Challenges for Russia's Recovery

Russia’s GDP contracted a less-than-expected 7.9 percent in 2009, but the improvement was largely due to revisions of previous growth numbers rather than dynamics in the economy.¹ Energy and raw material exports, the main driver of the post-crisis recovery, appear to be near their supply-determined maximum and, while private consumption is improving, domestic manufacturers have seen little of the benefit. The banking system is facing a debt crisis and credit continues to contract, but the Central Bank’s forbearance keeps the problem outside of the limelight. Important questions about Russia’s fiscal policy and economic growth remain, and many of the answers will only be illuminated as spring advances.

Is Russia’s Reliance on Exports Sustainable?

Exports of energy and raw materials drove the post-crisis recovery in 2009, but how much further can they grow? As of January 2010, the Development Center’s Index of Physical Export Volumes was less than 10 percent below its October 2007 peak and the seasonally adjusted Index was only 4 percent below its pre-crisis maximum, suggesting that the supply space for a continued export recovery is rapidly diminishing.

An analysis of Russia’s 10 major commodities—which together account for more than 70 percent of the country’s overall export volumes—shows similarly low output growth potential, with only those sectors who have small export shares exhibiting relatively high potential.

According to Deputy Prime Minister Sechin, oil production will increase by only 0.2 percent this year. Russia’s old oil deposits, located in well-developed Western Siberia, are declining and, in order to sustain even current production levels, oil companies must turn to Eastern Siberia, where deposits are much smaller and production costs much higher. Even with the Russian government’s preferential tax treatment of oil producers there,² production in Eastern Siberia is only projected to account for 19 million of Russia’s total 494 million mt in 2010, and to rise to 35 million mt and 45 million mt in 2011 and 2012, respectively.

This leaves little space for increasing exports—particularly given that the current export tax regime makes exports of oil and refined products no more profitable than domestic sales. The export growth that occurs in certain months is not due to increases in production or declines in domestic demand, but rather to the flexibility of the oil transportation system, which helps oil companies reduce the “Kudrin’s scissors” effect on profits³ by shifting quickly between exports and domestic sales.

Consumption Recovery But No Industry Response

Since November 2009, private consumption in Russia has grown at a steady average rate of 0.4 percent (m/m, sa), driven by recovering wage growth in the real sector, slowing inflation, and declining deposit interest rates in Russian banks. Though this growth is substantially lower than the 1 percent (m/m) growth exhibited in 2005–2008, it is a positive signal for the post-crisis period, indicating that Russian households are certain that the most difficult times are over.

However, the news may not be as good as it seems. Because Russian industry is not able to produce a number of consumer goods, consumption growth affects imports more than it helps domestic production. As a result, after six months of slow but consecutive growth, Russian industry stopped growing in November and even declined in December and January, falling 0.2 percent and 0.5 percent,⁴ respectively, in seasonally adjusted terms.⁵ In February, GDP contracted 0.9 percent (m/m, sa), while industrial production fell 0.6 percent (m/m, sa), according to the Ministry of Economic Development.⁶

Starting in December, certain sectors where growth had been stable (e.g., had occurred for four or more months in a row) stopped growing, including cars, ribbon, furniture, and soft drinks. In the “leading” industrial sectors—whose dynamics were predicting future GDP dynamics, based on 2000–September 2009 data—growth was not stable at the end of 2009/beginning of 2010 and, in January, each one contracted. Now, growth remains stable in only a few sectors—oil, non-ferrous metals, and meat and milk production; together, they grew 1.2 percent (m/m, sa) from December to February. Meanwhile, steadily declining sectors, such as light industry, machinery building (except of power generation), construction materials, and chemicals, held down overall industry growth.

Growth in “Leading” Industrial Sectors
Percent change, m/m, seasonally adjusted

It is not yet fair to say that Russian industry is on the edge of a new slowdown, however, given that the statistical data is unreliable, some aggregate data may be inexplicable, and data on defense industries, which hold a big share of industry, is not published. But—and this conclusion is strong—the data does not support statements being made by Russian authorities about Russia’s strong and stable recovery.   

Banks Not Willing to Lend

Russian banks continue to reduce the amount of credit outstanding. The pace of reduction is not fast (0.1 percent to 0.5 percent per month), but held stable from Autumn 2008 (for household credit) to Winter 2009 (for corporate credit). The overall amount of credit outstanding has fallen 7.9 percent from its January 2009 peak.⁷ With private deposits in the banking system exhibiting stable growth, the banking system is clearly not fulfilling its basic function of transforming savings into investments.

Experts agree that the Russian banking system is facing a bad debt crisis, but how deep and strong is it? Official Central Bank data paints an optimistic picture, placing the share of non-performing loans at about 5 percent. However, many bankers estimate much higher shares, up to 15 to 20 percent. To a certain extent, this is due to methodological differences—on average, auditing companies multiply Central Bank data by 2.5 to make it internationally comparable.⁸

At the same time, the Central Bank’s policy of allowing banks to use “window dressing” methods (e.g., loan restructuring, credit sales to mutual funds owned by banks or to affiliated collectors agencies, etc.) hides the full magnitude of the problem. The Central Bank has adopted a soft stance on banking supervision: the only bank in trouble is a fully illiquid bank that is therefore unable to meet current commitments. As a result, many zombie-banks are able to cover their losses with private deposits (it is easy to attract private money by increasing interest rates when the government guarantees deposits)—maintaining liquidity while hoping the problem blows over. However, history shows that the problem will disappear only if inflation is high; in Russia, inflation is at historically low levels and projected to fall even further.

Looking Forward

The spring of 2010 will be crucial for understanding future developments in the Russian economy. Regular statistical data and revisions of previous numbers will be available, shedding light on the economic situation and testing the contention that export growth has reached potential. In addition, the government’s budgetary debates will illuminate Russia’s approach to its deficit target for 2011. Are leaders ready to make unpopular decisions, including a freeze in wages, to meet the 4 percent of GDP target? Or will new, recently announced expenditures be implemented, wages and pensions indexed, and the deficit allowed to grow? The latter would not be a surprising outcome, as Russia’s Parliamentary elections are coming up in December 2011 and the Presidential election is in March 2012. Post-winter gas price dynamics in Europe will also provide important insights, as they will affect Gazprom’s finances and determine its long-run ability to develop new deposits.

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 Rosstat’s preliminary assessment of 2009 GDP growth—an overall decline of “only” 7.9 percent—surprised many experts, who had been anticipating a contraction of 8.5 to 9 percent. Without Rosstat’s previous revision of 2008 results, however, the result for 2009 GDP growth would have been an 8.5 percent decline. Moreover, even the announced figure could be revised significantly. This is a “preliminary assessment;” the first “official assessment” will be published this fall. A substantial difference between the two should not be surprising. In addition, as usual, the preliminary annual data is not comparable to previously published quarterly data. Because of methodological differences, annual 2009 GDP growth less GDP growth of the first three quarters does not equal fourth quarter GDP growth, and fourth quarter GDP growth is still unknown.}

^{2 The government has eliminated export taxes and instituted tax breaks in Eastern Siberia. Elsewhere, the current tax regime takes up to 90 percent of every additional dollar in the price of oil beyond $30/barrel, and therefore does not allow oil companies to accumulate adequate financial resources.} 

^{3 The export tax on oil exports for some future period is determined by the average price of Russian oil in Rotterdam over some previous period. Before September 2008, the period was two months; since then, one month. The “Kudrin’s scissors effect,” named for Minister of Finance Alexei Kudrin, refers to the effect that this system of tax rate determination has on oil exports. During periods of declining oil prices, when the basis for the export tax is higher than the current price, the rule hurts oil companies. In September 2008, for instance, the rule led to net losses from oil export. Under the pressure of the oil lobby, the government then changed the rules that gave oil companies approximately RUB500 billion ($20 billion at that time).}

^{4 This figure is based on Rosstat data and may be revised later. Starting in 2010, Rosstat changed the index year of its Russian industry indexes from 2002 to 2008. As a result, data for 2010 is not fully compatible with previous information.}

^{5 Data on February’s industrial production was published on February 15, but it showed non-adjusted growth of only 1.9 percent (y/y) for Russian industry, well below all previous estimates. Rosstat promises to re-produce historical data on the new basis during the second quarter of 2010.}

^{6 The Ministry’s estimates tend to be rather close to Rosstat numbers, published later, though differences of +/-0.3 percent do occur.}  

^{7 To a certain extent, significant increases in banks’ bond holdings has compensated for this decline, as the Central Bank accepts many corporate bonds as collateral.}

^{8 The Central bank considers credit to be “non-performing” after 90 days of deferral, while the international standard is 30 days. When calculating the amount of non-performing loans, the Central Bank uses only those traunches of credit that have not been repaid, while the international standard is to count the entire credit amount.}