“Russia has developed antibodies [to the sanctions] and it has a perfectly healthy body. All we have to do now is develop some more muscles.”

That was how Russian Finance Minister Anton Siluanov summed up the state of the Russian economy in the closely watched “How the Russian economy will develop” panel at St Petersburg International Economic Forum (SPIEF) on June 15, where an A-Team of liberal finance leaders that actually run Russia’s economy give a no-frills drill down on the state of play each year.

A former wunderkind of the Economics Ministry, Oreshkin was joined by CBR Governor Elvia Nabiullina, Russian Finance Minister Anton Siluanov and Maksim Reshetnikov, the Economics Minister.

Russia’s economy has been damaged by the extreme sanctions but it has done remarkably well. In the first week of the war European Commission President Ursula von der Leyen announced a devastating set of sanctions that she promised would “severely degrade” Russia’s economy and make it impossible to run a war. That didn’t happen.

Instead, Russia’s economy is expected to start growing again this year, while several of Europe’s major economies will go into recession. The Russian state poured macroeconomic support into its economy, but all the panellists point to what they call “accelerated adaptability” as the reason Russia has rebounded from the sanctions shock. To everyone’s surprise, including the financial A-Team, Russian private companies stepped up to the challenge of the radical changes in the market and rapidly adapted to the new realities.

Russia to grow 2% in 2023

Russia’s economic team has upgraded its outlook for the full year’s growth several times already and more recently the leading international financial institutions (IFIs) have also improved their numbers. The majority now expect the economy to put in positive growth, although just how fast it will grow remains a matter of debate.

The CBR estimates the economy will grow in the range of 0.5% and 2%, up from a previous guess of a range between a 1% contraction and 1% growth. However, during the SPIEF panel Nabiullina now suspects growth will come in at the high end of the range.

"Our estimates show that the gross domestic product (GDP) dynamics is now better than the pivot of our 0.5–2.0% forecast, a bit higher. It will likely be in the upper half of our forecast range," Nabiullina said.

Reshetnikov is of the same opinion. The official forecast from the Economics Ministry, which conducts its own research, is for a 1.2% growth this year, but he has already said that his ministry’s estimate is looking more and more conservative.

“It will be higher than our estimates, it is already clear. I will not provide figures, but apparently higher,” Reshetnikov told reporters on the sidelines of the panel.

Accelerated adaptability

The panel was positively jolly compared to the dour debate the same team had a year earlier. None of their worst-case scenarios have come to pass and they openly admit that they were surprised by the reaction of Russia’s private sector and its outperformance.

“In October 2021 we said that Russia needs radical transformation of its economy and a change in the share of domestic demand. And that happened much faster than we were expecting,” the central bank governor said. “The worst-case scenario didn’t appear thanks to hundreds of thousands of businesses that adapted.”

A year ago Nabiullina produced a forecast with three scenarios: base, growth and global crisis. Asked to assess where Russia was now, Nabiullina said that the CBR had been pleasantly surprised as it was a mix of all the scenarios.

In the global crisis scenario the CBR predicted that the global economy would fragment and geotensions would rise, both of which have happened. As bne IntelliNews has reported, the stand-off between East and West is not the start of a new Cold War, but it has led to a fractured world that saw long-stranding trade relations smashed. What has surprised the Russian policy makers was how fast the global market rebalanced and how successful Russian companies were in redirecting much of Russia’s strategic trade from West to East.

Nabiullina also predicted that global central banks would tighten monetary policy that would slow the world’s growth and that has happened too, although as inflation starts to ease rates are expected to start to fall now. On the day before the panel the US Federal Reserve bank kept rates on hold, ending a run of ten hikes in a row, the fastest pace of monetary tightening in the US for decades.

However, the last step in Nabiullina’s doomsday scenario – global financial crisis – has not appeared. Yet.

“The global crisis has not happened yet, but will come for sure,” Nabiullina said wryly, ever the cautious central banker.

The government did pour billions of rubles into the economy to cushion the blow in the same way as it provided support to companies during the coronavirus pandemic equivalent to around 3% of GDP that kept growth stable. The amount spent since the start of the war in Ukraine has been roughly equivalent to that spent during the pandemic, but Nabiullina did not agree with Reshetnikov, who believes the state spending was decisive. “The main factor was the adaptation of many, thousands of enterprises that turned out to be very flexible, agile,” Nabiullina said. Siluanov pointed out that life was made easier for companies as many could simply step into holes in the market left vacant by the sudden departure of foreign companies.

“Accelerated adaptability” was the mot du jour at the session. Russian companies stepped up to the challenge, meeting the rapid changes in the market caused by the imposition of extreme sanctions by aggressively investing to retool and find new suppliers and customers.

A CBR survey conducted last autumn found that only a tiny share of companies had found no solution to replacing banned goods. On top of that, trade via friendly third countries means that most of the products that disappeared last spring are back in the stores. Even the technology sanctions have largely failed, with the US admitting last week that Russia’s imports of technology have now exceeded pre-war levels.

“The Russian businesses, the Russian economy have been developing under a scenario of rapid adaptation. Our companies have adapted themselves very fast,” Nabiullina told the delegates.

In an example of how rapid and comprehensive this change has been, a Russian press report on the same day as the panel said the domestic market is currently oversupplied with iPhones. Apple is one of the many Western companies that pulled out after the war broke out, closed its stores and ended the direct imports of some 30mn handsets a year. Yet 12 months later, independent traders have stepped into the company’s empty shoes, but as they are unco-ordinated and selling to a network of unaligned retailers, the traders have overestimated the demand and sent too many iPhones to Russia this season.

To underscore the panel’s enthusiasm the latest industrial production figures went back into the black in April, increasing by 5.2% year on year, up from 1.2% y/y in March. (chart) The growth is largely due to heavy state spending on the defence sector and a low base effect, but RosStat’s own seasonal adjustment showed growth of 1.7% month on month, the fastest pace since late-2021. More indicative of the private sector’s performance has been the S&P Global Russia Composite Purchasing Managers' Index (PMI) which put its fourth gain in a row in May 2023 of 54.4. Any result above 50 represents an expansion. (chart)

State’s role

State support has clearly played an important role in supporting Russia’s economy and it will continue, but the panellists warned that the trick will be to adopt policies that don’t crowd out private enterprise but encourage it. The economics team were proposing a market-based rescue plan where private companies do the hard work, not the state.

“We have to ensure macroeconomic stability and the financial oxygen and that will allow strategic adjustments to the new realities,” says Siluanov.

Nabiullina warned there is a risk of a return to a planned economy. The state's concentration of the right to decide which projects to develop and where to allocate resources is a big risk, although the restoration of the administrative economy seems impossible, Nabiullina believes.

The temptation to manage the restructuring of the economy “may eventually suppress private initiative,” since the activity of the state in a crisis, which should be, is often confused with the desire to “permanently manage the economy,” said the head of the CBR.

“I'm not talking about the risk of restoring the planned economy. It seems that this is impossible, because everything is market-based in our country, but in fact it is enough for the state to concentrate the right to decide which industries, which projects need to be developed and where to direct financial resources instead of private initiative, and, in my opinion, this is a big risk,” continued Nabiullina.

The economist stressed that the efforts, within the framework of which “a big breakthrough in a wide range of industries” will be made at the expense of the budget and public debt, will definitely not become structural adjustment. She explained: “If we do this, we will get unavailability of private credit.”

Financial sector fuelling the change

Russia’s banking system is healthy, holds a fair reserve of “real” capital, and can play a great role to finance the economy’s structural transformation and development, Nabiullina said.

The financial system should adjust to service the structural transformation of the economy and to maintain the stability, she added.

The central bank will continue steps to support the trust in Russia’s financial system and the capital market, Nabiullina also said.

“Last year, the main task for me was to maintain the trust in the financial system so that people do not fear inflation and rely on the financial system’s resources,” she said.

The accelerations of corporate adaptiveness has been facilitated by the banking sector which as bne IntelliNews reported has returned to profitability (chart). The banking sector recorded a net profit of RUB224bn in April, with an annual return on equity of 21% and corporate lending in particular has been rising strongly.

Structural transformation

One of the manifestations of the structural restructuring of the economy is a change in the ratio of sectors in the economy. Nabiullina noted: “in our country this should be associated with an increase in the share of domestic demand.”

“I think everyone understands that we are going through this now. This entails both a redistribution of labour and investment. Structural restructuring of the economy is happening faster than we expected, the worst forecasts did not come true,” the head of the Central Bank emphasised.

The CBR supports the idea of floating shares of the companies bought from the firms leaving Russia, the details are being discussed.

It is considering various scenarios of exchange of frozen assets and does not disclose the amount of money on type C accounts.

"We are looking very cautiously at the ways of managing it in principle," she said.

The authority may toughen regulation of consumer lending and restrict the volume of risky mortgages, the official said.

Despite the strong performance, the government continues to run a budget deficit, which hit its full year target after the first ten days of March and is currently 17% over target at RUB3.4 trillion, although in May the m/m result saw the Russian budget return to surplus for the first this year, suggesting Siluanov’s target to keep the full-year deficit to RUB2 trillion is attainable.

Siluanov has been looking for new sources of revenue and the state has just introduced a windfall tax on large enterprises that should bring in an extra RUB300bn ($4bn) of revenues. And there are other options to raise more money if needed. When the moderator asked each of the panellists (except Siluanov) if corporate taxes would be raised “yes or no?” they all dodged the question.

Inflation is key

Nabiullina made it clear that her top priority is to keep inflation in check as the best way to sustain Russia’s economic recovery. Minister of Economic Development Maksim Reshetnikov said that Russia is in a “good place now” as inflation is low (2.5%) and so is unemployment (3.3%), but that “inflation will rise” and that the government must be ready. (chart)

“The problem then is that you have to hike interest rates and that sucks credits out of the market. At the same time you can’t raise more money by issuing too many bonds, as then it becomes more profitable for banks to lend to the state than it does to companies and that also slows growth,” says Nabiullina.

However, Nabiullina, who has earned a reputation as the most conservative central banker in the world, seems to have things in hand. The CBR’s official forecast for this year is for inflation to rise in the second half of the year to 4.5-6.5% before returning to the bank’s long-term target of 4% in 2024, and will be close to 4% further on.

“No one doubts the central bank’s ability to manage inflation. Its reputation is immaculate,” Nabiullina, giving herself a pat on the back. “If inflation goes up again we will pull the brake, but that slows the economy so we are going to try and avoid pulling the brake.”