Russia: Economic slowdown continues
Russia’s economic activity has continued to slow in 13Q3 and we expect growth in 2013 as a whole to be around 1.5%. The economic slowdown is starting to adversely impact public finances. The central bank has left rates on hold for now, despite falling inflation.
Weak economic growth in 13Q3
Russia’s economic growth continues to slow down. GDP growth in 13Q3 was 0% q-o-q, which was below consensus expectations. The contribution per sector has not been released yet, but the monthly activity data in 13Q3 give an indication regarding the main economic drivers. The monthly retail sales data show that after a drop of 1.4% m-o-m in September, retail sales picked up again with 2.8% m-o-m in October, indicating that consumer spending remains sound. Meanwhile, investment seems to have contracted in y-o-y terms. The monthly data on investment in productive capacity are consistent with fixed investment falling by around 1% y-o-y. The key message is that there is still little evidence of a much-needed shift away from an excessive reliance on consumer spending and more towards greater investment. Against this backdrop, we decided to revise downward our growth estimate for 2013 to 1.5%, from 2.2% previously.
Economic slowdown starting to hit public finances
Russia’s economic slump is starting to weigh on public finances, as the budget deficit is likely to widen in 2014 and 2015 to around 0.5%-1% of GDP. While this is not dramatic, the trend from a budget surplus to a deficit warrants closer attention. The deterioration of fiscal position is owing to rising expenditure and stagnating revenues. While the latter is partly due to stable oil prices this year, the weakness in economic growth is also taking its toll on revenues. Of course, the deterioration in the budget position is not all bad news. If the government had tried to prevent the deficit from widening (i.e. not allowing automatic stabilisers to operate), growth would have been even weaker. Government debt is likely to rise, but it will do so from a very low base (10% of GDP in 2013). A large part of the rise in expenditures consists of President Putin’s spending promises made during his re-election last year. Around half of the spending promises have yet to be implemented. This will need to be financed by either cutting spending in other areas or hiking taxes. While neither option will be popular, we expect that a large part of th promised spending, which is equivalent to 1% of GDP, to be pushed through in 2014.
Inflation continues to slow down, but interest rates on hold for now
The Central Bank of Russia (CBR) left its new benchmark interest rate, the one week repo rate, unchanged at 5.5% at its latest policy meeting. The CBR decided to stay put as inflation has been falling in recent months. That said, it appears the CBR is in no rush to cut interest rates. In particular, policymakers still believe that most of the slowdown in growth over the past year has been due to structural constraints. We agree with the CBR’s assessment that output is only “slightly below its potential level”. There are few signs that weak growth has been accompanied by an increase in spare capacity. Unemployment is close to a record low and survey measures of capacity utilisation remain fairly high. Inflation was 6.5% in November, which is slightly higher than the 6.3% recorded in October. However, the overall trend is a slowdown in inflation in the coming six months toward the CBR’s target of 5%, from the average 7.2% booked in 13H1. In particular, food inflation will slow due to this summer’s good harvest. Against this backdrop, government pressure on CBR to loosen monetary policy is expected to intensify, but looser monetary policy is unlikely to materially impact economic growth.