The IHS Markit Russia Manufacturing Purchasing Managers Index (PMI) showed a contraction in activity in May for the first time since July 2016, falling below the 50 no-change mark to 49.8 in May, down from 51.3 in April.

The result will disappoint the Kremlin as Russia’s economic recovery has been going better than expected this year, in part due to much higher oil prices than expected; the drop below the 50 mark highlights that the recovery remains fragile.

“For the first time since July 2016, PMI data signalled a deterioration in business conditions in the Russian manufacturing sector in May. Although the decline was only fractional, it was driven by falls in employment and stocks of purchases, while May also saw slower growth in output and new orders,” Markit said in its press release. “Despite signs of slower client demand, business confidence remained robust overall.”

The services PMI is due out next week and will likely continue to be strong and so lift the composite PMI, which will remain well above 50. After dipping to an eight-month low in March, IHS Markit's services PMI index put in a strong rise in business activity across the Russian service sector in April, Markit reported on May 7.

The manufacturing result comes after a relatively strong first quarter that saw a slight recovery in industrial output in April. The first-tier data of Russia Rosstat statistics agency showed improvements on the demand side as well, with retail trade increasing by 2.4% year-on-year in April, up from 2% growth seen in March.

Confirming the trend, the Ministry of Economic Development on May 23 estimated that GDP increased by 1.7% year-on-year in April, up from 1.4% in March and February and 1.1% seen in January. 

Markit said that the decline across the Russian manufacturing sector was only fractional, but the fragile nature of the recovery was highlighted by this, the first such deterioration since mid-2016.

Output levels across the manufacturing sector expanded at a slower rate in May, contributing to the fall in the headline PMI. The pace of growth was marginal and the weakest since October 2017, reports Markit.

The rate of growth in new business received by manufacturing firms eased to a marginal pace, and one that was the slowest seen in 22 months.

“Some panellists raised concerns regarding lower demand from traditional customers,” Markit added. “Meanwhile, new export orders increased only marginally, and at the weakest rate for four months.”

On the price front, cost burdens faced by goods producers continued to rise markedly. The steep rate of inflation was the fastest seen since September 2015, and was reportedly linked to exchange rate weakness that drove import prices higher. Although the pace of charge inflation softened slightly, it was still the second-quickest in almost two years.

Employment levels contracted in May, marking the fifth decrease in the last seven months.

“Anecdotal evidence linked job shedding to slower growth in new orders and efforts to cut costs. Reduced pressure on capacities was also reflected in a faster decline in the level of outstanding business,” reports Markit. “Following a slight improvement in April, supplier delivery times lengthened in May. The deterioration in vendor performance and higher input costs were commonly stated as factors behind the first fall in purchasing activity since October 2017. Supplier delays also contributed to a further decline in preproduction stocks.”

But Russia’s businessmen remain upbeat about the rest of the year. Expectations towards output over the coming year remained robust in May, despite slipping to a five-month low. Anticipations of production growth and more favourable demand conditions drove optimism, Markit reports.

The relatively strong performance of manufacturing is underpinned by improving demand driven partly by rising incomes.

Rosstat's report "confirmed the well established trends in nominal wages," such as double-digit growth due to indexations in the public sector and an increase in the minimum monthly wage.

Real wage growth for March was revised upwards (from 6.5% y/y to 8.7% y/y in real terms), and the estimate for April stood at 7.8% y/y. Real disposable income grew steadily for the third month in a row, with growth accelerating from 4.5% y/y in March to 5.7% y/y in April currently. 

"However, we believe that this uptick is mainly driven by one-off events and will taper off later into the year, coming closer to 3% y/y," VTB Capital suggests.