Russia Exits Recession

Russia’s economic indicators for the four months of the year and for April point to an end to the recession.

The GDP contraction in the period January to April was 1.1% compared to the same period last year. In April it was just 0.1%.

Industrial production in April actually grew 0.5% in annual terms. This is partly a reflection of the base effect, with industrial production appearing stronger by comparison with the sharp contraction in the second quarter of 2015. However there does appear to be a genuine industrial recovery underway. The Manufacturing Purchasing Managers’ Index (PMI) elaborated by Markit improved from 48.0 in April to 49.6 in May, where a figure below 50 points to contraction and a figure above 50 points to expansion.

As might be expected in a recession driven principally by a collapse in demand caused by last year’s inflation spike, the strongest indicators of recovery are in the services sector, reflecting the recovery in real incomes which is currently underway. Here the PMI points to strong expansion, climbing from 52.0 in March to 54.2 in April.

It is normal in a recovery for demand to recover more quickly than output and investment, which usually lag behind demand. This is the perfectly normal pattern this recovery is following.

The annualised rate of inflation was 7.3% in April, the same as in March – below the Central Bank’s and the market’s expectations, both of which had predicted a small rise.

The fact the figure for annualised inflation was the same in April as March reflects the base effect, with the Central Bank saying the annualised rate of inflation will actually increase in May and June for purely statistical reasons even though the rate of rises in prices remains stable. The Central Bank predicts the figure for annualised inflation will resume its fall in July.

At its last meeting in April the Central Bank predicted that the annualised rate of inflation would fall to 5% by April 2017, which is probably close to the real underlying rate of inflation now. Actual price growth at the moment seems to be below 6%. There may be further falls in price growth later in the year with reports of oversupply in the food sector leading to price falls for certain food products in the coming weeks.

The connection between inflation and growth in Russia is scarcely ever properly debated or understood even though the figures could not make it clearer.

Briefly, Russia experienced double-digit inflation (that is inflation above 10%) every year from the fall of the USSR in 1991 until 2011 with the exception of the crisis year of 2009 when inflation dipped to just below 10%.

Inflation then fell sharply in 2011 when the government and the Central Bank began to prioritise inflation reduction over GDP growth. Whereas before 2011 annual inflation except in 2009 was always above 10%, in the period 2011 to 2013 it fell sharply to a range of 6-6.5%.

The fall in growth rates since 2011 about which so much has been written is a direct – and natural – product of this anti-inflation strategy, which has sought to reduce inflation by limiting monetary growth and demand at a time when the government has been trying to keep its budget in balance. Whilst one may disagree about aspects of this strategy – I happen to think it is wildly overdone – there is no sense complaining about it unless one understands that it – and therefore the fall in GDP growth rates – is deliberate policy.

The anti-inflation strategy was temporarily blown off-course in 2014 because of the inflation spike caused by the devaluation that year. That in turn was the product of the authorities’ decision pre-2014 to keep the rouble trading within a narrow band. High inflation within Russia meant the rouble became seriously overvalued, which was the true cause for its collapse in 2014.

With the inflation spike over inflation has now fallen back to the levels of 2011-2013 – or even below – and with further falls likely, whilst the fact the rouble is now floating reduces the risk of such a spike happening again.

Though the average price of Brent crude in the period January to May has been $36 a barrel, for those who continue to worry about a crisis in the Russian budget, the federal budget deficit for the moment appears to be well below 4% of GDP, with the government predicting a federal budget deficit of just 3.3% of GDP if Brent crude trades at $40 a barrel.

The actual price of Brent crude at the present time is actually higher at over $50 a barrel. Whether it will remain so will depend on how the oil market reacts to the likely rise in US interest rates in June.

In light of these figures even the Central Bank – consistently the most pessimistic of Russia’s government agencies – is admitting the economy might actually grow this quarter.

The Economics Ministry for its part is saying that the GDP is contraction has almost ended and that this should be clear by mid-year, with the economy returning to growth in the second half of the year.

With inflation remaining subdued and the Central Bank signalling a likely cut in interest rates in June, barring an external catastrophe that now looks like a very high probability.