Stagnation looms for Russia as consumption and oil revenues fall

(Business New Europe – bne.eu – September 25, 2014) Consumer demand in Russia, around half of its $2 trillion economy, and the key growth driver over recent years, is stalling over the crisis in Ukraine, according to a World Bank analysis of the economy.

Consumption growth will slow to 0.5% in 2015 and 0.6% in 2016, down from around 2% in 2014. As a result, GDP will grow 0.5% in 2014, down from 1.3% in 2013, and slow to only 0.3% growth in 2015 and 0.4% in 2016, according to the World Bank report.

“Consumption growth is currently moderating to a new and lower growth trajectory in an environment of subdued consumer sentiments,” the World Bank said in the report.

An earlier World Bank forecast at the start of the year saw 1.1% growth in 2014.

The crisis with the West over Ukraine is causing the ruble to devalue, pushing up inflation and damping lending, according to the report. Growing household debt and continued high inflation expectations will further stifle demand., according to the World Bank.

“Geopolitical tensions are weighing down further on consumption growth,” the report says. “The Russia-Ukraine tensions negatively impacted already low business confidence in the economy and further depressed investor sentiment.”

The immediate impact of the crisis can be seen in that consumption added 2% growth in the first quarter of 2014, plummeted to add o.8% growth in the second quarter, when tensions with the West escalated over Russian aggression in Ukraine. But the root causes of the slowdown are not to be found in the Ukraine crisis and East-West tension, but in lack of reform in the Russian economy.

Structural causes

But the root cause of the slowdown is not the Ukraine crisis and resulting sanctions, but lack of reform in Russia, the report says. “Structural impediments slowed economic expansion to near stagnation even before the impact of increased policy uncertainty amid increased geopolitical tensions took hold,” the World Bank report said. “A return to higher growth in Russia will depend on solid private investment growth and a lift in consumer sentiment, which will require a predictable policy environment,” the World Bank warned.

“The key word herein is “stagnation”” writes Standard Bank’s Tim Ash in response to the World Bank report. “Weak growth drivers, deep-seated structural problems, a lack of reform initiatives. The World Bank argues that over the medium term the rouble is likely to weaken and even in the near term with oil going lower, the Russian economy looks pretty vulnerable.”

“If oil dropped to $80 a barrel I think Russia would look pretty grim, with recession (minus 1-2%), deteriorating current account and fiscal positions (budget deficit of 4-5% of GDP), heightened capital flight,” according to Ash.

Russia’s former long-serving and highly respected finance minister Aleksei Kudrin has also come out in public with gloomy prognosis of the Russian economy in the absence of reform. “There will be stagnation, like now. There could be recession. We will be balancing on the edge of recession all the time,” Kudrin said, speaking at an investment forum September 22, as quoted by Reuters.

Kudrin told the Reuters Russia Investment Summit that it would be “two to three years” before Russia could recover access to international capital markets, “this is the minimal time,” he said. Core Russian banks and companies have been effectively banned from borrowing internationally as a result of sanctions imposed by the EU and Russia over Russian aggression in Ukraine.

Kudrin also said that Russia’s 2012 accession to the World Trade Organisation was now largely redundant. “Russia in essence will temporarily not observe the rules of the WTO,” he said. “I’m afraid that we’ll have an exclusionary regime for more than one year. I think it will happen for several years and it will be difficult to return.”

But like the World Bank, Kudrin laid the blame for the stagnation at the door of government policy rather than the sanctions. “Today the decline of Russian economic growth is not so much the result of sanctions as of the lack of reform of the economic system, at a time when the oil price is not rising but falling. We need another economic model,” Kudrin said, as quoted by Reuters.

Kudrin warned that oil prices were now falling whereas they had risen for over a decade. As a result he said, Russian oil-and-gas tax revenues would fall around 1.5-2% GDP, approximately $30-40bn each year.

Kudrin called for the government to invest in infrastructure rather than spend on subsidies. Around 6% of GDP currently spent on subsidies should be reassigned to infrastructure investment, he said. Generous spending pledges made in May 2012 should be “corrected, because we’re in a special situation,” Kudrin said, according to Reuters.

“The economy can’t stagnate and policy continue as if nothing had changed,” he added. “On key matters the government hasn’t taken decisions, and that’s worrying,” he said.

 

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