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Russia - sharp slowdown and protacted recovery


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Russia - sharp slowdown and protacted recovery

  1. 1. Swedbank Baltic Sea Analysis No. 21 23 June 2009 Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 1028 e-mail: Internet: Responsible publishers: Cecilia Hermansson +46 (0)8-5859 1588 Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 1478 ISSN 1103-4897 Russia – sharp slowdown and protracted recovery • The Russian economy contracted during the first quarter by slightly more than 9.5% at an annual real rate. This is more than expected, and we are revising down our 2009 growth forecast to -6%, followed by a limited recovery in 2010 of 1%. The largest decline was seen in domestic demand, in particular consumption and investments, aggravated by the slowdown in global trade and financial flows. One trouble spot is an increase in loan losses and further weakening of the banking system. On the other hand, the recovery could be aided by the significant reserves at the disposal of the Russian government for expansive fiscal stimulus measures as well as a return to higher oil prices. • Russian authorities face difficult choices in the short and medium term. The economic slowdown appears to be deeper than previously expected, and the risk of major swings in the financial markets, both externally and internally, still remains. Large fiscal stimulus packages can mitigate the impact of the recession, but have to be balanced against the need for stability in domestic prices and exchange rates. In the medium term, Russia cannot hope for a repeat of the previously high growth levels without extensive structural reforms of the economy. Unexpectedly large drop in economic activity The economic slowdown in Russia was surprisingly severe during the first quarter of 2009. GDP is estimated to have shrunk by 9.5% on an annual basis, mainly due to a contracting manufacturing sector, although indicators for retail sales and investments also pointed to significant declines. After a long period of steady growth, driven by favorable global economic conditions and exceptionally high energy prices, the Russian economy now faces challenges not seen since the last crisis in 1998-99. This time around, however, it cannot expect much support from global economic environment, and it is unlikely that oil prices and capital inflows will reach the same levels as in 2006-08. The downturn is the most severe since 1998-99
  2. 2. 2 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 Economic activity, 2003 – 2009 GDP (real) Manufacturing Retail Investment Source: Reuters EcoWin Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 03 04 05 06 07 08 09 Annualchangeinpercent -25 -20 -15 -10 -5 0 5 10 15 20 25 30 The external demand contraction exacerbates the downturn. The global recession has hit the Russian export sector hard and the value of exports fell by nearly 50% during the first three months of the year compared with the same period of 2008, largely due to falling oil prices. Despite lower imports, the trade surplus fell significantly, reducing Russia’s foreign reserves. The rouble was devalued stepwise last fall, but rising oil prices and tighter monetary policy has strengthened the value slightly in recent months.1 The value of the rouble has not fallen in real terms as much as during the crisis in 1998-99, when it dropped by more than 50%. In May 2009, it had declined about 11% compared with November last year. This provides the Russian economy with a slight competitive advantage, while, however, the servicing of foreign debt becomes more costly. Foreign trade and oil prices, July 2006 – April 2009 Export (value, USD) Import (value, USD) Oil price (Ural) Rouble against basket (55% USD; 45% EUR) Source: Reuters EcoWin jul okt jan apr jul okt jan apr jul okt jan apr 06 07 08 09 USDperbarrel 30 40 50 60 70 80 90 100 110 120 130 140 150 Annualchangeinpercent -50 -40 -30 -20 -10 0 10 20 30 40 50 60 70 1 Russian exchange rate policy is built on a target rate for the rouble against a basket consisting of dollars (55%) and euros (45%). During the latter half of 2008, the target rate was raised as the international financial crisis worsened and oil prices dropped. At present, the Russian central bank has a target of 41 versus the basket. Global demand is slowing …
  3. 3. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 3 Domestic demand is also weakening quickly. Growing losses for companies and banks, coupled with a rapid slowdown in foreign capital inflows, have created liquidity problems in the financial sector, reducing lending to businesses and households. Though lending volumes have fallen from exceptionally high levels, the rapid cutback is, in turn, creating liquidity problems for companies. This, together with a more downbeat outlook for the economy, led to a drop in investments of slightly over 2% in real terms during the last quarter of 2008, a decline which continues in early 2009. Foreign direct investment has also fallen substantially, by 43% in the first quarter 2009 compared with the same period in 2008. Lending to businesses and households, September 2007-March 2009 Lending rate (RHS) Credit to households Credit to enterprises Source: Reuters EcoWin sep nov jan mar maj jul sep nov jan 07 08 09 Percent 10 11 12 13 14 15 16 17 18 Annualchangeinpercent 0 10 20 30 40 50 60 Household demand has also slowed. Falling real wages and rising unemployment have pushed real disposable income down. The Russian labor market is flexible in terms of wage setting and is quickly adapting to lower demand, but unemployment is still rising substantially, and reached in April 10.2% before moderating slightly in May to 9.9%. Growing wage arrears further worsen the economic situation for households. Lower labor costs are helping to ease declining profitability in the private sector, but could, at the same time, create social unrest and tension. The consequences of the economic crisis have been especially tangible in cities and regions dominated by few industries and employers. Labor market development, August 2002 – April 2009 Disposabel income (real) Real wages Unemployment rate (RHS) Source: Reuters EcoWin aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr 02 03 04 05 06 07 08 09 Percent 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 Annualchangeinpercent -20 -15 -10 -5 0 5 10 15 20 25 30 35 … reinforced by weaker domestic demand Households are struggling with real wage cuts and rapidly rising unemployment
  4. 4. 4 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 The Russian government has the will and the fiscal resources to mitigate the economic slowdown, but there are risks inherent in overly expansive policies. Lower interest rates and a weaker rouble, combined with fiscal measures, have mainly supported the financial sector and businesses. To ease the impact of the growing recession, a fiscal stimulus package equivalent to up to 10% of GDP is planned in 2009. The main part has, to date, been allocated to corporate tax cuts, but it is expected that an increasing share will be used to alleviate the social consequences of the crisis. The risks remain high, however. Overly expansive policies could exhaust the possibilities of fighting the crisis at a later stage. The problems in the financial sector could be more severe than currently estimated, and may require considerably greater resources to avoid acute liquidity problems. Furthermore, tax cuts and increased subsidies to the business sector could be hard to claw back once the economy rebounds, eroding fiscal sustainability. Expansive policies also put pressure on exchange rates and inflation. External capital inflows and investments could also decline further if the international outlook on the Russian economy deteriorates. Moreover, oil prices, which are currently helping Russia to mitigate the crisis, could quickly reverse again. The economy, thus, remains vulnerable. Fiscal resources, 2006 – 2008 0 1 2 3 4 5 6 7 8 2006 2007 2008K1 2008K2 2008K3 2008 PercentofGDP 300 350 400 450 500 550 600 USdollarbillion Reserves Budget balance (LHS) Source: Russia Economic Report No. 18 (World Bank, 2009) The political situation in Russia can still be considered stable, despite that the number of protests has grown in the wake of the economic crisis. Rumors are flourishing about President Medvedev’s and Prime Minister Putin’s roles, and about the possibility of a new presidential election to reinstate Putin. This is unlikely, however, and both are still popular and the opposition remains divided. The biggest risk of disturbances is thought to be in regions where the recession has been especially severe, and it is likely that a considerable part of the fiscal stimulus package will target these areas. Foreign policy has received less attention despite the BRIC2 summit last week. Discussions of Russian membership in the WTO also seem to have hit a roadblock. If anything, the latest maneuver by Russia announcing that it would seek to join the WTO as part of a customs bloc together with Belarus and Kazakhstan will delay rather than speed up the membership process 2 Brazil, Russia, China and India. A massive fiscal stimulus will ease the recession … … but the economy remains vulnerable The political situation is stable, but openness to the world tends to be limited
  5. 5. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 5 Productivity gains for long-term growth Looking beyond the current recession, it seems clear that the growth potential of Russia’s economic will stagnate if reforms to raise productivity are not implemented. The recovery was rapid following the crisis in 1998-99. This was largely the result of extensive overcapacity following the breakdown of the Soviet economy. Labor was shifted from an inefficient agricultural sector to more productive service and manufacturing industries, and productivity rose significantly as a result. That can only happen once, and without an underlying driving force that raises productivity, the potential for higher growth levels is reduced. At the same time, real wages have been boosted by large capital inflows and significant surpluses in the oil sector. A real appreciation of the currency has affected Russia’s competitiveness, and an increasing share of domestic consumption has been met through imports, leaving a large share of Russian industry with low value-added production. Higher productivity and growth potential often require extensive and controversial reforms. Certain industries and segments of the population will benefit, while others will not. The political costs could be high. However, periods of economic crisis can offer an opportunity to implement such reforms. When large sectors of the population are financially affected by the crisis, there tends to be less resistance to reforms that lead to change. In many respects, Russian reform policy was put on hold during the recent years of high growth. Investment, both public and private, has been neglected. In the EBRD Transition Progress Index, which measures the transition to a market economy, Russia trails the countries that have made the most progress in terms of infrastructure reforms (see diagram). Despite, or perhaps as a result of, Russia’s large energy resources, investments in energy-efficient technologies have suffered. For example, nearly 40% of heating plants in Russia are more than 40 years old, compared with less than 3% in China. Low electricity prices have left little incentive to expand capacity and make efficiency improvements. Other public investments have also proved insufficient, and limited construction of roads and transports have hindered productivity growth in the private sector. Infrastructure reforms in Russia – EBRD transition index, 1989 - 2008 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Russia Best Source: Transition Report 2008 (EBRD) The last decade’s productivity gains won’t be repeated Opportunity to increase economic reforms Investments are lagging
  6. 6. 6 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 The Russian labor market is flexible in terms of wages and employment conditions, but mobility is often low. Education, which otherwise maintains a high level, does not always fit the needs of modern businesses. Insufficient investment in the education system and occupational training has led to a shortage of the right competencies. Mobility is limited by the social insurance system, which is far from comprehensive and not tied to the employee. Demographic trends are another factor that could limit growth opportunities. Life expectancy and birth rates are low, and health problems persist, which will lead to a dwindling population and growing share of pensioners. In the next two decades, the Russian population is expected to fall by 12%, from about 140 million to slightly over 120 million. Moreover, participation rates are already high. Other important aspects affecting the productivity development are business conditions and the degree of competition. The business environment and opportunities for domestic and foreign companies to set up and expand operations in Russia have improved significantly in recent years. The regulations have been simplified and start-up costs are relatively low compared with countries such as Brazil, China and India. Still, Russia is not considered a stable market and is ranked 75th of 177 countries in a recent survey on the efficiency of its regulatory framework (World Economic Forum). In addition, there remains a widespread notion that private enterprise is limited by corruption (Transparency International, 2009). In the latest “Doing Business” report from the World Bank, Russia fell from a ranking of 52nd last year to 65th in 2009. Productivity growth is also hurt by the lack of competition. In Russia, reforms in this area have stagnated compared with more reform-friendly emerging market economies (see diagram). Competitive reforms in Russia – EBRD transition index, 1989 - 2008 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Russia Best Source: Transition Report 2008 (EBRD) Labor skills do not fit the business sector’s needs Russian demographics pose a big risk to economic development Doing business isn't easy enough yet
  7. 7. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 7 A crossroads for Russian economic policy Russian economic and financial policies are, in the near term, geared toward counteracting the global economic turbulence until financial markets stabilize and oil prices bounce back. To do so, the country has considerable financial reserves that were built up during the boom years. High commodity prices and large financial resources will not resolve Russia’s long-term growth challenges, however. Growth potential will stagnate unless reforms are implemented to raise productivity. In the medium term, the Russian economy must grow more organically to withstand economic fluctuations and lessen its dependency on global development. Previously high growth levels were partly the result of huge surpluses from commodity production and capital inflows, and partly of the overcapacity in the economy. Without reforms to stimulate productivity, Russian growth may not rebound to those levels. Magnus Alvesson Economic Research Department SE-105 34 Stockholm, Sweden Telephone +46-8-5859 1031 Legally responsible publishers Cecilia Hermansson, +46-8-5859 1588. Magnus Alvesson, +46-8-5859 3341 Jörgen Kennemar, +46-8-5859 1478 ISSN 1103-4897 Swedbank Baltic Sea Analysis is published as a service to our customers. We believe that we have used reliable sources and methods in the preparation of the analyses reported in this publication. However, we cannot guarantee the accuracy or completeness of the report and cannot be held responsible for any error or omission in the underlying material or its use. Readers are encouraged to base any (investment) decisions on other material as well. Neither Swedbank nor its employees may be held responsible for losses or damages, direct or indirect, owing to any errors or omissions in Swedbank Baltic Sea Analysis. A new growth model is needed to realize Russia’s potential