CENTER FOR MACROECONOMIC ANALYSIS AND SHORT-TERM FORECASTING Tel.: (7495) 129-17-22, fax: (7495) 129-09-22, e-mail: mail@forecast.ru, http://www.forecast.ru D. Belousov, E. Abramova, A. Apokin, K. Mikhaylenko On the Economic Situation in Russia During Fourth Quarter of 2014 Third Quarter of 2015 and the Outlook for 2016 2018 1. Recent Trends General Overview of the Situation For over a year, a growing downturn has been the key trend defining the state of Russian economy. Year-end of 2014 demonstrated GDP growth of +0.6%. However, this growth was guaranteed only for the first six months, and also this was mostly due to increase in household consumption, against the background of the growing decline of fixed capital investments. This year the economy is projected to decline by.5 4.0% (see Chart 1). Probabilities of shifting towards growth in the coming years are not yet clear. It is highly likely that in 2016 the Russian economy will face a mild downturn (stagnation is best case scenario), and in 2017 2018 there will be an extremely sluggish growth. 4 2 1 0-1 -2 - -4 Chart 1. GDP (Growth Rates, %) 4.5 4..4 -.9 2010 2011 2012 201 2014 2015, estimate 1. 0.6 9 6 0 - -6-9 -12 Chart 2. Contributions of the factors to GDP growth (% of GDP growth) 4.5 4..0.4 1..5 1. 4.1 2.0.8 2.5 2.0 2.8 1.4 1.4-1.9-0.8-5. -4. -0.7-2.0 0.6 0.7 1.8-1.2-0.4 -.9 1.0 6.8-5.1-1.6-5.0 2010 2011 2012 201 2014 2015, estimate household final consumption expenditure government final consumption expenditure gross fixed capital formation change in inventories export import other factors An essential feature of today's crisis is the contraction of almost every element of domestic final demand (see Chart 2). If participation of gross fixed capital formation went into the negative as far back as 201 (201: -2.0 of GDP percentage point; 2014: -1.2 of GDP percentage point; 2015, estimate: -4.6 of percentage point), then the absolute decline in household consumption became a brand new and very powerful downturn factor only in the current year (2015 estimate: -5,0 of GDP percentage point). With this, the slowdown of household consumption is attributed to med-term factors: the need for companies to lower the pressure of labor expenses on their competitiveness; leaving the overheated consumer lending domain. Therefore, we have all the reasons to presume that a slowdown 1
in private demand will linger, which means a major restraint on the economic growth. The output is supported solely by expansion of net export, primarily due to major decrease in import, first of all owing to several waves of ruble devaluation. The export (even if we ignore the raw commodities and their dependency on the volatile market conditions) grows at low rates which is normal in the circumstances of the corporate lending collapse that occurred. How the Crisis Formed It should be noted that both the crisis itself and its pre-conditions formed two to three years prior to its official start. And they stem from the mechanism for recovering from the previous crisis wave by means of increased labor compensation growth (in the public sector and, due to activity of the competition on the labor market, in the economy overall 1 ), which encouraged a major expansion of households consumption. In the end, thanks to the increase of labor expenses, company profit margins have never recovered from the crisis, which initiated the reduction in private investment (201), forced bank lending to move from corporate into consumer sector, and resulted in depreciation pressure on the economy. In this circumstance, which basically still warranted correction in 2014 2015, the Russian economy moved towards the shock of the second half of 2014. During the past year (fourth quarter of 2014 third quarter of 2015) Russia's economic development went through two phases, each approximately six months in length a deep recession at the turn of 2014 and 2015 and stagnation in the second and third quarters of 2015. Shock Recession Phase The crisis moved into the open in the latter half of 2014 and became full-blown in its fourth quarter. The end of 2014 was marked by a combination of three factors: the strengthening of the sanctions regime, the drop in oil prices, and the devaluation shock. On the one hand, the economic sanctions turned up an issue related to access of the Russian corporations to external lending which previously provided a basic resource for financing major longterm projects 2. On the other hand, global oil prices dropped by half (from USD 96 to 46 per barrel between September and January, see Chart ). This deprived the Russian companies and later the treasury of a major fraction of revenue; moreover, it inflicted a serious blow to the balance of payments stipulating strong devaluation pressure on the ruble. A drop in oil prices and general deterioration on the foreign and domestic markets led to an abrupt capital outflow (USD 76 billion in the fourth quarter). At the same time, the balance of payments crisis became a factor in major ruble devaluation: the rate of the ruble against the dualcurrency basket had dropped by more than time and a half. This, in turn, couldn't help but cause a spike in inflation, which in six month increased year-onyear from 7.5% (August 2014) to 16.9% (March 2015). 1 Economy-wide, the average monthly salary of a single employee per the exchange rate was around USD 1,000 by the start of 2014, moving close to the level of the Eastern European countries. 2 Here, a part was played often not even by the inflow of money to large projects, but by an anticipated through attraction of external financing international quality assessment of a project, risks, profitability, etc. The situation was worsened by the necessity for the companies to save up on currency in order to get through the peak of corporate debt repayment at the start of 2015, and possibly, for speculative purposes; in any case, December 2014 marked a spike in currency demand on the stock exchange on behalf of only several major agents most likely serving the interests of some kind of heavy borrowers. 2
1.2010.2010 5.2010 7.2010 9.2010 11.2010 1.2011.2011 5.2011 7.2011 9.2011 11.2011 1.2012.2012 5.2012 7.2012 9.2012 11.2012 1.201.201 5.201 7.201 9.201 11.201 1.2014.2014 5.2014 7.2014 9.2014 11.2014 1.2015.2015 5.2015 7.2015 1.2010 2.2010.2010 4.2010 1.2011 2.2011.2011 4.2011 1.2012 2.2012.2012 4.2012 1.201 2.201.201 4.201 1.2014 2.2014.2014 4.2014 1.2015 2.2015.2015 115 105 95 85 75 65 Graphic Chart. Urals Oil Prices (USD per barrel) 119.4 82.2 72.7 72. 122.6 114.7 111.5 108.9 107.6 101.0 9.4 6.4 Graphic Chart 4. Ratio of inflation and the interest rate of the Bank of Russia for shortterm REPO auctions (year-on-year, growth rate, %) 15 1 11 9 7 7. 5.9 6.2 minimum interest rates on REPO actions with maturity from 1 to 6 days, % (annual average) CPI (as compared with the same period last year, %) 8.2 9.6 9.6 8.2 6.8 7.5 7.7 7.2 7.2 6.6 6. 6.4 6.4 6.1 16.2 15.9 15.9 15.5 9.6 12.9 11.2 55 5 5.9 5.0 5.5.9.9 5. 5.5 6.0 45 46. 45.4 A unique crisis of the "stop-go regulation" became an additional factor: under the circumstances when a full-blown recession had already been underway in Russia, the Bank of Russia followed a strict interest-rate policy oriented towards suppression of the inflation and stabilization of the exchange rate. At the same time, up until the end of the year it was believed that in Russia utilization of the factors of production (low unemployment rate, high capacity utilization) remained on the high level, however, the signs of recession were practically ignored 4. Therefore, the rate (based on one-week direct REPO auctions) of the Bank of Russia was increased twofold, from 7.9% in the third quarter to 15.5% in the first quarter of 2015 (see Chart 4). However, this could not avert a spike in inflation 5, but the recession strengthened abruptly. In the fourth quarter fixed capital investments remained its primary focus. What turned out to be a deterrent was not even the drop in availability of the lending resources in itself (which definitely took place), but also demotivation of potential investors with the established level of rates and risks it is more profitable and safer to keep the existing resources in financial assets rather than engage in high-risk investment into real assets. With this, it seems that antiinflation efforts of the Bank of Russia worked "towards the opposite direction": a reduction in fixed capital investments led to the release of financial resources that in turn migrated to the foreign exchange market stipulating ruble devaluation and eventually increase of the inflation. In the fourth quarter of 2014 the output was somehow still supported by a rapid expansion of households consumption (in December, given the expected price growth in the new year, the consumer demand became abnormal and feverish). From the start of 2015 consumer spending naturally began to decline (see Chart 7), and a fullscale economic downturn emerged. 4 Note that in accordance with the law, support of the output (prevention of recession, etc.) are not included in the objectives of the Bank of Russia. 5 It goes without saying that in certain way the inflation was aided by the "anti-sanctions" introduced by Russia on the food market in the third quarter of 2014, the intention of which was to deprive the European countries and USA with allies of their motivation to extend the economic sanctions against Russia. The increase of the monopoly on regional food markets spurred up the inflation of course, but the consequences of the "anti-sanctions" were completely absorbed by the results of ruble devaluation (even more so that the specified restrictive measures one way or another helped to offset the balance of trade; without those measures the devaluation obviously would have been more profound).
Jan-2010 Feb-2010 Mar-2010 Apr-2010 May-2010 Jun-2010 Jul-2010 Aug-2010 Sep-2010 Oct-2010 Nov-2010 Dec-2010 Jan-2011 Feb-2011 Mar-2011 Apr-2011 May-2011 Jun-2011 Jul-2011 Aug-2011 Sep-2011 Oct-2011 Nov-2011 Dec-2011 Jan-2012 Feb-2012 Mar-2012 Apr-2012 May-2012 Jun-2012 Jul-2012 Aug-2012 Sep-2012 Oct-2012 Nov-2012 Dec-2012 Jan-201 Feb-201 Mar-201 Apr-201 May-201 Jun-201 Jul-201 Aug-201 Sep-201 Oct-201 Nov-201 Dec-201 Jan-2014 Feb-2014 Mar-2014 Apr-2014 May-2014 Jun-2014 Jul-2014 Aug-2014 Sep-2014 Oct-2014 Nov-2014 Dec-2014 Jan-2015 Feb-2015 Mar-2015 Apr-2015 May-2015 Jun-2015 Jul-2015 Aug-2015 Stagnation Phase Starting from the second quarter of 2015, the economic situation began to improve somewhat. Ruble devaluation allowed Russian companies (especially those oriented towards non-resource exports) to improve their financial state to a certain extent, although not as much as could have been expected judging by its depth 6. The Bank of Russia moved to a more stimulative policy by starting careful reduction of the interest rate. Under these circumstances Russia's economy began "searching for the bottom": long-term (2 months) periods of stabilization of real wages and consumption have been noted. Unemployment grows slowly (except that there is almost no growth in the skilled labor segment). Periods of investment stabilization have been noted (see Chart 8). This means that companies continue to hope for a speedy conclusion of the crisis and a shift to growth. By mid-year there even were hopes that signs of growth would appear already in the fourth quarter. At the present time these hopes have turned into an illusion. On the one hand, another drop in oil prices led to the new devaluation wave with its appropriate inflationary effect. On the other hand, this was also topped by a sharp increase of the regulated tariffs on the housing and utilities as well as transport services as of 1 July 2015. Consequently, the inflation spike had practically "consumed" the potential of possible economic revival. It should not be left unmentioned that in itself the economic stabilization based on households consumption in our circumstances is a manifestation of the crisis: the increased risks of corporate lending push the banks to consumer lending. As a result, the economic growth is, of course, supported, however it is done at the expense of potential destabilization of the banking system. Therefore, consumer lending most likely and in the long view will start to die down. Graphic Chart 5. Nominal foreign currency to ruble exchange rates (rubles to a unit of foreign currency) 115 110 105 95 90 85 80 75.5 106.4.1 6.2 7.1 112.8.0 10.7.4 114.4 6.6 107.4 112.1 5.2 116.0 real effictive ruble exchange rate (august 2008=%, left scale) 7.4 111.7 bicurrency basket rate (0.55 USD+0.45 euro), rubles, end of the month (right scale) 10.4 112.0 61.7 80.0 7.1 54.8 92.8 86.9 77.8 60.7 64.6 98. 54.0 78.6. 9.9 6 61.5 58.2 7 70. 68 58 5 91.5 48 4 81.0 8 Graphic Chart 6. Dynamics of the investments into fixed capital and retail turnover (growth rates, %) 10 5 0-5 -10 6.5 6. 10.8 7.1 6.8 6. fixed capital investments retail trade.9 0.8 2.7-2.7-6. -8. 2010 2011 2012 201 2014 2015, estimate 6 Clearly, the "pendulous" strengthening of the ruble in the first and second quarter of 2015 noticeably weakened the positive results of devaluation for competitiveness of the Russian companies. 4
01/12 0/12 05/12 07/12 09/12 11/12 01/1 0/1 05/1 07/1 09/1 11/1 01/14 0/14 05/14 07/14 09/14 11/14 01/15 0/15 05/15 07/15 01/12 0/12 05/12 07/12 09/12 11/12 01/1 0/1 05/1 07/1 09/1 11/1 01/14 0/14 05/14 07/14 09/14 11/14 01/15 0/15 05/15 07/15 Graphic Chart 7. Retail trade turnover (% to monthly average of 2012) Graphic Chart 8. Investments into fixed capital (% to monthly average of 2012) 200 10 10 180 125 120 160 120 115 140 110 105 95 97.4.1 102.6 104.8 105.1 107.5 106.8 108.4 101.7 97.5 97.0 120 80 97.8 10.1 101.9 101.0 102. 97.6 99.2 97.5 98.1 95.5 9.6 91.5 110 90 90 85 actual value seasonally adjusted 60 40 actual value seasonally adjusted (right scale) 80 2. Assumptions on National Policy and External Environment It is assumed in optimistic scenario that global oil prices will recover from an average of USD 50 per barrel in 2016 to USD 55 in 2017, and USD 60 in 2018. In pessimistic scenario it is expected that the oil prices will drop further and will not gain back for the rest of the forecast period (about USD 40 per barrel in 2016 2017, and USD 45 in 2018). Russia's economic policy of the last year overall was designed to stabilize the situation (its nature was anti-crisis). The primary policy measures were focused on the following: - drop in inflation (a rather strict monetary policy of the Bank of Russia); - stabilization of the public sector (conducting random sequestration of state spending; in order to preserve budget stability, given the deficit of approximately,5% GDP, federal budget reserve funds are being used as the primary source of funds instead of the sharply inflated borrowings on the foreign and domestic markets. - large-scale recapitalization of the banking system. At the same time, development objectives are resolved on a very limited scale a number of fairly large investment projects (in the field of transportation system reconstruction) as well as projects involving procurement of high-tech weapons, primarily aviation and space equipment, despite sequestration are carried out using funds from the federal budget (as well as a number of large regional budgets, in particular, Moscow's budget). The scope of support for science and technology activities remains fairly large (specifically, the National Technology Initiative has been launched mid-year).. Forecast Summary An Optimistic Scenario In the circumstances of recovery of global oil prices, the companies that obtained additional financial resources will resume their investment activities (2016: continued stagnation of -0. + 0.1%; 2017: + 2.9 +.%; 2018: +4.6 +5.0%) after a three-year "innovative timeout" in 201 2015. At the same time, in order to sustain competitiveness, real wages will experience a much slower growth (2016: -0.5-0.8%; 2017: +1.9 +2.2%; 2018: +2.9 +.%). With this, there is going to be an almost inevitable in such situation soft correction of consumer lending, which will cause the trade turnover to fall behind personal income. In 2016 sales of consumer goods are going to decline by 0.9 1.2%; in 2017 they will begin to grow by 2.5 2.8%, and in 2018 by 4.0 4.4%. Therefore, gross domestic product will settle down in 2016 (-0.1 +0.2%); it will begin to grow in 2017 2018 (+1.2 +1.5% and +1.8 +2.2%, respectively). 5
Thanks to the expected strengthening of the ruble in the context of improved foreign economic conditions, it will be possible to keep the rate of inflation in 2016 in the range of 8.8 9.1%, followed by a rapid drop (2017: 5. 5.7%, 2018: 4. 4.7%; the target rate for the Bank of Russia is the inflation rate of 4.0%). A Pessimistic Scenario The further drop of oil prices is going to send a bad signal for the companies; the outflow of their resources into financial assets including foreign assets will remain. The treasury will have to conduct tough sequestration cuts of every major program according to most aggressive proposals of Russia's Ministry of Finance. Consequently, one can expect that the negative trend of investments into the fixed capital will continue (2016: downturn continues at -.8 4.2%; 2017: stagnation at -0.2 +0.2%; 2018: minor gain at +1.8 2.2%). Neither the companies, nor the budget system have enough resources to increase salaries (it is expected that regions will face a fairly harsh crisis). Consequently, it is expected that there will be an absolute reduction in real wages in 2016 (-4.2-4.5%), and slow growth in 2017 2018 (+0.8 +1.1% and +2.4 +2.8%, respectfully). Given the inevitable in this scenario consumer lending crisis, sales will also be sluggish (2016: -.8 4.1%; 2017: + 0.6 0.9%; 2018: +.9 4.%). Under these circumstances one can expect that the full-scale crisis is going to continue in 2016 (GDP drop by 1.7 2.0%), followed by an extremely slow growth in the next years (2017: +0. 0.6%, 2018: +1.7 2.1%). In 2016, yet another ruble devaluation can be expected (to 10.6 11.0% against the dualcurrency basket) followed by its stabilization. Consequently, the rate of inflation in this case will remain quite high (2016: 10.0 10.%; 2017: 5. 5.7%; 2018: 4.7 5.1%). 4. Policy Issues and Uncertainties The established economic policy is expected to remain in place as follows: - a moderately strict monetary policy (with the interest rate around the inflation rate); - a floating exchange rate for the ruble; - a moderately conservative budget policy (using budget reserve funds for partial financing of its deficit; saving budget resources including freezing of federal budget nominal expenditures in 2017 proposed by the Ministry of Finance of Russia in the event of unfavorable market conditions). Mid-term uncertainties are as follows: - commodity prices which largely depend on the regional situation of hydrocarbon producers (entry into market of carbohydrates from Iran, Iraq, and Libya; possibility of new agreements on production quotas between Iran and Saudi Arabia) and on the situation in demand regions, first of all in China's economy, to a large extend defining the growth scale for fuel demand; - behavior of companies. On the one hand, implementation of the opportunities for import substitution that emerged as a result of ruble devaluation and introduction of restrictive measures on the food markets anticipates that the issues associated with the level of quality and technology of Russian products will be resolved, which requires investment. On the other hand, investments, even those made at the expense of company own resources, are impeded by high risks (and an overall lack of understanding of mid-term market development), as well as disparity between investment returns into real assets and financial assets. This disparity to a large extent is stipulated by the high ruble interest rates. - risks of conflict zone expansion at Russia's south borders. 6
Table 1. Main macroeconomic indicators forecast (optimistic scenario) 2015 2016 2017 2018 CPI (end of the year) 14.6 9.0 5.6 4.6 GDP -.9 0.0 1. 2.0 Industrial output -.5-0.1 0.8 1.9 Fixed capital investments -6. -0.2.2 4.9 Real wage -8.5-0.7 2.0.2 Real disposable houshold income -5.1 0.1 2.6.6 Retail trade turnover -8. -1.1 2.6 4.2 Paid services -2.7 0.0 2.1.1 Export, bln. USD 48 0 54 79 Import, bln. USD 194 191 212 22 Trade balance, bln. USD 154 19 142 147 Ruble exchange rate, annual average, rubles per USD 60.7 67.0 62.5 58.8 Urals oil price, USD per barrell 52. 50.0 55.0 60.0 Table 2. Main macroeconomic indicators forecast (pessimistic scenario) 2015 2016 2017 2018 CPI (end of the year) 14.6 10.1 5.4 4.8 GDP -.9-1.8 0.5 2.0 Industrial output -.5-1.4 0.1 2.1 Fixed capital investments -6. -.9 0.1 4.7 Real wage -8.5-4.4 0.9 2.6 Real disposable houshold income -5.1 -.2 1.2.6 Retail trade turnover -8. -4.0 0.8 4.2 Paid services -2.7-2.8 0.9.1 Export, bln. USD 48 296 299 25 Import, bln. USD 194 176 184 197 Trade balance, bln. USD 154 119 115 129 Ruble exchange rate, annual average, rubles per USD 60.7 72.8 72.4 70. Urals oil price, USD per barrell 52. 40.0 40.0 45.0 7