Russia’s economy is basically healthy and solid. It’s just not growing fast enough. The problem is not in the ratios and reserves, but in its total lack of dynamism. With growth rates of around 1% for an emerging market that is actually stagnation. The Kremlin is attempting to address this problem, but so far its efforts have been off to a slow start. 2020 should be the year when the pace picks up and it will become clearer how successful the government’s programme will be. The lack of clarity over how likely this is can be seen in the spreads of GDP forecast numbers for 2020.

Growth remains under par and came in at about 1% in 2019, but while most observers expect growth to improve in 2020, but opinions on just how fast it will accelerate are divided. Still, no one expects growth to increase to much beyond 2% in 2020, with the government saying it will then reach 3% in 2021 and most analysts saying it will be less than that. 

President Vladimir Putin gave the keynote speech at VTB’s RUSSIA CALLING! 2019 annual investment summit where he outlined the key challenges the government has to address in 2020.

Putin said: “The key indicator of economic development is the real income of the population.” 

The president highlighted:

 i) although GDP grew +1.1% y/y in 9M19, there was a certain acceleration in 2H19; 

ii) the average unemployment rate was 4.6% in 9M19, the lowest in modern Russian history; and 

iii) the current inflation rate is 3.6%, which might decline to 3% or even lower at the beginning of 2020. 

Putin said he regarded price stability as the most important achievement for Russia — after the hyperinflation of the 1990s Russians are particularly allergic to inflation — which was the result of systemic work by the government and the Central Bank of Russia (CBR), creating new opportunities to boost the economic growth rate and its quality.

The country’s key structural challenges lie in: 

i) increasing labour productivity via cutting-edge technology, higher growth of qualifications and new competencies; 

ii) increasing the competitiveness in non-military sectors, such as the manufacturing, agriculture and services sectors. 

The result would likely be an increase in non-commodity exports alongside the defence and mining industries. To achieve this, the government has set the task of launching a new investment cycle, where the annual volume of fixed investment will be 25% of GDP, and eventually 27%. Fixed investment was 21.6% in 2019. The government expects investment growth to reach 5% in 2020 and 6.5% in 2021.

The investment goal is possible, but Russia is suffering from a crisis of confidence that is visible in the extremely high dividend payments (owners take cash rather than invest) and extremely low corporate borrowing, which is the other side of the same coin. 

The government understands it needs to do something about boosting domestic investors’ confidence in the economy, but while the draft version of a new investor protection law was very radical, the version that was submitted to the Duma was so twisted by state-owned enterprise (SOE) lobbying that everyone hates it and it is very unlikely to be passed. This is in a nutshell the problem the government needs to overcome. 

Russia is also hoping to diversify away from its traditional raw material exports thanks to investment into technology and digitisation of the economy. While the virtual economy is flourishing it is more focused on retail and tapping the 146mn consumer market than producing new innovative technologies and so is unlikely to affect the balance of payments. 

Russia continued to run a healthy balance of payments surplus thanks to its raw material exports and will continue to do so in 2020. 

The recovery of oil to around $60-65 in 2019 was well ahead of the circa $40 a barrel of oil the budget needs to break even. A new OPEC+ agreement signed on December 9 has increased the level of production cuts (see below) that will support the price of oil at this level until March when the deal will be reviewed so there is little danger of Russia’s balance of payments changing much in the first half of 2020. 

In addition to oil Russia’s agro exports continue to grow, adding an expanding source of foreign exchange earnings. In 2018 Russia exported a record amount of grain from which it earned $20bn. In 2019 Russia enjoyed another good harvest and export earnings rose to $24bn. While it is impossible to predict the size of the harvest in any one year, the overall trend, thanks to ongoing heavy investment into this sector, is that grain export revenues will continue to rise over the medium term. 

The CBR listed some of the main risks to the Russian economy in 2020 in December. The debt burden of the population growing against the background of a weak increase in people's disposable income is top of the regulator’s list. From April 1 to October 1, 2019, this load increased by 0.4 pp to 8.9%, approaching the maximum value of 9.3% in 2014. 

Demand for loans is growing due to lower interest rates and banks are attracting new borrowers who did not have loans as of January 1, 2019 (5.6mn people, or 21% of borrowers).

Although the situation is gradually improving — the annual growth rate of consumer loans decreased to 23.5% on October 1, 2019 (from a maximum of 25.3% on May 1, 2019), and the share of bad loans decreased to a minimum over the past five years ( as of October 1, 2019 — 8.1%). Thus, the share of unsecured consumer loans with debt overdue by more than 90 days decreased in the second and third quarters. 

A negative impact on the economy would also result from a decrease in external demand for Russian exports, weak investment growth (in the third quarter, investments grew by only 0.8-0.9%), as well as temporary tightness of budget policy, the central bank said.

Stock market outperforms expectations 

Judging by the financial market dynamics, Russian assets and national companies, and their capabilities, are attracting strong investor interest.

Russia’s stock market performed better than anyone dared to hope in 2019, returning 45% over the whole year with the dollar denominated Russia Trading System (RTS) index finally breaking out of its 900-1,300 range to end the year around 1,500.

Analysts at BCS Global Markets expected the RTS to return 17% in 2020 with the RTS at 1,500, but the RTS had already broken through the 1,600 level by the end of the first week of January. 

Other analysts are predicting the market will return at least 20% in 2020, which is the typical return for the Russian market in any non-crisis year. But those analysts were predicting 20% gain and for the RTS to rise to 1,500, when it had already risen by another 100 points in January. The typical return for the market in a crisis year is -75%. 

What the market will do in 2020 remains heavily dependent on politics and oil prices. The average dividend yield in 2019 was 6.5% and this is expected to increase to 7% in 2020, largely driven by the biggest SOEs finishing off their transition to paying out 50% of profits as dividends. In the past few years high dividend yielding stocks have consistently outperformed the market. Earnings are also expected to improve further in 2020 on the back of the ongoing modest economic recovery. 

However, it is important that interest in financial assets is transformed into investment in real assets, the creation of new production facilities and jobs, and efforts to carve out promising market niches, which is not happening yet. 

Clinical depression 

Unlike the markets, Russia’s political scene remains as barren as ever. Putin remains in charge and the people have little influence on politics. The Kremlin’s biggest problem is the United Russia ruling party continues to lose legitimacy and is polling at its lowest level ever at around 34%. United Russia scraped into power at the last elections barely clearing the 50% threshold to take charge, but there is no way that the party can pull the same task off again without blatant vote rigging or a suitable crisis. 

The current mood of Russian society can be compared to clinical depression, one Russian sociologist thinks. Following two years of surveys across eight regions, sociologist Viktor Poturemsky published a report about the “new political reality” in Russia. 

He claims that the public feels frustration at the lack of development and the degradation of their living standards. Many express a loss of faith in the authorities, in their ability to provide for their families, and in the idea of a “bright future”. This sinister and hopeless outlook on the future is characteristic of patients with clinical depression, Poturemsky argues. 

Public dissatisfaction with Putin is clearly on the rise, as was illustrated by the protests over the summer of 2019 and the brutal police response. This is a concern for Putin but it is not yet a problem as the overall numbers taking part in these demonstrations are still in the thousands or a few tens of thousands, which is a level the Kremlin can dismiss and ignore. But the situation is getting worse slowly and the Kremlin needs to respond. In short the national projects programme that is supposed to transform the economy needs to work.  

Conservative budget planned for 2020-22

The Duma approved the new conservative federal budget for 2020-22 in the third and final reading in December. Despite expected spending expansion, the government’s revenue and expenditure as a percentage of GDP are projected to fall: from 18.1% for revenue and 17.3% for spending in 2020 down to, respectively, 17.2% and 16.9% in 2022. 

The government is still trying to balance growth with security so while spending will be increased the government is allergic to leverage. In a nod to the need to invest more the government has approved a potential deficit, but because of the security concerns this was limited to a mere 0.5% of GDP. 

Formally, the government’s fiscal balance will remain in the black: the surplus will stand at 0.8% of GDP in 2020 and 0.2% in 2022. The stringent approach to spending – via continued implementation of the ‘fiscal rule’ – will remain unchanged, allowing the sovereign fund, the NWF, to expand from $167bn in late 2020 to $242bn by end-2022. The other concession that might be made to pursuing faster growth is the fiscal rule cap of $40 price of oil (all revenues over this level are sterilised) might be raised to $45. 

Most of the extra spending will go into the national projects, which will account for 9.8% of gross federal expenditures in 2020, 10.8% in 2021 and 12.2% in 2022. 

In 2020 the actual amount of funding in this area could top 14.7%, or RUB3 trillion, if the government puts to work all unspent money on these projects carried over  from 2019. However, additional public funding on the economy from the sovereign fund will remain limited: the Duma approved the government’s proposal to spend no more than RUB585bn a year in the next three years via the Development Fund – an investment vehicle that will source its funding from the NWF’s surplus.

 

This is an excerpt from bne IntelliNews’ Eastern Europe Outlook 2020. The full version will be available in pdf format in the coming days.