Despite the global turbulence and capital outflow, Russia’s economy has demonstrated its ability to grow using domestic sources.
Total growth in 2012 is expected at around 3.7%, which is not a bad result compared with the developed world and many emerging economies. Expansion in domestic demand remained the major driver of this growth, which is evidenced by a 6% increase in retail and 8.4% rise in investments over 11m12.
At the same time, the effectiveness of the economy is moderately improving. The total increase in labor productivity over 9m12 was at 3.1%, while electricity intensity fell 2.6%. Overall, economic development is moderate, but seems to be more sustainable than any time in the past decade.
Industrial output climbed 1.9% y_o_y in November, putting the 11m12 figure at 2.7%. After seasonal adjustments, the data demonstrated 0.6% m_o_m growth. We expect annual growth to be at around 2.8%.
Importantly, output in the manufacturing sector remained sustainable: up 4.0% y_o_y in November and 4.4% over 11m12. The dynamics in the manufacturing sector, which is mainly domestic_oriented, illustrate that household consumption is the major driver of economic growth in Russia. As a result, output of food, construction materials, automobiles, refrigerators and TV sets has been both sustainable and robust this year.
Raw materials extraction edged up just 0.3% y_o_y in November and 1.2% in 11m12. The supply and redistribution of electricity, gas and water was down 2.6% in November and up 0.7% in 11m12. The slowdown in raw material extraction was due to the sector’s near_100% capacity utilization and sluggish external demand. The contraction in the utilities sector in autumn was linked to warmer temperatures than a year earlier (by 2.5 degrees Celsius in November). However, as we discussed in our previous Russia Economic Monthly, the economy’s energy intensity is generally falling, and this can be treated as a sign of continuing restructuring.
Investment was up 1.2% y_o_y in November, while the 11m12 figure was at 8.4%. Investment statistics remain extremely volatile and seemingly biased, while frequent revisions just support this view. This leads to a deterioration in the quality of the forecasts. Nevertheless, total investment growth this year will be at around 6% or even higher.
Retail and Household Consumption
Retail sales were up 4.4% y_o_y in November, bringing the 11m12 figure to 6%. As expected, the annual expansion in retail sales slowed in y_o_y terms in 2H12. This was due to an acceleration in y_o_y inflation on the back of food price growth and the revision of regulated tariffs, which was shifted this year from January to July_August. Thus, annual growth in retail sales will be at around 5.7%.
Inflation between December 1 and 24 was at 0.4%, the same level as a year earlier. Thus, y_o_y inflation was at 6.5%, while the YTD figure was at 6.4% (6.1% a year earlier). Annual inflation is expected to be close to 6.5%, while next year it could be at around 5.5%. Russia currently seems to be somewhat unique as a country that is growing relatively fast, has no debt problems and operates in an environment of positive real interest rates, while y_o_y inflation is expected to slow.
Real disposable income was up 4% y_o_y over 11m12, while real wages grew 8.8%. As we have reiterated in the past, the official statistics of real disposable income seem to be below the actual figure, which we estimate at around 6% y_o_y growth in 11m12. The problem with the official methodology is that it classifies the sale of the foreign currency as income, while this transaction is actually just rebalancing of savings. The official estimate becomes biased, and the population then changes its investment behavior. For example, this year Russians bought more foreign currency (and sold less) than a year earlier, and the official statistics thus undervalued actual income.
Federal Budget Execution
Federal budget revenues came in at R953.6 bln ($30.3 bln) in November, while expenditures totaled just R888.7 bln ($28.2 bln), which is below the October result. The budget ran a surplus of R64.8 bln ($2.1 bln). In December, budget execution will change radically and the balance will be negative. This happens every year due to the uneven allocation of federal expenditures throughout the year. The government spent R10.6 trln over 11m12, while the annual figure (after an upward revision) is at R13.0 trln. We do not believe the state will meet its annual target, but expenditures will nevertheless exceed R2.0 trln in December. We forecast revenues of at least R1.5 trln in December, so the annual budget will be at or near balanced, but the monthly budget will be deeply negative.
Money supply growth (y_o_y) in 2012 decelerated from 22.3% at the beginning of the year to 15.8% at end October. Given the monetary base dynamics, growth in M2 in 2012 (December to December) will be close to 12%. The Central Bank’s refinancing operations became the major source of the liquidity, while the Finance Ministry was a net absorber of liquidity. In 2013, the Finance Ministry will continue borrowing domestically in order to accumulate more capital in the Sovereign funds. Thus, the situation with liquidity will remain tight and money supply growth will continue to slow.
The Central Bank left the majority of base interest rates unchanged in December. Specifically, the refinancing rate remains at 8.25%, the direct overnight and weekly repo operation rates at 6.5%, and the minimum overnight and weekly rate for repo auctions at 5.5%. However, the Central Bank reduced the overnight rate for swaps from 6.75% to 6.5% and increased the deposit rate from 4.25% to 4.50%. The reduction in the swap rate will support the money market, but the effect should not be overestimated since the swap is a secondary refinancing instrument. Meanwhile, the increase in the deposit rate is neutral as the interest rates on the money market are already substantially higher. Overall, the Central Bank has again confirmed that it uses y_o_y inflation as an indicator for interest rate policy. Given that y_o_y inflation will probably remain around the current 6.5% until mid_2013, no movement in official rates is expected in coming months. We also stress that the Finance Ministry’s activities on the money market (both the injection of liquidity via deposits with banks and the neutralization thereof via local borrowing and surplus accumulation) are disruptive and unpredictable. The interventions drive the risk of an acceleration in inflation in the event that the Central Bank injects too much liquidity to support the money market, as occurred last August, especially when the interventions come in the form of refinancing with non_market collaterals.
The ruble fluctuated almost freely in 2012, without any massive intervention from the Central Bank. As a result, the ruble/dollar rate saw a high of R28.9/$1 (at end February) and a low of R34/$1 (at the beginning of June). The exchange rate followed the movement in oil price and stabilized at around R30.8/$1 at year end. The exchange rate volatility became routine and is already expected by the market, which is why it did not have a significant influence on economic development this year. Its effect on inflation was even very moderate, only temporarily driving up fruits and vegetables prices in June and July, while prices dropped in August, once the local harvest was gathered. We expect the Central Bank to allow the ruble to float freely in 2013, as well.
Foreign Trade and Balance of Payments
The current account surplus in 2012 is estimated at around $90 bn, or only slightly below that in 2011 ($98.8 bn).
The average oil price was almost the same in 2011 and 2012 (at around $110/bbl). The current account was strong due to a very modest increase in imports (only 3.5% growth y_o_y over 10m12). These dynamics show that the Russian economy is becoming more competitive and that local producers (though many are subsidiaries of foreign companies) are able to satisfy domestic demand.
Russia started the year with very high capital outflow ($34.6 bln in 1Q12), but it later decelerated to average about $13 bln per quarter. Capital outflow seems to be acting as an air valve in order to prevent the economy from overheating. For example, when the average oil price was unexpectedly high ($117/bbl Urals) in 1Q12, economic agents preferred to save unexpected revenues in the form of foreign assets (as does the government, as it continuously accumulates the State Reserve Fund via borrowing).
This decision caused increased capital outflow. When the oil price normalized, the agents simply reduced the savings and capital outflow also shrank.