Russia Country Report Jun21 - June, 2021

June 2, 2021


Russia’s economy continued to recover in the first three months of this year. Although January and February posted negative growth the moment was clearly already growing on the returning optimism as the coronavirus pandemic recedes.

Growth turned positive in March and the State Statistics Service revised its estimate for the first quarter growth and improved its reading to a 1.0% y/y contraction against the 1.8% y/y contraction in 4Q20.

Russia's seasonally adjusted GDP started to contract already in the second half of 2019, ie before the corona pandemic. In the fourth quarter of 2020, GDP was 4.2% lower than in the second quarter of 2019. This says that the Russian economy is suffering from problems other than the corona.

Since then the mood amongst businesspeople has become very buoyant as the Russian business confidence survey run by Rosstat every month has turned positive for the first time in eight years, and for the second time ever. The index was at zero in April, after it was knocked off its feet by last year’s coronacrisis. However, it fell to a low of -7.3 in November, which is less than the -8 of the previous two years its fall offset to an extent by the appearance of the first vaccines to counter the coronavirus (COVID-19) pandemic. The only other time the index has been positive was for eight months during the height of the noughties boom in 2006 and 2007, before the 2008 crisis knocked the index back to its all time low of -20.

In April, industrial production grew by 7.2% year on year. In the first quarter, the annual change was still −0.9%. In the coming months, the annual changes in many economic variables will be high, because in the spring of 2020 the Russian economy also suffered e.g. many measures restricting economic activity and movement.

In April, however, seasonally adjusted industrial production was unchanged from March. The annual growth came mainly from the manufacturing industry, whose production was 14.2% higher than last year. Production in the extractive industries decreased by 1.8% as the OPEC + agreement continues to limit Russian crude oil production. The annual change in oil production was −5.7% in April.

The Russian labour market is also showing clear signs of recovery. In April, the unemployment rate was only 5.2%, after peaking at almost 6.5% last autumn. The Russian labour market has traditionally been quite flexible, which has helped keep unemployment low. The employment rate is still somewhat lower than at the end of 2019.

The story is playing out more or less as bne IntelliNews speculated it would in our cover story “Brighter Days Ahead” in December, which argued that as the pandemic recedes, following the start of vaccine production in November, the release of the pent up demand would provide a strong positive jolt to economies around the world and lift all the boats simultaneously as soon as the first quarter of this year.

But Russia is not out of the woods yet as real incomes are still in decline and inflation is still a problem. From a slight improvement of 5.5% in April, in May the fast moving indicators ticked up again suggesting an increase to 5.8%, well above the Central Bank of Russia (CBR) target rate of 4% which is not going to be regained until next year, according to the experts.

The CBR has already abandoned its easing policy and begun to tighten with two rate hikes in March (25bp) and April (50bp) and is expected to tighten by another 50bp-75bp or the course of this year. With the cost of stables, especially food, soaring the population’s expectation for higher prices is at a multi-year highs of 14.5%. CBR governor Elvira Nabiullina is afraid that inflation expectations will become unanchored from reality and that will in itself be inflationary so she is acting decisively and aggressively now to manage those expectations.

At the macroeconomic level the picture is mixed. The basic sector data showed that the biggest sector declines in 1Q21 had come in industrial production (down 1.3% y/y), retail sales (down 1.6%) and "services to the population" (down 4.3%), while the biggest gains had come in agricultural output (up 0.4%), cargo turnover (up 0.4%), construction (up 0.2%) and wholesale sales (up 4.2%).

At the microeconomic level things are better with Russian corporate earning the best profits in five years and the bank sector also is earning profits on a par with the pre-crisis 2019 level. Economists estimate that Russia’s economy is already back to 98% of its 2019 level, which was the first year of strong growth following the 2014 oil price shock and devaluation crisis.

Rosstat data shows a faster-than-expected recovery in the two key segments of the Russian economy: the consumer sector and the resource industry that is being driven by a post-crisis commodities boom. In addition to the recovery in oil prices those for things like iron are at a nine-year high and copper prices topped $10,000 per tonne to reach a new all time high, which is only adding to both revenues and positive sentiment. A cold spring has also seen gas prices in Europe double to over $200 per thousand cubic meters that will boost Gazprom’s bottom line and ensure a 50% of profit dividend payout that also lifted Russia’s stocks, up 12% YTD, at the time of writing.

Budget execution is also good with stronger than expected revenue flows not only from oil, which has benefited from prices consistently over $60 a barrel – well above the $42 breakeven price for the budget – but also from non-oil tax collection. March tax collection as up by a third (33%), largely on the low base effect which will confuse all the reporting this year, but revenues will easy cover the extra social spending Russian President Vladimir Putin announced in his state of the nation speech and analysts say the government could increase spending by even more than promised to give the economy a boost.

Overall, Putin’s package of measures announced will cost the Russian government RUB400bn ($5.2bn) over the next two years, Russia’s Finance Minister Anton Siluanov said after the speech — equivalent to 0.2% of Russia’s GDP per year. With the extra revenues there is also talk of reducing Russia’s borrowing programme this year.

The official forecast for growth this year is 2.9% and 3% is the consensus guess, but given all the good news coming out in May analysts are already revising up their expectations: BSC GM is predicting growth of 3.3% this year with possible surprises on the upside.

The new US sanctions on Russian domestic OFZ bond issues imposed on April 15 are due to kick in on June 14, but the MinFin has already almost completed its borrowing programme for 2021 and could stop issuing OFZ completely in June if it wished. However, to keep the markets liquid it will almost certainly continue to issue more OFZs and the ministry is already starting to issue new debt to retire the most expensive debt issued last year during the height of the crisis.

At the same time the ministry tapped the international capital markets with a €1.5bn Eurobond issue the day after Russian foreign minister Sergei Lavrov and his counterpart US Secretary of State Antony Blinken met in Reykjavik on May 20 in a positive meeting – the first top level meeting between the new Biden administration and the Kremlin. Demand was decent, but the issue was not seen as a knock out success. The Kremlin seems to be following a policy of continued debt issues partly to keep international investors exposed to Russian debt and so make it more difficult to sanction.

Geopolitical tensions remains the main political issue, but the Biden administration has made it very clear that it wants to wind the confrontation down and is willing to compromise. The main even in May was the US decision not to sanction the operating company that is building the Nord Stream 2 gas pipeline and thus more or less assuring its completion this summer. A state department official commenting on the decision said that Washington’s relationship with Germany, which wants the pipeline, is more important than its argument with Russia. This decision will go down very well in Moscow and clears the path to constructive talks between Putin and US president Joe Biden slated to happen in the middle of June. A further de-escalation of tensions will lead to lower borrowing costs and more investment that should act as a tailwind to Russia’s already better than expected economic recovery.

Against the positive news on the international stage, the Kremlin has been ramping up its repression of political opposition groups and the free press on the domestic front ahead of September Duma election. Jailed anti-corruption activist and opposition politician Alexei Navalny group has been effectively labelled a terrorist organisation and outlawed. Its members can now not do anything at all without facing heavy prison sentences for participating in “extremist” activities. Likewise, a raft of publications, including and (a new title set up by the staff of top newspaper Vedomosti, who quit en masse after the Kremlin took the paper over) have both been ladled “foreign agents” that will kill their commercial viability. It seems that after the PR damage done by arresting Navalny the Kremlin feels it has nothing to lose anymore so has taken the opportunity to clean house and close down all possible rivals to its rule.

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