October 13, 2020 (04:53)

Overview of the state of the Russian economy 2020-09: “Every cloud has a silver lining”

Sergey Khestanov – Russian economist, associate professor of ‘The Russian Presidential Academy of National Economy and Public Administration‘, macroeconomic adviser to the general director of the Moscow investment company ‘Otkrytie Broker’.

 

 

Immediately after the onset of a strong negative event (whatever the nature of such an event), analysts’ forecasts deteriorate sharply. Usually this deterioration corresponds to the extremely pessimistic scenario. But, fortunately, extremely pessimistic, as well as extremely optimistic scenarios rarely take place in practice. The coronavirus pandemic that broke out in Russia in spring of 2020 was no exception. As the economy adapts to new conditions (and in the course of accumulation of statistics), understanding of the true scale of the problems comes. And now it has become clear that current problems of the Russian economy are serious, but they are not catastrophic.

Moreover, the Russian economy goes through the 2020 crisis about 1.5-2 times easier than the economies of the US and the EU. This is due to the fact that the share of the service sector (which was most affected by the coronavirus pandemic) in the Russian economy is relatively small.

In the second quarter of 2020, when the most stringent quarantine restrictions were introduced both in Russia and in the world, production in the industrial sector in the Russian Federation in April-June decreased by 8.5%, while retail turnover decreased by 16.6%. Passenger turnover decreased and the catering sector decreased by 79.0% and 48.9% respectively. This is significant, but not disastrous at all.

 

Reference: Russia’s GDP in 2019 amounted to RUB 110,046.1 billion. It amounted to RUB 25,317.7 billion in the first quarter of 2020 (the growth rate of gross domestic product amounted to + 1.6% in annual terms) and RUB 23,288.2 billion in the second quarter of 2020.

The impact of the coronavirus has revealed itself as of the second quarter. The fall in GDP in April 2020 was especially dramatic. This month, GDP fell by 12.0% in annual terms, due to introduction of non-working day regime from March 30 in order to combat the spread of a new coronavirus infection in the country, as well as in the result of unfavorable conjuncture in foreign markets. Changes in the structure of Russia’s GDP associated with adaptation to new conditions have not yet been reflected in statistics.

According to preliminary estimates of Rosstat, the volume of Russia’s GDP for the II quarter of 2020 showed a decline by 8.5% in real terms. The volume of Russian exports of goods in the second quarter of 2020 amounted to USD 67.9 billion, which is 33.0% less than in 2019. The volume of import of goods decreased by 13.5% to USD 53.6 billion.

With relation to the Russian budget, export industries are of the greatest importance. Due to the long-term well-coordinated work of the monetary authorities (the Central Bank and the Ministry of Finance), due to changes in the exchange rate and budget, the Russian economy is effectively adjusting to the external economic conditions. This practice has developed especially clearly after accession to an office of the current head of the Central Bank, Elvira Nabiullina. A tight fiscal policy and flexible exchange rate have resulted in the Russian economy adapting quickly even to severe external shocks. The price of this adaptation is a decrease in the well-being of all economic entities, nevertheless, critical imbalances have been avoided so far.

The coronavirus pandemic is a new phenomenon (the Spanish flu pandemic of 1918-20 cannot be analogous). Uncertainty is compounded by the onset of seasonal exacerbation, i.e. “second wave”. If we assume that the “second wave” will not cause a repetition of massive lockdowns, as it happened in the spring of 2020, then the potential for a fall in GDP by the end of 2020 can be estimated at 4-5%. But it’s more realistic to assume that some of the lockdowns will be repeated. This will require adjusting the magnitude of the possible decline to 5-8%.

In general, up to 70% of the Russian economy is directly or indirectly linked to the state. During periods of rapid economic growth, this factor limits the growth of the Russian economy. But when a strong recession begins, the same factor contributes to the greater stability of the Russian economy. The state is cutting its spending much more slowly than the private sector, which helps to slow down the recession.

This is good with respect to financial stability. But this also leads to the low efficiency and rigidity of the economy, as well as low wages for a significant proportion of workers. The Russian economy slowed down its growth rates dramatically by 2012-13. It was then that the model of restorative raw material growth, which had underpinned the development of the Russian economy since the collapse of the USSR, exhausted itself. It is noteworthy that by 2014, oil prices were over USD 100 per barrel and there no sanctions were applied, but stagnation had already begun.

GDP of the Russian Federation in annual terms, USD billion

The fall in oil prices and the imposition of sanctions led to a decline in the Russian economy. The adaptation of the Russian economy to the new conditions was painful and took 2 years. The main mechanisms were the devaluation of the ruble, import cuts and moderate budget sequestration. Contrary to popular belief, sanctions and counter-sanctions did not play a big role. The reduction in imports was due to devaluation, as effectual demand fell. The role of sanctions was reduced to a sharp halt in investment inflows and an increase in capital outflows.

An interesting lesson of the 2014-15 devaluation was that imports fell more than exports. This supported both the trade balance and the current account positions. The Central Bank’s idea of a floating ruble exchange rate received clear confirmation – the weakening of the ruble helped to quickly reduce the budget deficit and keep the current account in the positive zone. This means that the government did not have any serious problems with fulfilling its obligations.

The main challenge for the Russian economy in 2020 is the reduction in oil production as part of the OPEC + deal. As a result, export earnings fell (by 33.0% following the results of the second quarter of 2020), the budget deficit increased, the ruble weakened (on December 31, 2019, the ruble rate against the US dollar was 60.95; as of October 1, 2020, the ruble rate was already 77; the devaluation was more than 25%) and inflation has grown.

Oil production in the Russian Federation, million barrels per day

A separate group of economic problems of the Russian Federation is associated with the technological limitations of oil companies. Unlike Saudi Arabia, the Russian oil industry has a large number of wells with low flow rates. All major Russian fields are old (unprecedented oil production rates were recorded in 1987). For some wells, production shutdown will make it impossible to restart them. It will be either technically difficult or economically meaningless. It is not yet possible to even approximately estimate the share of such unprofitable wells. This can be done about a quarter after the next increase in OPEC + quotas, which is scheduled for January 2021.

The quarantine restrictions have led to an increase in unemployment and impoverishment of a large part of the population. The Russian method of accounting of unemployment is so different from the method of the International Labor Organization (UN) that it is practically useless for analysis. It is not possible to objectively assess the unemployment rate in the Russian Federation on a quarterly basis during 2020 and make a forecast of unemployment in 2021. The problem is aggravated by rather high level of shadow employment. Therefore, it is impossible to directly link the official data on unemployment with the level of social stability. However, the very fact of repeated payments to families with children suggests that the problem is perceived by the Russian authorities as serious.

This forced the government to take an unprecedented measure – payments of RUB 10,000 per child. The government also had to save part of the business, which is critically important, as considered by the government. All this increased the burden on the budget and during 2020 expenses exceed revenues, but taking into account the accumulated reserves, such a situation is not dangerous yet.

Reference: according to federal law No. 380-FZ as of December 2, 2019 “On federal budget for 2020”, the total amount of revenues was projected in the amount of RUB 20,379.4 billion; expenses in the amount of RUB 19,503.3 billion; surplus in the amount of RUB 876.1 billion.

Ratio of income and expenditures of budget of the Russian Federation, billion rubles

Until July 1, 2020 (the day of the “nationwide vote”), there were no significant changes in the Russian budget. Serious adjustments (sequestration) to the budget are still ahead. So far, only the priorities have been announced, which are social policy and the preservation of reserves. Due to the need of coordination between ministries and departments, the development of the plan for sequestering the Russian budget is a slow process. It is unlikely that it will be completed before the end of October – early November 2020.

The immediate challenge for the Russian financial system is the reduction of the current account of the balance of payments, which by the end of 2020 may obtain negative values. This will increase pressure on ruble and may drive inflation well above the target level (4%). The extent to which this particular risk is realized will depend on the demand for Russian oil, which is highly dependent on the dynamics of the COVID-19 pandemic.

Current account status of the balance of payments of the Russian Federation, USD million

In addition, the Russian economy is threatened by the prospect of tougher western economic sanctions. The risks of increased sanctions directly depend on the outcome of the presidential campaign in the United States: Trump’s opponent has already announced tougher sanctions if he wins the election. All this taken together creates a period with a high degree of risk for the Russian economy, which is very likely to last at least until the beginning of 2021.

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