There were hopes that the gradually improving real incomes in Russia and the first signs of life in retail credits would spur better-than-expected economic growth at the end of this year and into next. The most recent data releases from Rosstat tell the opposite story.

Russia’s retail turnover crashed in December 2015, dropping a massive 15.3% y/y. The stellar 6-8% growth enjoyed in the boom years, which came to an end in 2008, was largely driven by expanding consumption, fuelled by relentless 10% rises in nominal wages each year in the period. That began to faulter after the onset of the Great Recession, even though it took another few years for real income growth to go negative at the end of 2014 for the first time since President Vladimir Putin took over.

Since then, the population has been constantly squeezed. While few people lost their jobs –unemployment remains at a record 6% and dropped to 5.9% in November, the first time since the fall of the Soviet Union that it has gone under 6% – real wages contracted by about 10% y/y for most of 2015.

To add to the woes of the hoi polloi, the collapse of oil prices led to a double whammy: the ruble rapidly devalued, making prices in the shop soar – swathes of consumer durable products and a lot of Russia’s food, especially cheese and tomatoes, are almost entirely imported - and at the same time the falling value of the currency sent inflation spiking.

However, the screw turned in the second half of this year. The Central Bank of Russia (CBR) has managed to drive down inflation to 5.8% as of November, which has lifted real wages up and put growth back into the black: real wages increased by 0.4% in November.

Retail sales were also recovering. After the shock of the end of 2015, retail sales were still contracting all year, but each month the contractions were getting progressively smaller and everyone was hoping turnover would turn positive before the end of this year.

But something went wrong in November when the contraction began to widen again. The contraction in retail sales reached its lowest point in September, shrinking by a modest 3.6%, but in October they surprised by shrinking by 4.4% and again in November by another 4.1%.

“Retail trade dropped 4.1% y/y in November, in line with our minus 4.0% y/y forecast but much worse than the consensus estimate of a 3.4% y/y contraction. The figures confirm that the sudden improvement in retail trade in September was a one-off related to the parliamentary elections and not the beginning of a sustainable recovery in consumption,” Natalia Orlova, chief economist at Alfa Bank, said in a note.

Underlying this contraction is the fall in real disposable wages, as opposed to the more general real wages number.

Nominal wage growth (ie. simply the number of extra rubles in a pay packet) has been growing quite strongly this year and was up 9.7% in August, although Rosstat just revised the numbers for September and October down to increases of 8.5% and 6.5% and pay rises in November added 8.3% to pay packets (although this could well be revised down too next month).

These increases are pretty close to the level of inflation, which has fallen from 6.9% in August to 5.8% in November. As real wage increases are just the nominal increases minus inflation, the spending power of the average ruble wage has remained about flat in the second half of this year.

But for the average Russian household even flat real wage growth means a drop in the quality of life in real terms. The problem has been the sharp increases in food prices, brought about by first the self-imposed Russian sanctions on EU agricultural products, followed by more sanctions on Turkish goods after the diplomatic bust up when Turkey shot down a Russian bomber over its airspace in November 2014.

Because of the cold weather in Russia, there are whole food groups it simply doesn't produce – most famously cheese and tomatoes (which are extremely popular). Russia even struggles to produce enough milk and potatoes to meet domestic demand. Prices for many of these products soared by 20% or more since the sanctions were imposed, so that the share of food in the average shopping basket has increased from about a third in the boom years to just over half more recently. Concurrently, food retail turnover has fallen faster than the more generic retail turnover, dropping by 5.4% in October, the last month for which data is available.

This has impacted the more tightly defined and more significant real disposable incomes, as opposed to the more general real incomes; real disposable incomes, the money Russians have to spend on everything other than staples, fell by 5.6% in November and the rate of the fall has accelerated in the last two months from this year’s best result of a -1.5% contraction in September. That wasn't supposed to happen. Year-on-year from October 2015 to October 2016 real disposable incomes are down a whopping 12.5%, according to Rosstat. And the share of Russians who say they have been affected by the current crisis has risen in the last year from 66% to 75%, according to independent pollster the Levada Center.

In per-capita terms, that means the real income of the Russian population has now fallen back to the same level it was at in 2006 and the disposable incomes of public servants have fallen even faster than the national average.

Russians are now cutting costs and trying to save on everything: in November, 52% said they had cut spending on food vs 49% a year earlier, on drugs 26% vs 19%, paid medical services 33% vs 25%, and entertainment 57.5% vs 51%. Half the population has saved money by holidaying in Russia and 60% say they have cancelled foreign holidays. Finally, and most tellingly, the number of Russians that say they are growing food in their dacha gardens – the classic crisis response – has increased from 29% to 35%.

Despite these gloomy results, the squeeze on incomes is not a disaster. Russians have built up such a large income buffer over the last decade and a half all that is needed is some belt-tightening, which is uncomfortable, but most households can more or less maintain their middle class standard of living. And the outlook for 2017 is better. First, Russia and Turkey have kissed and made up as Turkish President Recep Tayyip Erdogan does a rapid about face, abandoning his hopes for EU membership and closer ties with the US following the attempted coup in July. Erdogan wants the Islamic cleric Fethullah Gulen extradited from his self-imposed exile in the US, but Washington has so far refused. And the Turkish president’s increasingly blatant purge of suspected Gulen supporters coupled with the obvious desire to make himself president for life has led to the EU openly admitting that Turkey will never be admitted to its club.

That should be good news for Turkish-Russian trade, where food imports account for some 40% of the total food stuffs consumed in Russia (and over 65% in Moscow). But while Russia has started to roll back its sanctions on Turkish agricultural products, the process is slow and Moscow is being careful to keep its stick in hand until the fickle Erdogan has reached the point of no return in his pivot. Food prices have started to come down in the last month, but they remain higher than before.

This process will continue in 2017, so food prices will continue to fall. In the meantime, the Kremlin actually seems pretty happy with the sanctions regime on food, even if it has driven up the cost of living for the average Russian and exposed millions of Russian to the danger of poverty. While the fact that some 21mn Russian are now “vulnerable to poverty” was widely reported following the release of a recent World Bank report, the same report said that the absolutely level of poverty has fallen thanks to those gains in real income in the second half of this month: poverty in September was 13.9% vs 14.1% a year earlier, which is also below the OECD average

The practical upshot of the sanctions is that Russian firms have been investing heavily into things like cheese production, which has soared in the last year. And companies like RusAgro have plans to build four greenhouses, each the size of 100 football pitches, to grow tomatoes. (RusAgro recently said construction of the first greenhouse would be delayed, as it wasn't getting enough subsidies from the state). In effect, the Kremlin’s import substitution policy has been forced on Russian companies by the Russian sanctions. The Kremlin recently said that it wants to keep its own sanctions in place “as long as possible”.

Another factor driving import substitution and the development of Russian agriculture in general is that the Chinese are starting to open their massive market to Russian agricultural products, a trend that will only accelerate in 2017.

Consumption in 2017 will also be supported by the recovery of retail loans. Much of the shopping in the boom years was paid for by an explosion in unsecured point-of-sales consumer borrowing. However, the Central Bank of Russia (CBR) got worried about an obvious credit bubble and popped it with an increase in prudential reserve requirements in about 2014. Unfortunately, this came exactly at the same time as the general slowdown in the economy, a slow moving crisis that has in many ways been worse than the 2008-09 crisis, leading to rout in consumer loans.

After several years of deleveraging retail loans have finally started to recover in the last few months and will build somewhat in 2017, but won't increase to anywhere near their previous level. The CBR released preliminary banking statistics for November that showed the positive retail lending but poor corporate lending: retail loans gained 0.4% m/m in November versus 0.2% m/m in October, showing a “slow but stable recovery”, says VTB Capital. However, corporate loans, which at first glance also delivered growth, were only up as a result of ruble depreciation. Adjusted for the forex effect, corporate lending was stagnant.

“The very slow recovery in retail lending implies a poor outlook for consumption in 2017. We believe that the 2016 results will increase the risk of additional cabinet spending in 2017, especially if oil prices remain above the $50/bbl level,” says Alfa’s Orlova.

The government too will hold back a return to rapid growth in both wages and consumer borrowing as part of its plan to remake the drivers of the Russian economy. Former Finance Minister and co-head of the presidential council Alexei Kudrin has presented his “Plan K” of what needs to be done to put Russian back on the path of sustainable economic growth, but a central part of this plan is to hold down the growth of wages and consumer borrowing as part of a drive to keep inflation low. That will drive down inflation faster to the CBR’s target of 4%, which will then allow multiple rate cuts to cut the cost of borrowing.

When all this is in place, companies should borrow heavily to invest and Russia will enjoy an investment-driven, not consumer-driven, economic boom. (As an aside, Kudrin says that Russia can return to 4%-plus sooner than the official forecasts by doubling agricultural exports every year for the next several years.)

The one caveat in this sober plan that will see Russians income improve in the coming years, but not by that much, is in 2018 there are crucial presidential elections where Putin can stand for the last time. The government is almost certain to splash the cash on the population through social spending programmes and hikes to wages at state-owned enterprises (SOE), which currently account for up to 70% of the economy.