It’s been a little over one year since Vladimir Putin’s formal return to the Russian Presidency on May 7, 2012. What he originally envisioned as a time to cement his legacy has turned into a much messier period of seeking a new equilibrium, both at the political and the economic front. While Putin has somehow managed to remain on top politically, he has been forced to sacrifice his broader social and economic agenda. Result: A big stress test looms for Putin.
Squeezed by Europe’s recession to the west and China’s slowdown to the east, Russian economy may record dismal growth this year, way below the goal of 5% annual growth set when Putin returned to the Kremlin last year. In fact, Russian GDP expanded just 1.6% year-on-year (y-o-y) in Q1 2013, according to Rosstat’s (Russia’s statistical agency) preliminary estimate. Although the estimated growth was higher than the 1.1% predicted previously by the Ministry of Economic Development, growth decelerated from 2.1% y-o-y in the final quarter of 2012. Slower fixed investment growth and falling export receipts were the key drags on the economy’s performance. Fixed investment grew just 0.1% y-o-y in Q1 2013, compared with 16.5% in Q1 2012. An unfavorable investment climate, coupled with tight corporate credit (interest rates on corporate loans longer than one year exceeded 12% in Q1 2013, and rates on short-term corporate loans rose from 8.8% in January 2013 to 10% in March 2013), is constraining investment. Although reforms to business registration and tax procedures raised Russia’s ranking in the World Bank’s “ease of doing business” table by six places in 2012, investment is still burdened by relatively high taxes, cumbersome regulation, and widespread corruption. Interestingly, some of the country’s largest enterprises, including Gazprom, has also scaled back planned investments for 2013. Even the Ministry of Economic Development’s estimates fixed investment will grow 4.6% in 2013, down from 6.5% forecast earlier
As if this wasn’t enough, recession in much of the European Union too has reduced the demand for Russian energy exports, pushing the price of Urals crude down 5.5% y-o-y during the first quarter of 2013. This caused Russian real exports to fall 5.2% in Q1 2013. In addition to fuel and energy exports, machinery, equipment and transport goods exports fell by 1.8% y-o-y in Q1 2013, in contrast with a 35.7% expansion a year earlier. Even the Ministry of Economic Development sees foreign sales stagnating this year, and long-term prospects for Russia’s natural gas exports may also be reduced if the US goes ahead with plans to sell its much cheaper liquefied natural gas to EU. Weak fixed investment, falling exports, and a strong base effect in turn have forced industrial production to contract 0.8% y-o-y in January and 2.1% in February. Forward-looking indicators too imply further weakening in Russian industry. For instance, while, in March, the Markit PMI for manufacturing dropped to 50.8 from 52 a month earlier, in April, the Rosstat confidence gauge for manufacturing worsened to -1 and the Markit manufacturing PMI declined further to 50.6. The PMI found new orders growing at their slowest rate since August 2012. New export orders fell for a third consecutive month, while investment goods production fell sharply and manufacturing employment dropped for a sixth successive month. Rosstat data also shows that railroad turnover fell 3.8% in February and 4.2% in March.
Moreover, at the same time, core inflation remains high and, on current policies, headline inflation is projected to stay above the Bank of Russia’s forward-looking target, aimed towards 4-5% inflation by end-2014 (IMF data). In fact, inflation remained above the central bank’s target range throughout the first quarter. While in March, the CPI was up 7% y-o-y, in April, inflation rose to 7.2%. Although the central bank aims to bring inflation back within its target range, its ability to do so depends crucially on agricultural yields. However, despite the weaker growth data, the central bank left its main policy rate unchanged at 8.25% in May, implying that it still thought inflation was a bigger threat than slow growth. The central bank nevertheless cut interest rates on its 12-month repo operations and gold-backed loans for a second straight month, in an effort to boost interbank lending.
Consumer spending, which was the main locomotive of Russia’s growth in 2012, was also undercut in Q1 2013 by high inflation, slower real income growth, tighter credit, and a worsening outlook. Over the first quarter, real disposable income grew 5.3% y-o-y, down from 5.8% in Q4 2012.
Thus, with investment sluggish, consumer spending weak, and export conditions unfavourable, policy options for stimulating Russia’s growth in 2013 appear limited. The government plans to tap the National Welfare Fund for infrastructure projects in partnership with some private firms. This may help in the short run, but the formula for Russia’s recent growth – high oil prices, extensive state investment, and surging consumer credit – does not appear to be working as it did in the past. Agrees Ashot Tsharakyan, the Prague based Economist at Moody’s Analytics, as he tells B&E, “More radical regulatory and tax reform is needed, along with a reduction in corruption, to improve the investment climate and reduce capital outflows.”
Under current conditions, Russia’s growth rate will not pick up until Europe recovers from recession. What Russia actually needs at the moment is a policy overhaul, both in the short term and in the longer term. While in the short term, Russia will need to prevent domestic demand from expanding at a pace exceeding the economy’s potential, and at the same time build further flexibility and, especially, buffers and “fiscal space” to respond to possible external shocks, in the long run Russian economy needs investment in new and productive capacity, and therefore needs to become more investment friendly in order to put economic growth on a higher path.
Furthermore, growth cannot be increased durably through stimulus to domestic demand, be it through budgetary or monetary policies. Attempts to do so would lead to pressure on the domestic price level and the balance of payments, and would eventually need to be reversed, possibly in a disruptive manner. Russia’s economic policies should instead aim to boost productive investment in new capacity over time; i.e., focus on the supply side of the economy.
Putin still retains sufficient resources to ward off his challengers. In fact, with a stronger set of policies in place the Russian economy could grow by as much as 6% annually over the medium term. But which scenario will materialise will depend on Putin’s policy choices. No doubt, significant progress can be made, but it will require a strong political will. Does Putin have one?
