Russia Country Report Sep22 - September, 2022

September 5, 2022

Russia’s GDP contracted by 4.3% year on year in July 2022, moderating the decline of 4.9% y/y seen in June, according to the latest date by the Ministry of Economic Development. To remind, For 2Q22 overall GDP contracted by 4%.
The main support to GDP came from extraction that increased by 0.9% y/y growth in July (versus 1.4% y/y in June), with construction growth accelerating to 6.6% y/y and agriculture posting 0.8% y/y growth.
BCS GM warns that a number of industries continue to suffer from unfavourable external environments and high uncertainty domestically. Wholesale and retail trade posted 25.4% y/y and 8.8% y/y contraction in July, respectively.
Russia’s economy has bounced back from the initial shock of the seven packages of sanctions imposed in March. The country came close to a financial crisis in the first two months, but the fast action by the Central Bank of Russia (CBR) quickly stabilised the situation and since then Russia’s companies and government have worked hard to find new suppliers and supply routes to main business.
While the long-term consequences of the sanctions will clearly reduce Russia’s productivity and reduce its potential growth rate to around 1-1.5% in the short-term Russia Inc is earning more money from sky-high commodity prices than it has ever earned since the end of the Soviet Union.

The EU in the first half of 2022 paid Russia $52bn for oil, $24bn for natural gas and $5bn for coal leading to an all-time record current account surplus of $166bn – a $100bn more Russia had as a surplus in the first half of 2021, and that was also a record.

On the flip side the cost to Europe has been even higher. In total, European countries have spent about €280bn ($278bn) over the past year to mitigate the effects of the energy crisis on businesses and households, the Bruegel think tank has calculated: Germany €60.2bn), Italy (€49.5bn), France (€44.7bn), Great Britain (€44.3bn) and Spain (€27.3bn) allocated the most funds to support the population in the context of the energy crisis.

As winter approaches, tension and costs are only going to rise. Gazprom has reduced the gas flows through Nord Stream 1 pipeline to 10% of capacity and while Europe filled its storage tanks to 80% of capacity a month ahead of schedule by the end of August, the German tanks, for example, only hold enough gas to last two months should Russia halt gas flows completely during the winter. The energy crisis, in the form of very high energy prices, is very likely to last all winter as a result.

Despite the manoeuvrings due to the war Russia’s economy has still taken a big hit. Russian GDP contracted by 4% y/y in the second quarter of 2022, according to Rosstat, consistent with a fall of 6% in seasonally-adjusted q/q terms and in keeping with the growing consensus that the contraction of the economy his year is going to be much milder than previously anticipated at may 3-4% by year end – down from 15% predicted at the start of the war.

Russia’s Central Bank for the first time gave a forecast of a fall in Russian GDP in the third quarter: according to the regulator, the economy may fall by 7%, and inflation will continue to slow down.
But the Central Bank does not expect new serious sanctions, nor a global recession. All this together means that, other things being equal, the reduction of the key rate should continue, the bank said in a report on August 1.

War sets Russian economy back 4 years in a quarter. Twelve analysts offer a median forecast of a 4.7% drop in Russia’s GDP in the second quarter, Bloomberg reported on Aug. 11. The drop would bring the economy to its 2018 indicators. The level of the crisis caused by the sanctions is being likened to that of 2015, a relatively mild crisis, as opposed to the big ones of 1998 and 2008.

The short-term conclusions of the experts boiled down to the fact that the third quarter will be the peak of the decline in GDP (this also follows from the forecast of the Central Bank). But on a “longer trajectory of recession,” new tests await the economy, the most obvious is the entry into full force of EU sanctions at the end of the year, banning the import of Russian oil. This could trigger a second wave of GDP contraction.

Oil has been in focus and while the Yale report predicted that production would fall from the 11mbpd output pre-war to 6mbpd by the end of this year, by the summer oil production was recovering from a mild dip to 10mbpd in April. In July Russia’s oil output climbed back to near pre-war levels, averaging almost 10.8mn barrels per day -- the third consecutive month of oil production recovery.

That may change in December when the EU is due to ban the import of Russian oil completely and refined products from February. But many analysts speculate that a total ban will not be possible, although volumes may be reduced. The government is forecasting a possible reduction to 9mbpd by year end.

Trade in general remains reduced as sanctions and especially self sanctions by international companies producing products that are not on a sanctions list have all fallen heavily. The exception is Turkey where trade is up by half in the first half of this year on the level in the same period a year earlier. However, trade with most other countries was also starting to recover by August.

The domestic car sector has virtually collapsed and went from producing circa 100,000 cars a month to a low of 3,400 in June, but has since recovered to circa 13,000 – still only around 10% of previous production levels. However, other sectors are faring better with metals and mining actually growing y/y and the agricultural sector remains relatively stable.

Russia’s manufacturing sector is highly import dependent and output was 7% lower in June than in December. Sectors that have experienced the largest falls are higher-tech sectors where foreign inputs are greatest, such as motor vehicles (-65%), pharmaceuticals (-25%) and electrical equipment (-15%). Less import-dependent sectors with limited foreign inputs have held up best, such as mineral products (+1%), food production (-1%) and coke refining (-2%). Import substitution is in motion in some areas, but is not enough to offset various headwinds and prevent a downturn in manufacturing from taking hold.

The last serious package of sanctions was the sixth package but by the seventh package of sanctions introduced on July 21 there is little left to sanction without causing extreme economic pain to the sanctions. Oil price caps were supposed to be introduced in the seventh package but failed to appear as this scheme seems to be unworkable.

Government tax revenues have generally held up well too despite the unfavourable appreciation of the ruble. The budget was still in a surplus in June, although a fall in gas and oil revenues meant month on month the budget was in deficit.

The Ministry of Finance expects that most of the social support spending will come in the fourth quarter and the EU oil sanctions will bite then too so that the budget is expected to end the year with a 2% of GDP deficit, but this can easily be covered by cash in Ministry of Finance’s account and the National Welfare Fund (NWF).

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