As predicted the Russian economy continues to put on speed.
According to Rosstat (the Russian government’s statistical agency) industrial production was 1.7% higher in June 2016 than in June 2015 – above most forecasters’ expectations. Importantly manufacturing production grew for the third successive month, increasing by 1.6% in June as against 0.6% in April and 0.3% in May. The Central Bank now estimates the level of GDP decline in the second quarter (April to June) at just 0.2 – 0.4%.
Meanwhile food production continues to accelerate rapidly, with predictions of bumper food output this year and Russia’s Agricultural Ministry saying Russian farmers will have replaced all food imports and will be supplying the country with 100% of its food products within just 10 years.
The sharp rise in inflation many predicted for June and July failed to take place. Where there were concerns that inflation might rise to an annualised rate above 8% it actually fell to an annualised rate of 7.2% at the end of July. There is now general agreement that there is likely to be slight deflation in August. The Central Bank is revising down its expectations for inflation this year and next year. Whereas earlier in the year it was predicting that annualised inflation would fall to 5% by the second quarter of 2017, it now expects it to be below this figure. It still expects to reach its 4% target by the end of 2017.
As is always the case at the start of a recovery the news is not uniformly good. Fixed capital investment continues to fall (according to the Central Bank by 3.2 – 3.4% in the second quarter) whilst manufacturing PMI re-entered negative territory in July, falling to 49.5. This however contrasts with a surge in services PMI which rose to 55.
The continued fall in investment and the fall in manufacturing PMI may be connected to the decline in oil prices since the middle of June, which must be hitting investment in the energy industry, and which has undoubtedly caused worries that with renewed pressure on the rouble the Central Bank will put off further cuts in interest rates. The Central Bank in fact kept interest rates unchanged at 10.5% at its latest meeting on Friday, though it left open the possibility of a further cut at its next meeting in September.
Though the fact continues to be denied, it is the high interest rates rather than the famous structural factors which are the main brake on recovery. The Central Bank has made its position crystal clear: despite complaints from the Economics Ministry it intends to keep interest rates high until its inflation target of 4% is reached and for some period beyond this. Any discussion of the Russian economy that does not grasp this fact is missing the fundamentals. The Central Bank is quite intentionally sacrificing the short term growth of the economy in order to achieve a sustained decline in inflation to an annualised rate of 4%, and this has been its policy which it has stuck to with extraordinary single-mindedness ever since 2010. Moreover in pursuing this strategy the Central Bank has Putin’s full backing.
Once the inflation target of 4% is reached and the Central Bank is confident it will not rise above this figure interest rates will finally fall. At that point the expectation is that the growth rate will surge to a sustained long-term rate of 4% a year – high by any standard and especially so by the standard of Europe or north America. Kudrin for his part – perhaps over-optimistically – actually believes the rate of growth can be increased even more to 6%. This was confirmed in my presence at SPIEF by Kudrin and Nabiullina (the Central Bank Chair) and by Putin himself.