Uncertainty surrounding Russia’s statistical data1 makes passing any unequivocal judgment on the economy’s current state impossible. The trajectory of the inflation rate is particularly ambiguous, and the May data offers little clarity. While bank credit has begun to flow again—from both private and state-controlled banks to both households and corporations—investment remains low, posing the biggest risk to the economy’s recovery. If strong investment growth does not materialize soon, the economy may be headed for a long period of stagnation.
Limited Potential for Lower Inflation
Since the beginning of reforms in 1992, authorities have failed to bring inflation down to internationally acceptable levels. It took five years to move from the hyperinflation of 1992–1993 to the low inflation of early-1997 to mid-1998 (7 percent (y/y) in June 1998). Following the 1998 crisis, it jumped again, reaching more than 30 percent and was gradually reduced from 20 percent in 2000 to 12 percent in 2008. Recently, only the significant decline in demand, which began in the second quarter of 2009, has led inflation to drop again. It reached 6 percent (y/y) in April and May.
Some experts, including those at the Central Bank, argue that the demand recovery, expected to occur in the second half of this year, will make further reduction impossible.2 On its face, the May data seems to support this view: the CPI accelerated last month, growing 0.5 percent (m/m), compared to 0.3 percent in April. On the other hand, seasonal factors have traditionally raised inflation in May and this year was no exception, suggesting that the decline may continue. The price of fruits and vegetables, which rose 7.2 percent (m/m), and of railway transportation, which increased by between 9.4 percent and 12.1 percent (m/m),3 drove May inflation; the core CPI grew by only 4.7 percent (y/y), down from 5 percent (y/y) in April.
In order for inflation to be kept below 5 percent in 2010, the government would have to limit the increase in regulated prices or aggregate demand would have to slow.
Unfortunately, the likely increase in state-regulated tariffs (gas, electricity, utilities, and railway transportation)4 limit the potential for further decreases in inflation. They impact inflation both directly, as utilities account for 8.5–9 percent of the consumer basket, and indirectly, via the effect they have on production costs for consumer goods. In order for inflation to be kept below 5 percent in 2010, the government would have to limit the increase in regulated prices,5 which is unlikely, or aggregate demand would have to slow.
The Investment Pause Drags On
For the first time since August 2008, loans to both corporations and households from both state-controlled and private banks grew in March, and they strengthened in April.
Private banks exhibited stronger growth in credit to corporations (1.9 percent [m/m] in April, compared to 0.9 percent [m/m] from state-controlled banks), while state-controlled banks increased loans to households faster (1.3 percent, compared to 0.8 percent). Reductions in the portfolio of Sbersbank, Russia’s biggest bank and traditionally most active corporate loan provider, held down growth in state-controlled bank loans to corporations. While this is a little worrying, it does not yet point to a trend.
However, Rosstat data on investments in March and April was discouraging. Though it shows increases for both March and April, seasonally adjusted growth failed to exceed 0.1 percent (m/m), suggesting that investment has been stagnant since December 2009 (prior to which it declined at an average rate of 1.5 percent [m/m] eleven months in a row).
Rosstat data suggests that investment has been stagnant since December 2009.
Traditionally, investment by state-controlled monopolies (the G3) in gas, electricity, and railways has played a significant role in the country’s investment dynamics. This year, the G3’s investment was expected to grow by more than 40 percent (y/y),6 which would have increased investment by 8 percent across the economy even if no other sectors raised investment.
However, Rosstat data shows that neither Gazprom nor electricity production and transportation were close to their announced targets in the first quarter of 2010. Investment in the extraction industry (including oil and gas) decreased by approximately 5 percent (y/y), while that in pipeline transportation fell by more than 50 percent. Though investment in electricity production and transportation increased by a quarter (y/y) and investment in Russian Railways jumped by one third, it failed to compensate for the negative investment dynamics in the rest of the economy.
The Government Envisages Growth, but Where?
Though it is clear that economic activity is no longer falling sharply, each indicator pointing to positive developments can either be disputed or shown to mean little. For instance, industrial production in January–April grew 6.9 percent (y/y), but much of this was due to a low base effect. Similarly, the slow, but accelerating, growth of retail sales—4.2 percent in April compared to the first four months of 2009 and 2.0 percent since December 2009—is largely fed by skyrocketing imports, which grew more than 30 percent (y/y) in March and April and were largely fueled by ruble appreciation.
In the beginning of June, the Ministry of Economic Development and the Ministry of Finance finally agreed on the official forecast for 2010–2013. The main difference from the December 2009 version is a higher GDP growth estimate for 2010.
GDP Growth in 2010
(according to the official forecast)
|GDP Growth in 2010 (%)||Share in 2009 GDP (%)||Share in GDP Growth in 2010 (%)|
|December Version||June Version||December Version||June Version|
|Fixed Capital Investment||2.9||2.9||20.2||0.6||0.6|
|Aggregated Domestic Demand for Locally Produced Goods and Services||-1.6||-1.8||75.5||-1.2||-1.3|
|Other (including inventories)||0.1||3.2||4.0|
|Source: Development Center estimates.|
What influenced this? All of the forecast 2010 GDP growth is expected to come from the “Other” component, comprised of inventory increases (as well as any statistical discrepancy)—a rather strange hypothesis, given the stagnation in domestic demand. Despite higher oil prices being incorporated into the forecast ($75/bbl versus $70/bbl), projections for domestic demand for locally produced goods and services (household and public consumption plus investment minus imports) remained stagnant. Moreover, given the underestimation of the import growth forecast,7 the decline in domestic demand for locally-produced goods and services may turn out to be more serious.
Official forecasts for the longer term (2011–2013) remain foggy. Rather than target the now unrealistic pre-crisis annual growth rates of 7–8 percent, the government is limiting its goal to 3–4 percent, which is in line with most forecasts. Rising investment—up 9.2 percent—and slowing imports8 are expected to drive the growth. The latter expectation is strange, however, given that the forecast also projects ruble appreciation (from 31 rubles/dollar today to 28 rubles/dollar in 2012), which should result in higher—not lower—import growth.
Russia’s poor investment climate appears to be the main obstacle for recovery.
In addition, the forecast assumes that domestic production will account for 70 percent of the domestic demand increase in 2013, but it only accounted for 40–50 percent in 2009–2010. This can only occur if the quality and competitiveness of Russian goods increases substantially in the coming two years—an impossible outcome unless foreign direct investment inflows well-exceed the official forecast.
Russia’s poor investment climate appears to be the main obstacle for recovery. At the end of last month, President Medvedev met with heads of U.S. venture funds, who specified corruption, an idle judicial system, and a lack of property rights protection, including for intellectual property, as key problems. However, Medvedev failed to promise decisive solutions in response. If a strong investment recovery does not begin amid the current oil prices, the economy may face prolonged stagnation.
Sergei Aleksashenko, former deputy minister of finance of the Russian Federation and former deputy governor of the Russian central bank, is a scholar-in-residence in the Carnegie Moscow Center’s Economic Policy Program.
1. Because Rosstat adjusted its method for measuring industrial growth in 2010 and has yet to recalculate the historical data using the same method, data for 2010 is not compatible with information for previous years.
4. For years, the government tried to keep the indexation of prices in those sectors below inflation. However, this led to significant underinvestment. In 2003–2004, the paradigm was shifted and those prices have been indexed well above inflation ever since. The gas price is the key driver of this process: as the bulk of electricity in Russia (65–70 percent) is produced by gas-power stations, the indexing of the gas price also fuels the price of electricity. The government has decided to move domestic gas prices to the export price level (minus the difference in transportation costs) by 2014. Currently, the price is $90/1000 m3 in the most-Western region of Russia, Smolensk, and $160/1000 m3 in neighboring Belarus. The discount for gas in Belarus is around 30 percent, implying that the potential price in Smolensk may increase up to $210/1000 m3—that is, 2 to 3 times in four years. Moreover, during the 2007–2008 reorganization of the power monopoly, RAO UES, the government committed to a certain growth path for electricity prices and electricity transportation tariffs in order to attract private investment to the sector. Combined with the effect of the gas price increase, this commitment may lead the price of electricity to reach 15–20 c/KWt by 2015, compared to 3–3.5 c in 2007.
5. If core inflation (not including regulated prices) is 3 percent in 2011 and the impact of other prices is limited to 0.5 percent, the government must limit the impact of regulated prices to 1.9 percent in order to keep inflation at 5.5 percent. This would require limiting the indexing of regulated prices to 8–13 percent in 2011. In order to lower inflation to 5 percent, the indexation should not exceed 7–10 percent.
6. Gazprom planned to increase investment by more than 30 percent (y/y) (to 664 billion rubles), government plans for increasing power capacity and grid construction assumed 70 percent investment growth (to 998 billion rubles), and Russian Railways planned to hold investment steady at the 2009 level of 300 billion rubles.