Russia: More than oil and gas

Transcription

1 Allianz Dresdner Economic Research Working Paper Nr.: 87 Authors: Dr. Rainer Schäfer Gabriele Steck Russia: More than oil and gas The Russian economy has turned an important corner in recent years: the private sector is expanding strongly and domestic financial intermediation is showing clear signs of recovery for the first time since the 1998 crisis. This fuels hope that the country is increasingly using its immense revenues from oil and gas exports to modernize and expand its battered capital stock. Steep rises in investment and imports point in the same direction. The related broadening of the foundation of the Russian upswing comes at a time at which attention is again increasingly focused on the risk of self-isolation and government meddling in Russian economic policy. But in view of Russia s current rapid economic integration with the rest of the world, as reflected in foreign trade and capital transactions, we believe such fears are overdone and regard Russia s path to the market economy as irreversible. Nor will this be altered by a new incumbent in the Russian presidential office next year. Despite these economic successes Russia is still of course in the early stages of its recovery process. Above all the manufacturing sector is suffering from the Russian economy s commodity bias, the strong ruble on the currency markets and the related loss of competitiveness at home. On the other hand the enormous currency reserves now amassed provide good protection for the recovery against external shocks, e.g. a massive drop in energy prices. State intervention in corporate affairs remains a burden for the economy (corporate governance).

2 Economic development: Upswing gaining breadth In the past five years, real GDP has expanded on average by 6.5 % annually. The economic momentum was sparked off by rocketing energy prices followed by stronger domestic demand. However, following the introduction of the Stabilization Fund in 2004 the energy sector has steadily forfeited its status as economic locomotive. The fund absorbed oil export revenues emanating from prices in excess of USD 27. The fund's foreign currency investments are part of the currency reserves and could only spur domestic demand to a limited extent, if at all. In the meantime, however, private consumption and construction investment in particular have gathered steam noticeably. On the supply side by contrast, strong productivity gains were notched up in Russian big cities, above all in the expanding service sector and construction industry. The latter is profiting from the boom on the housing market which has been humming for several years now. In contrast, the manufacturing sector managed to expand its production to an only below-average extent due, among other things, to the blow dealt to industrial competitiveness by the soaring ruble on the foreign exchange markets. Last year more than 90 % of domestic consumption gains were covered by imports, with domestic companies hardly profiting from the consumption boom. Real disposable income has climbed far more strongly than labor productivity. Companies will struggle to maintain the wage increases of recent years. Pent-up investment demand and robust domestic demand will also ensure that economic growth this year matches that of the period Real GDP growth and gross capital formation percentage change over previous year p GDP Capital formation 2

3 Government budget: Spending gaining the upper hand Budgetary policy is on an expansive path, which is understandable given the challenges in the welfare sector and the large revenues from the oil and gas sectors. With revenue set to remain more or less constant, the government is planning an extremely steep rise in spending this year. As a result the budget surplus, which stood at 7.4 % in 2006, is likely to tumble to 2.7 % in Stripping out oil and gas revenues, the budget deficit would top 10 % this year. Going forward, the government intends to channel only a good half of the revenues from the oil and gas sector which had hitherto flowed into the budget into future budgets. A courageous step indeed, when one considers that in 2007 this would have resulted in a budget deficit of over 3 % of GDP. And according to the multi-year budget plan, spending is set to rise still further in the coming years. For example, plans exist for the introduction of a funded pension system which, given the country s unfavorable demographic data, is understandable and to be welcomed. However, hefty subsidies will need to flow into the system in order to make it more popular. A change in the Stabilization Fund s investment strategy is also planned. The Fund now has funds at its disposal to the tune of 10 % of GDP. These are deposited at the central bank and are thus part of the currency reserves. The government intends to channel future inflows in excess of this into the so-called Future Generations Fund which for its part will place this capital in higher yielding investments. This step, the envisaged cap on the budgetary use of oil and gas proceeds and the vague use of the money in the new fund do little to enhance budget transparency. However, so far neither the budget nor the division and use of the Stabilization Fund have been approved by parliament. The realization of these strategies will therefore presumably not take place before the elections. Budget balance in % of GDP Budget balance Non-oil budget balance Source: IMF, own estimates 3

4 Monetary policy: Inflation risks still lurking The fall in inflation to below 8 % compared to a year earlier still does not mean that the all-clear can be signaled. For one thing, the increases in administered prices usually made at the beginning of the year have not been carried out this year so far. For another, the robust economic growth, expansion in government spending and inflow of capital from abroad are keeping inflation under pressure. The money supply has mushroomed again in the first four months by more than 50 %, and the central bank is expressing growing concern. In May it had already raised the minimum reserve rate for ruble deposits from 3.5 to 4 %. Raising the minimum reserve rate will not suffice to keep inflation in the single-digit region. The central bank will therefore have no other choice but to allow the currency to appreciate more strongly this year, something which we would welcome. Foreign trade: Imports catching up On the back of high oil prices and the steep rise in output, exports clearly outstripped imports in recent years. As a result the current account surplus mushroomed. However, last year saw a reversal. The strong ruble meant that the bulk of domestic demand could be satisfied more cheaply via imports. Moreover, domestic financial intermediation has gathered momentum. This puts firms in a better position to modernize their capital stock with borrowed capital, giving an additional boost to imports. By contrast, export growth is losing steam as the reduced expansion in oil and gas output is barely being offset by higher prices. Last year this already resulted in import growth clearly outstripping export growth despite the high oil price. Difficulties on the oil and gas production front, ongoing buoyant domestic demand and the rising ruble will intensify this trend still further, blowing a substantial hole in the current account surplus. However, Russia s excellent liquidity situation is not at risk. Since last year inflows of foreign capital have been on the increase, generating a surplus on the capital account as well, as reflected in the steep rise in currency reserves. Gross inflows of foreign direct investment more than doubled last year to USD 28bn and now substantially top Russia s direct investment abroad. In addition, the high oil price, strong ruble and the abolition of capital market restrictions in the middle of last year attracted further portfolio investment into the country. Given moderate export growth, due to the modest rise in energy exports, and the buoyant import momentum the current account is likely to shrink until But, on the other hand, the positive economic backdrop will attract growing volumes of foreign capital into the country. 4

5 While the government has been paying off foreign liabilities in recent years, Russian businesses have increasingly been taking up loans abroad. The official sector currently accounts for only 13 % of foreign debt compared with 93 % in the year The government invested its currency reserves abroad and Russian firms drummed up capital on the international financial markets. This sequence of transactions was not least the result of weak domestic financial intermediation which, so to speak, had been partially shifted abroad. Balance of Payments in USD bn Imports Foreign direkt investment in Russia Energy sector: Investment urgently needed Gas shortages in Russia appear almost unthinkable given the country's enormous gas resources. Owing to high export prices, which on average lay at USD 295 per 1000 cubic meter last year compared to USD 43.4 on the domestic market, a major portion flows into exports. Rising domestic demand, an outmoded pipeline system and insufficient extraction capacities already resulted last year in initial bottlenecks and gas imports from Turkmenistan. Compounding this is the fact that tapping new gas fields is difficult and expensive. For this reason we see little likelihood of the gas supply expanding before To counter the domestic shortages, all that can be done is to make more efficient use of the available resources. However, without massive price 5

6 increases, it will be difficult to prompt the public and companies to implement energy savings measures. The oil sector is also experiencing a substantial rise in extraction and transport costs, with production having to be expanded to less readily accessible oil fields and pipeline bottlenecks making transport necessary via the more expensive sea routes. As a result of hefty export taxes, the oil price increase on the world market practically by-passed Russian oil producers. However, the earnings for companies at USD 25 per barrel way exceed production and extraction costs which amount to USD per barrel even for new oil fields. The economic incentive of companies to invest in oil extraction and the pipeline system thus still exists. However, on the other side, private companies are still put off by the uncertain framework in the energy sector. It is therefore not surprising that production rose only 2.3 % last year. In the years 2000 to 2004, the average growth rate was still at no less than 8.5 %. Financial system: Still a long road ahead Domestic financial intermediation is increasingly gaining in importance. All sector indicators are continuing to record high growth rates this year, but they are still at a fairly low level. This is particularly evident in the comparison with Kazakhstan: In Russia the ratio of assets to GDP lies at 56 %, whereas in Kazakhstan the rate is 90 %. In recent years, above all lending to private households has surged enormously. The bulk of these loans are still consumer loans, but the share of mortgage loans is also rising noticeably. Consumer loans nearly doubled last year, but at 8 % of GDP are still far lower than in other eastern European countries. In the whole of the banking sector, these loans account for only 20 % of total outstanding loans. Even if there were to be a marked rise in loan defaults, we consider a systemic banking crisis unlikely. For one thing, in this segment the banks are still able to rake in very favorable (if easing) conditions which could cushion the losses. Secondly, in international terms interbank trade is still underdeveloped. Although this flags up the lack of efficiency of the domestic banking market, it helps counter the risk of contagion within the banking system. The infancy of Russian financial intermediation is evident in the short loan terms. For consumer loans they are six to nine months, for mortgage loans mostly only up to three years. More than half of all deposits are still held at the state-owned Sperbank which, given its nationwide branch network and the state guarantee covering its deposits, enjoys key competitive advantages. To regain investor confidence, which was totally shattered after the 1998 financial cri- 6

7 sis, and generate competition the government introduced a deposit guarantee system back in Initially only banks which fulfilled stringent minimum standards were to be included in the system in order to achieve a clear quality differentiation among the banks. In the meantime, however, hardly any banks are excluded from the system, a factor which of course dilutes the quality seal of membership. As a result of the corporate investment boom, companies are increasingly turning to the national banking market. Above all large banks are beginning to focus more strongly on small and medium-sized companies after margins dropped in the retail sector. In the medium to long term the generally more productive domestic financial market will alter companies financing structures. Domestic loans can be expected to gain in importance compared with foreign loans. The Russian equity market index RTS nearly doubled last year. Numerous flotations of Russian companies are attracting investors into the country. On top of this, Russia scrapped the controls on the movement of capital last year. This was also a boon to the stock exchange. Compared with the equity market the Russian bond market is underdeveloped. Publicly listed corporate bonds are the exception and the market for government bonds dried up in the shadow of budget surpluses. The note market, based largely on private placements, is a positive feature and also offers small and medium-sized companies, above all from the manufacturing sector and farming sector, a forum for issuing bonds. Outlook: High growth potential We think it likely that Russia s positive economic situation will continue in the years ahead. Arguing in favor of ongoing buoyant growth is the fact that the boom, which has so far been confined to just a few cities, will increasingly spread to other parts of the country. We will also see further productivity gains in the economic centers, probably also a reflection of more modern production plant in the manufacturing sector. On the demand side investment and imports will rise particularly strongly. We do not see the current extremely expansive fiscal policy as a threat to future stability, particularly if in the medium term the government endeavors and manages to bring revenue into line with spending wit the help of sweeping tax reforms. 7

8 Obviously, external shocks can deal a bitter blow to growth in Russia as well. This would, for example, be the case if the oil price were to tumble below USD 30 a barrel, but we deem this highly unlikely at least over a 2-3 year horizon. Of course, a minimum degree of political continuity is also a requirement for ongoing high growth. We also consider this likely particularly as the boom is closely linked with Russia s integration into the world economy, rendering political solo turns increasingly difficult. All told, we expect to see average annual real growth of % over the next three years. RUSSIA f 2008f Domestic economy GDP change in % (real) GDP (USD bn) , ,386.8 Inflat ion in % (annual average) Budget balance in % of GDP External sect or Merchandise exports (USD bn) Merchandise imports Current account balance Current account balance in % of GDP Net foreign direct investment Gross foreign debt Short -t erm foreign debt Foreign debt in % of exports* Foreign debt service in % of exports* Foreign exchange reserves excl. gold Im port cover in m ont hs* Interest rates Credit rate (up to 1 year, weighted, annual average) Spread (EMBI+) (basis point s, year-end, 2007: 07/ 18) St ock m arket RTS index (year-end, 2007: 07/ 18) 614 1,126 1,642 2,036 Exchange rat e Year-end (USD/ RUB) Annual average (USD/RUB) * Goods, services and income f = forecast 8