gas pipeline.
President Putin’s speech unveiled a very ambitious plan reform plan during his state of the nation speech on March 1. The President wants productivity growth to accelerate to 5% per year (since 2009, the average growth was only 1%) during next decade, the share of SMEs in GDP to go up to 40% (from current level of 20%), the number of people employed in SMEs to go up from 19mn to 25mn people, and to halve the number of people living below the poverty line (currently 13.8% of the population or 20mn people).
This growth is planned to be supported by a decline in interest rates, including a decrease in mortgage rates to 7% (9.9% in January 2018), increased cabinet spending on healthcare (up to 4-5% GDP per year vs. current 3% GDP) and education spending. The Central Bank cut rates again to 7.25% and is expected to cut at least once more this year, although some economists say the end of year interest rates could fall to 6% this year as the regulator is starting to switch its focus from inflation to growth.
How all Putin’s ambitious spending plans will be funded, remains a question to the government has yet to elaborate on. But, it is quite clear from the speech that stronger growth indicators are expected to generate enough budget revenues to enable continued defense spending. Also it is becoming clear there will be a major shuffle of social benefit payments, a raising of retirement ages and probably increases in taxes after Putin is inaugurated in May. A big government reshuffle, including a change in prime minister, is widely expected in the second quarter.
The CBR expects 1.5-1.8% y/y GDP growth in the first quarter of 2018, with 1.5-2.0% y/y growth for the full year. Some economists are predicting surprises on the upside to growth: Goldman Sachs is predicting 3.3% growth this year. To reach Putin’s call for a 50% expansion in the size of the economy over six years Russia’s economy would have to grow by 6% or more a year, which is highly unlikely.
The main driver is expected to be consumption growth supported by continuing salary and retail lending growth. While bankers share the view that consumption looks to the main driving force of the growth, Alfa Bank has a different view on the scale and seasonality of this year’s recovery.
Natalia Orlova, chief economist at Alfa Bank expects stronger growth in the first half, reflecting the finalization of state investment projects. Alfa also believe the recovery in consumption should have a positive effect on producers and inventories. However, entering the second half of 2018 Orlova expects retail lending growth to trigger inflationary concerns, as a result of, which the CBR will be forced to implement tighter regulation, which would cool the economic sentiment.
The cabinet is expected to focus on better tax collection, which would put a strong ceiling on the growth recovery. As a result, Alfa has a modest expectation of only 1.0% y/y GDP growth this year, which is below the official forecasts.