Economic growth in Russia should stay dynamic in the first half of this year, but we anticipate that the economy will lose some steam in the second part of the year. Following 4.2% growth in 2011, we think the slowdown will lead to GDP growth of about 3.5% for the full year. Initially, we expect that consumption will be boosted by the increase in military salaries and pensions. Inflation, too, should remain moderate in the first half of the year because the government has postponed regulated tariff hikes on electricity and gas prices to July, allowing inflation to stay below 5%. Consumer lending, which reached an expected double-digit rate last year, should also continue to underpin consumer demand in the first part of 2012.
Later in the year, though, we see growth moderating for several reasons. The Central Bank of Russia (CBR) is likely to curb credit growth in the second part of the year. This is because inflation will likely accelerate again on the back of the July electricity and gas tariff hikes, which in turn will slow growth in consumer demand. The fixed capital investment outlook is equally uncertain. Investment growth accelerated in the second part of 2011 on the back of a rise in corporate profits and bank lending. This trend will continue in the first part of 2012, but is likely to slow in the following 12 months as bank lending becomes tighter and somewhat more expensive.
- Russia's economic growth is likely to slow this year, to about 3.5% GDP on higher inflation and tighter bank lending. We expect GDP growth to average 4% in 2013.
- This follows stronger growth last year on the back of strong industrial production, lower unemployment, and buoyant consumer demand.
- Nevertheless, a recovery in investment spending last year was not enough to ease capacity constraints in the underdeveloped natural resources extraction sector, which makes up 25% of the economy.
- Furthermore, capital outflows have accelerated on perceived investment restraints, and political uncertainties about structural reforms. We expect that these uncertainties will continue after the March 4 presidential election.
Russia's external sector will remain highly dependent on the outlook for commodity prices. In our baseline scenario for the world economy, we anticipate that growth in developed markets will bounce back in the second part of 2012 on the back of a recovery in emerging markets, in particular China and Brazil. This would be supportive of Brent oil prices staying above $115 per barrel (/bbl) through the beginning of 2013. We note, however, that the so-called breakeven point for Ural oil prices (the price associated with a balanced budget) has risen every year and currently stands above $120/bbl.
Overall we anticipate that real GDP growth will stabilize at about 3.5% this year before experiencing some acceleration on the back of a more dynamic world economy in 2013 (see chart 1).
Momentum From Last Year Carries The Economy Forward
Russia's economy is entering 2012 on a good footing, after 2011 turned out to be a reasonably strong year on balance, with GDP and industrial production up and unemployment down. GDP reached 4.3%, the same as in 2010, on the back of strong credit growth and a rebound in incomes. The industrial production index (IPI) gained 3.3% in manufacturing and 1.8% in mining and quarrying in December 2011 on the same month of the previous year. Both these IPIs had shown upbeat movement during 2010 and 2011, reflecting the recovery from the slump in 2009. Meanwhile, the unemployment rate declined to 6.1% in December, its lowest level since mid-2008. The federal budget recorded a surplus equal to 0.8% of GDP (after minus 4.0% a year earlier), with an average oil price of $109 per barrel.
Buoyant consumer demand also helped drive strong GDP growth. Retail sales accelerated to a record high for the year, rising 9.5% in the 12 months to December. Meanwhile, retail lending rose by 36% over the 12 months to December. Consumption was underpinned by lower inflation. The Consumer Price Index (CPI) dropped to a record low of 6.1% in the 12 months to December, near the floor of the 6%–7% target band set by the Central Bank of Russia (CBR). Between 2004 and 2010, Russia had the highest inflation rate among the so-called BRIC countries (Brazil, Russia, India, China), but this was no longer the case in 2011, as Russia's inflation ran slightly below that of Brazil. This decrease is due in part to the shift in the CBR's monetary policy to a more flexible exchange rate. This has allowed the CBR to reduce its interventions on foreign exchange markets, which used to be an important driver of money supply growth prior to 2008. Money supply growth declined to about 20% in 2011 (chart 2).
Chart 2
A partial recovery in investment and construction also supported the economy overall in 2011, but in our view will not be sufficient to ease the capacity constraints in Russia's important natural-resource extraction sector. Capital spending in December 2011 was 9% up on the previous December, while construction was up 6.7%. Natural resource extraction currently represents 25% of the entire economy. Exports of fuels and metals typically account for three-quarters of total Russian exports, and the gas and oil sector is responsible for as much as 60% of federal budget receipts. Oil and gas faces significant capacity constraints because of an extended period of insufficient investment following the post-soviet economic transition. Moreover, capacity needed to replace depleted older deposits is typically associated with more difficult geological, logistical, and climatic conditions and hence is far more capital intensive to develop and exploit. Capital expenditures remain heavily concentrated: The total capital expenditures of OAO Gazprom, Russian Railways (JSC), OAO AK Transneft, as well as electric utilities reached 4.1% of GDP in 2011. Investment by those very large companies is also heavily dependent on growth in tariffs set by the government. Year on year, these tariffs can increase at a more or less rapid rate depending on the overall economic and political context: Electricity prices rose 13% in 2011, gas prices 15%, but further hikes in 2012 have been postponed to the second half of the year.
Russia's external sector benefitted from the rise in commodity prices during 2011. Merchandise exports grew at 32.2% year on year to reach $380.1 billion. Of this amount, 65.5% were exports of oil and gas, up from 63.5% in the same period of 2010. While merchandise imports grew at an even faster pace of 34.8% to reach $232.3 billion, this was from a much lower base than exports, so that the merchandise trade surplus widened compared with a year earlier to $147.7 billion, an increase of $32.4 billion. At the same time, the physical volume of energy exports from Russia was apparently little changed from a year earlier. According to data published by RosStat for the first 10 months of 2011, the physical volume of crude oil exports was actually down 4.0%, refined product exports were 1.9% lower, and natural gas exports were up 7.4%. But the received price for crude oil in October was 36.7% higher than in the same month a year earlier, and the price of natural gas was up 25.2%
Capital Outflows Have Intensified On Investment Constraints And Political Uncertainty
In spite of these economic achievements, CBR estimates suggest that the best part of Russia's current account surplus of $101 billion (5.8% of GDP) in 2011 was absorbed by $84 billion of capital outflows. This is the second-largest outflow in the history of modern Russia (chart 3).
Chart 3
This sharp rise in capital outflows is the result of a combination of factors, in our view. First, the global financial crisis and the decrease in risk appetite by international investors has made the refinancing of foreign debt and new borrowings abroad more difficult, putting a cap on capital inflows. Additionally, the increased flexibility of the ruble exchange rate has made portfolio inflows based on carry trade less attractive. Second, outbound investments by Russian banks have been a key contributor to capital outflows since the middle of 2010. According to balance-of-payment data, on a cumulative basis by the end of the second quarter of 2011 foreign banking assets had reached $201 billion (12% of GDP). Of these, about $78 billion were parked in the EU: 34% in the U.K., 18% in Germany, 13% in Austria, and 13% in Cyprus. But interestingly, a good part of the increase in banks' foreign assets corresponds to loans made to Russian corporate borrowers. This is because many large Russian companies (and almost all of the publicly listed ones) have part of their holding structures registered in foreign jurisdictions for legal reasons.
According to VTB Capital, a Russian bank, offshore loans by Russian banks stood at $60 billion as of November 2011. Yet, this observation leads, in turn, to another: that large corporate entities borrow through their foreign entities but decline to repatriate those funds. If they did, it would offset the outflows in the capital account. More generally, this also shows that funds generated by Russian exports are not fully reinvested at home, which seems to reflect a perceived lack of investment opportunities in the domestic economy. Institutional limitations can be seen by investors as disincentives, as the central government continues to influence significantly infrastructure developments via the large state-owned companies. In addition, political uncertainties have increased in the past year as the presidential elections, due in March, were approaching, while more anti-government protests were taking place in Moscow.
Looking forward, it is difficult in our opinion to see what would slow this rise in capital outflows in 2012. The continued increase in net foreign assets could be compensated by higher external borrowing on the back of higher lending rates in the domestic economy. However, we only anticipate a very gradual return to financing conditions more favorable to borrowers on international capital markets. This is because we believe that the sovereign crisis in Europe and the associated hike in bond yields will take time to resolve. Meanwhile, political uncertainties at home will not necessarily disappear immediately after the presidential elections. There will still be many questions relative to the pace at which the new government will be ready to undertake structural reforms.
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