Russia Country Report Nov21 - November, 2021

November 5, 2021

The Russian economy continued to normalize on a y/y basis in September, with the GDP growth rate slowing to 3.4% y/y during the month vs. 3.7% y/y in August. Russia’s 3Q21 GDP growth is estimated at 4% y/y vs. 10.5% y/y in 2Q21.

All in all, it is clear the period of easy recovery (thanks to the negative output gap closing) is over.

The Ministry of Economic Development estimates that Russia’s GDP grew 3.4% y/y in September vs. 3.7% y/y in August and 4.9% y/y in July.

Overall, the ministry estimates Russia’s 3Q21 GDP growth at 4% y/y, which is close to our updated expectations (+4.2% y/y).

Now that Russia's economy has essentially returned to where it was at the end of 2019, the main question is what will drive economic growth in the future. Exports will clearly remain an important factor, and Russian exporters strengthened their positions during the crisis. Another important factor will be how effective the investments from the national projects and the National Wealth Fund prove to be.

Basic sector output growth slowed to 4.4% y/y in September, down from 7.1% in July and 4.8% in August. After seasonal adjustment, m/m growth in September was just 0.5%, not enough to fully offset the 0.7% decline in August.

This meant that basic sector output growth came in at 5.4% y/y in 3Q21, down rather sharply from 13.5% in 2Q21, the quarter when overall economic output moved past the pre-Covid level and the gap in potential output, which emerged in 2Q20 during the lockdown and consequent sharp correction in economic activity, closed in most industries (excluding entertainment).

The September figures show a strong y/y and SA m/m performance in the production segment thanks to crude oil and natural gas production.

Demand for goods remained strong due to higher incomes, as well as due to loan growth remaining strong on the back of real interest rates remaining low.

But analysts expect Russia’s economic performance to weaken in 4Q21 due to less business activity as COVID-19-related restrictions affect the real economy (to a lesser extent) and services sector (to a larger extent). As a result, Russia’s 4Q21 GDP growth could be 1.7% y/y, putting the country’s FY21 GDP growth at 3.8% y/y.

Industrial production (IP) bounced back in September, showing higher-than-expected growth rates. IP growth accelerated to 6.8% y/y vs. 4.6% y/y in August (Bloomberg consensus was 4.6% y/y) following an uptick in mining and quarrying (+9.5% y/y in September vs. +6.6% y/y in August).

Likewise The headline seasonally adjusted IHS Markit Russia Manufacturing PMI registered 51.6 in October, up from 49.8 in September, and signalled the first improvement in the health of the Russian manufacturing sector for five months.

“October PMI data signalled a renewed improvement in operating conditions across the Russian manufacturing sector. The overall rate of growth was the strongest since May, with faster expansions in output and new orders supporting the upturn. At the same time, employment expanded for the first time in five months amid greater production requirements,” Markit said in a press release.

Manufacturing – the backbone of the real sector – was up 4.6% y/y in September vs. 2.9% y/y in August. Electricity and gas supply was up 9.1% y/y in September vs. 6.8% y/y in August, and water and sewerage was up 10.7% y/y in September vs. 12.7% y/y in August.

Labour shortages significantly affected harvests, with harvests of grain and leguminous crops, potatoes, and vegetables down 12.7% y/y, 12.7% y/y and 3.5% y/y as of 1 October, respectively.

Demand for goods and services was strong, while cafes and restaurants felt the effects of COVID-19-related restrictions. Retail sales continued to improve, although they still came in below expectations. Social outlays fueled demand for goods, with retail sales up 5.6% y/y in September (vs. +5.3% y/y in August and +5.1% y/y in July) thanks primarily to the non-food segment (+8% y/y in September vs. +7.5% y/y in August).

A more robust economic backdrop led to higher incomes. The growth in real disposable incomes in 3Q21 surged to 8.1% y/y vs. 7.4% y/y in 2Q21 and -3.7% y/y in 1Q21. Real money incomes were mainly driven by the expansion in salaries and wages; entrepreneurial activity; and social outlays. While the recovery in corporate profits supported salaries and wages, budget spending boosted social expenditures. The unemployment rate improved further, falling to 4.3% SA in September vs. 4.4% SA in August.

Consumption was the key driver of the 2Q21 economic recovery and remains that in 3Q21, with August employment and retail trade above expectations ahead of the likely spike in September. We upgrade our 2021 GDP growth to 4.3%. Yet moderating lending, sluggish non-oil production, tight budget draft and Covid risks keep us at a cautious 2.0-2.5% for 2022.

On another positive note, investment growth was also strong at 12.8% y/y, adding a noticeable 2.6%age points to 2Q21's GDP growth of 10.5%.

Despite rate hikes, demand for retail loans was up 4.6% SA q/q in 3Q21 vs. 6.8% SA q/q in 2Q21 (+23.9% y/y in 3Q21 vs. +21.7% y/y in 2Q21). Loan demand, which was up 27% y/y in September, drove the growth in mortgages.

The bugbear remains high inflation. Russian inflation accelerated to a fresh five-year high of 7.4% y/y in September and, while this was mainly driven by a sharp increase in food inflation, the central bank is likely to continue its tightening cycle for a little longer at the next couple of meetings.

That caused the Central Bank of Russia (CBR) to hike rates by an aggressive 75bp in October as the regulator continues to battle against inflation.

However, real interest rates still not high enough to push households to shift from consumption to saving. CBR officials admit that higher inflation expectations are still pushing the growth in retail lending despite deposit rates adjusting after CBR’s 100bps and 25bps hikes in July and September, respectively.

The government has also decided to prioritize the further accumulation of reserves for infrastructure spending from the National Welfare Fund (NWF), which should be limited (c. RUB1.5trillion over 2021-24, but no more than RUB2.5trillion). The cap on spending in the new 2021-2024 budget from the NWF will be increased from 7% of GDP to 10% which means even more money will be parked in the rainy day fund – an extremely conservative policy.

The Russian government approved a list of 42 strategic initiatives for socio-economic development of the country on October 7. Their aim, according to the official announcement, is “to improve people’s quality of life and make the Russian economy more modern and flexible.”

To arrive at the initiatives, five working groups analyzed 250 ideas and selected those that will respond to citizens’ real needs, provide tangible results, and further national development goals.

The initiatives are divided into six categories: technological breakthrough (15), social sphere (10), construction (7), digital transformation (5), ecology (4), and the state for citizens (1).

The ruble has appreciated vs. the US dollar due to higher commodity prices (especially non-oil commodities) and topped RUB70 to the dollar at the end of October – a level it was not expected to reach until the end of the year. Higher gas prices and the seasonality of volumes should support the ruble in 4Q21.

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