The war with Ukraine has dragged on for over two months by the start of May and instead of the $1bn that a three day war, initially expected, it is now costing an estimated $500mn per day. This is unsustainable and is one of the reasons the Kremlin has refocused on a Phase 2 that concentrates on taking Donbas. That effort was ongoing at the start of May and Russian forces were making progress, albeit slow progress. Experts believe that this will be the last offensive as Russia’s forces are already close to exhaustion. The Battle for Donbas is underway but at the time of writing it was turning into a logistic race: Russia is putting what it has left of its offensive forces into the fight while the West is rushing in heavy weapons to counter the Russian effort. It remains up in the air as to which side will prevail.
The first full month of economic results were released since the start of the war and showed a surprisingly mild picture thanks to the fiscal fortress and large reserves but also soaring commodity prices. Russia's invasion of Ukraine and the ensuing economic sanctions were immediately reflected in Russia's financial markets. In March, the effects have also begun to be felt in the real economy, although development has still varied across sectors, Bank of Finland Institute for Economies in Transition (BOFIT) reports in its weekly update.
Consumption has once again seen a spike in preparedness, as in Russia in general before the economic crises. Retail sales grew by a further 2% year-on-year in March, driven by food sales. At the same time, stocks of many foods, such as vegetable oils and sugar, dwindled to exceptionally low levels. In other goods, the peak in sales growth was mainly seen in February, and in March their sales began to decline. New car sales in particular contracted sharply, by as much as 63% year-on-year. New cars have been sold less only in the deepest phase of the interest rate crisis in the spring of 2020.
The consumption spike has contributed to accelerating inflation. In March, consumer prices rose by 17% year-on-year. Rapid inflation has already begun to gnaw at the purchasing power of households.
The average real disposable income of Russian households has started to decline again in the first half of the year. In January-March, real income contracted by more than 1%. In March, the average pension was 8% lower in real terms than a year earlier, although pensions were increased at the beginning of February. Weaker revenue developments will also reduce consumer demand in the coming months.
One of the major surprises was a flat unemployment rate – in March it printed at 4.1%, the same as February (we expected 4.3%, while the market was even more bearish). One of the factors behind such robust unemployment was a continued decline in the labour force amid ageing as well as COVID-19 implications and, possibly, already reflected in the statistics, labour outflow. In March, the labour force decreased to 74.5mn people from 74.8mn in February – 500,000 below the year ago level. We stillexpect to see an increase in the unemployment rate in early summer. The efficiency of government support will be crucial to curb a potential deterioration (see more here).
Industrial production grew by 3% year-on-year in March, but industrial development has also been twofold. Production in the extractive industries increased in March. The development of the processing industry has weakened throughout the first part of the year, and production slipped further in March. The processing industry has suffered from a shortage of imported components. Production in the automotive industry fell by almost half from its level a year ago in March.
The impact of sanctions has been strongest in air transport. The volume of air transport decreased by more than 80% year-on-year in March. Overall, however, the number of transports increased by 3.5%.
Russia's economic development is expected to weaken significantly in the coming months. According to the latest forecasts, Russia's GDP is expected to contract by 8.5-15% this year. Many forecasters expect the economic contraction to continue next year as well. The risk of an even darker-than-expected development is high due to the enormous uncertainty caused by the war of aggression in Russia.
Russia's GDP in 2022 will decline by 11.2%, according to a forecast by the World Bank. Growths of 0.6% and 1.3% respectively are expected in 2023 and 2024. The official estimate for this year’s contraction by the CBR is 8%-11%, but uncertainty is high and much depends on what, if any, oil sanctions are imposed.
The budget will also be hit, again how badly depends on how sever the oil sanctions are. According to the Ministry of Finance (MinFin), the budget deficit in 2022 will amount to at least RUB1.6trn (1.1% of GDP) and wilwl depend on anti-crisis measures to be taken. However, thanks to soaring commodity prices several analsyts believe Russia will end 2022 with a budget surplus on the order of 0.7%.
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