Tighter external conditions and higher VAT to slow economic growth in 1Q19

Tighter external conditions and higher VAT to slow economic growth in 1Q19
Russia's VAT hike in July will lead to an economic slowdown 1Q19, add to rising inflation rate / bne IntelliNews
By bne IntelliNews November 15, 2018

Tighter external conditions and higher VAT will lead to a slowdown in economic growth in the first quarter of 2019, but the economy will not enter into recession, said Alexei Zabotkin, director of the Central Bank’s monetary policy department, in an interview with Interfax .

“In the medium term, changes in VAT and other tax innovations, combined with government spending decisions, are neutral in terms of the fiscal impulse for the economy,” said Zabotkin. “Probably, in the first months of next year, in the period when the system is adjusted to the changed conditions, this will affect growth. The weaker dynamics in the first quarter somewhat lower the figures for the year as a whole. Then the economy returns to potential growth.”

As part of the government’s reforms to create new revenue to cover the RUB2 trillion of extra spending mandated by President Vladimir Putin in his May Decrees the ministry of finance increased the VAT rate in July from 18% to 20%, the first time the Kremlin has directly increased the tax burden on the population since Putin took office in 2000.

The VAT hike will also drive up prices, the CBR believes. "In the first quarter we will have a significant surge in inflation, most likely, we will see it already in the data for January," Zabotkin noted. “Probably, the adjustment process for VAT will take two to three months. According to our estimates. In the first quarter annual inflation will be higher than 5%,” he said.

Consumer price inflation (CPI) was 3.5% in October, up from a record low of 2.21% set in January this year. The CBR’s inflation target rate is 4%. Inflation will return to levels “near 4%” in the second half of 2019, and on average for the year, according to the central bank’s forecast, it will be 5–5.5%. However, the CBR said the rise in prices in October were below its expectations.

Answering the question of whether the Central Bank sees risks of recession in the first half of 2019, Zabotkin stressed that “there will be [economic] growth.”

“In the baseline scenario, we see growth in all components of GDP. The export forecast has been revised upwards — largely due to the extractive sector, but the rest of the export sectors also feel good,” concluded Zabotkin.

Earlier, the Ministry of Economic Development said it sees a more difficult end of the year than at the start of the year. The ministry has already downgrade its growth expectations for this year twice and now forecasts a slowdown in GDP growth from 1.8% in 2018 to 1.3% in 2019, as well as a decline in investment and a temporary peak acceleration of inflation in the first quarter to 4.5-5% with its subsequent reduction to 3-4% by the end of the year.

The central bank stated that the VAT increase could have a “small deterrent effect” on business activity and estimated the contribution of tax growth to inflation at 1 percentage point.

In anticipation of growing inflationary pressure and more ruble instability caused by potential “crushing” sanctions by the US this autumn the CBR front-loaded monetary policy with a prophylactic rate increase in September of 25bp bring the policy rate to 7.5% that will also depress growth.

Data

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