MOSCOW BLOG: Russian economy starts to turn up but so does inflation

MOSCOW BLOG: Russian economy starts to turn up but so does inflation
Russia's economy has clearly emerged from the coronacrisis in March, but the outlook for the rest of the year will be determined by things outside the Kremlin's control, including oil prices and its unfolding relations with the new Biden administration. / WIKI
By Ben Aris in Berlin May 4, 2021


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Russia’s economy clearly began to emerge from the coronacrisis in March as industrial production went into the black for the first time in almost a year, posting a 1.1% expansion, and inflation peaked and started to fall again in the same month.  

Russia’s economy contracted less than expected in 2020 and now is bouncing back more strongly than anticipated in the first quarter. But it is still early days, as while the economy expanded by a modest 0.5% in March, contractions of over 2% in January and February mean the results for the first quarter remain negative.  

Other indicators were also positive. The PMI Services index was over 55, signalling that services, which had been especially hurt by the lockdowns, are bouncing back. Car sales are down but car loans are up and residential construction is expanding, helped by a generous state-backed mortgage subsidy.

The bigger macro indicators were also doing well. The current account balance shrank, but that is a good thing in that it was due to imports expanding quickly as Russians start to shop and are feeling confident enough about the future that they are buying bigger-ticket (and often imported) items, dipping into the large pool of savings they built up over the crisis year.

Likewise, the federal budget was back in profit in March after running a deficit in 2020 for the first time in years. This was helped by a recovery in oil prices, which were up into the mid $60s by the end of April on the back of recovering global demand.

The bugbear in this otherwise upbeat story is that inflation began to surge in the fourth quarter of 2020 and really took off at the start of this year, as companies anticipated the end of the pandemic after the vaccines appeared and commodity prices began to rise strongly. In addition to the recovery in oil prices, iron prices are at nine-year highs and copper prices topped $10,000 per tonne for the first time ever at the end of April.

Inflation is also being driven by a rise in food prices and the pass-through from the devaluation of the ruble in 2020. The government stepped in with administrative food price controls and a voluntary pledge by producers to refrain from passing on price increases to consumers. However, these measures, while politically appealing, are ineffective and cause distortions. The ruble has been very volatile and just the uncertainty has also fuelled inflation.  

The Central Bank of Russia (CBR) stepped into the breach and hiked rates aggressively in both March (25bp) and April (50bp) to try to nip the problem in the bud. Previously the CBR had been predicted to hike rates in 2021 by about 75bp, but it has already added that amount and is now looking at adding a total of 125bp this year, bringing six years of easing to an end, which will weigh on growth. 

As inflation is being driven by food and the devaluation effects neither of these things are monetary problems so the CBR hikes will only reduce inflation at the margins and its main tool is ineffective. There is little more the central bank can do other than simply to wait for the economy to find a new equilibrium, but that should take about six months tops and the psychological impact of decisive action will help the process along.  

At the same time, real incomes were down 3.6% in the first quarter and this is a more serious problem at both economic and political levels. The situation is confused here, as the low base effects and distortions from last year’s crisis are already making themselves felt. For example, retail turnover in March was down 3.4% year on year, but that is measured against March 2020, when retail sales surged a whopping 6.1% y/y as the population started stockpiling goods ahead of the widely anticipated lockdown that was imposed in April. Looking at the month-on-month results and the situation doesn't appear quite as dramatic as the headline numbers suggest. This is a problem that will only get worse in the coming months.  

The good news is that all these problems are seen as temporary and a result of the economy rebalancing as it recovers from the multiple shocks it received last year. Inflation should fall as the seasonal effect on food prices starts to kick in over the summer dacha season (last year potato production surged as Russians retreated to their dachas during the lockdown) and the pass-through devaluation effect also usually takes about six months to run its course and so will also fade in the next few months.  

Analysts see the ruble strengthening from here under all scenarios. Just how much it will strengthen depends a lot on geopolitical tensions and the oil prices, the two big concerns going forward. With the OPEC+ deal still in place and a global economic bounce-back already underway the outlook for oil appears good; Geopolitics, not so much, though.  

April saw tensions flare again as Russia moved some 40,000 troops up to Ukraine’s border for “exercises.” The Kremlin claimed it was only reacting to Ukraine’s decision to move troops up to the line of contact in Donbas during the previous two months as part of the spring rotation in preparation of the new campaigning season, and there are some reports that Ukrainian troops were on the move, bringing up heavier artillery too. Some have speculated that this was a move by Ukrainian President Volodymyr Zelenskiy to provoke exactly the response he got from Russia as a way of putting pressure on the West for more aid. It is still unclear exactly what just happened, but whatever the truth, Russia’s response was overkill and clearly designed to send a message to the White House that the Kremlin can, and will, make serious trouble if more sanctions are imposed.

As bne IntelliNews has been extensively reporting, the geopolitical situation is very fluid at the moment as both the US and Russia attempt to set the tone of relations for the next four years under the Biden administration. The US imposed fresh sanctions on April 15 that were largely symbolic, but targeted Russian domestic debt for the first time. That will threaten an outright ban on the foreign ownership of the widely held ruble-denominated OFZ treasury bills – the so-called “nuclear option.”  However, in remarks following the sanctions Biden went out of his way to point out that the US “could have done more, but didn't” and that he was interested in a “stable” relationship with Russia. Together with the stick of sanctions he offered the carrot of a summit to start talking about arms controls and other global issues like the Climate Crisis.  Diplomacy really is back. 

Russian President Vladimir Putin set a similar tone in his State of the Nation speech on April 21, which mixed threats of retaliation if red lines were crossed but also held out an offer of talks on the same issues.  

The mere fact international relations are back to being conducted in traditional terms is a very positive sign. As bne IntelliNews has been arguing, all these moves are posturing, but there is real common ground between Moscow and Washington and both presidents need to focus on fixing their own economies. The tensions are an expensive distraction. The same is true for the EU with knobs on, which is clearly very tired of “the Russia problem” and is looking for a new pragmatic, if not friendly, relationship. It is notable that at the end of the same day the Kremlin withdrew its troops from Ukraine’s border Putin was sitting in a video conference, face-to-face with Biden, and committing Russia to doing more in the Climate Crisis campaign.  

The Kremlin seems to have accepted the April 15 sanctions as measured – given Trump’s legacy of being “soft” on Russia and the US domestic political set-up, it was inconceivable that no sanctions at all would be imposed – as they did no “economic damage” at all. The the proposed summit between Biden and Putin is still on, tentatively slated for June 15-16. If progress is made, then tensions will ease further, the ruble will rally to some RUB69, according to Renaissance Capital, and as the cost of borrowing comes down investment will rise, fuelling the economic bounce-back that is already underway.  

The Kremlin is also preparing the ground for the key September Duma elections and since jailed anti-corruption activist and opposition politician Alexei Navalny returned to Russia the Kremlin has decided that it has suffered so much PR damage already there is nothing to be lost from crushing Navalny and his organisation completely. As April comes to an end the Moscow courts are poised to brand Navalny’s Anti-Corruption Foundation (FBK) an “extremist” organisation on a par with terrorist groups, and Team Navalny decided to close down all operations to protect workers who would otherwise face lengthy jail sentences.  

The Baltic-based media project was also labelled a “foreign agent” and is now required to carry a warning to readers in double-sized font on all its pages that it works for a foreign government that it claims will kill it as a publication. Meduza has been actively reporting government abuses, human rights and corruption.  

This is flat out repression. Russia’s non-systemic opposition is fissiparous and ineffective. Navalny doesn't enjoy much support as a politician but he is widely respected as an anti-corruption activist and his documentary “Putin’s Palace” has over 100mn views. Navalny has sparked a national conversation about what sort of country and government regular Russians want, which in effect holds the government to account. Losing Navalny’s voice is a step back for Russia, as this is a conversation that is badly needed.