A Collective Sigh of Relief - Deloitte

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Global Economic Outlook 2nd Quarter 2012 RUSSIA 34 Russia: Conflicting influences by Dr. Ira Kalish Russia’s economy is performing reasonably well, but it faces some obstacles going forward. In 2011, the economy grew 4.3 percent. This included consumer spending growth of 6.4 percent and investment growth of 6.0 percent. However, growth is likely to be somewhat slower in 2012, given global headwinds. Slower growth in Europe and China will have a negative impact on the volume of exports. About two-thirds of Russia’s exports are energy related, and energy demand may decline in these markets. In China, for example, which is Russia’s largest single export market, demand for energy is expected to dampen considerably. On the other hand, there has been a significant increase in the global price of oil lately, largely the result of political risk. This will boost Russian export revenues and contribute to continued trade surpluses. Influences on growth There are other factors that will influence growth in 2012. First, credit market conditions in Russia have been good. Credit for consumers and construction has grown rapidly, fueling a boom in consumer spending and construction activity. Moreover, stabilization of European financial markets — the result of massive ECB lending to commercial banks — bodes well for Russia. Although Russia runs a current account surplus, making it a net creditor nation, it has a deficit in net interest payments. Consequently, Russian access to global credit markets is important. With Europe evidently stabilizing, Russian credit market conditions are likely to remain relatively good. Second, wages have been rising faster than inflation. This increase in real wages has also contributed to rising consumer spending. It is largely due to a sudden and unexpected decline in the rate of inflation. Lately, prices are up only 4.3 percent over a year ago. This low inflation, in turn, is partly due to the government’s decision to postpone increases in a tax on energy, which was originally scheduled to be implemented in January of this year, but instead was postponed to July. Thus, inflation was temporarily suppressed. In addition, a rising value of the currency recently had a disinflationary impact. On the other hand, there is concern in the market that inflation is likely to rise in the coming year. Unless nominal wages keep up, consumer purchasing power might be negatively influenced. In addition, rising inflation is likely to constrain the central bank in its ability to operate an easy monetary policy. Thus, interest rates might not come down any further. The expected rise in inflation is due to the imminent rise in energy taxes, the impact of rising oil prices, and the lagged impact of an easy monetary policy. Third, fiscal policy has lately been expansionary in anticipation of the recent presidential election, thus contributing to economic growth. It was made possible by higher-than-expected oil prices, which have boosted government revenues. The result, interestingly, has been a budget surplus when the government had originally anticipated a deficit in the year that just ended. In the coming year, government expenditures are likely to continue growing in areas such as defense, public sector compensation and pensions, infrastructure, and social spending. Again, this is feasible given the relatively high price of oil. On the other hand, it is estimated that if elevated spending is maintained, Russia will require an oil price of about $120 per barrel in order to balance the budget. As recently as 2007, an oil price of $55 was sufficient to balance the budget. The risk for Russia is
that if the price of oil were to decline, then fiscal probity would be thrown into question. The government would then face a choice of fiscal contraction, which would have a negative impact on GDP growth, or continued borrowing and spending. Given that the currently high price of oil is largely related to a political risk premium, the possibility of a drop in the price cannot be dismissed. Fourth, capital flight remains a problem and reflects a dearth of confidence in Russia’s immediate future. Capital flight diminishes business investment from what it otherwise would be. Interestingly, capital flight is taking place at the same time that foreign direct investment is increasing. The latter reflects increased investment in the energy sector, especially as the government has lately taken a more open attitude toward foreign involvement in energy development. Despite capital flight, the currency recently rose in value, reflecting the rise in oil prices. Longer term issues Vladimir Putin was recently elected president for the third time, replacing outgoing President Medvedev. He will now serve a six-year term. His margin of victory was substantial and, therefore, sufficient to quash skepticism. Although Russia we know who will lead Russia, the policy regime remains somewhat murky. It is not known whether Mr. Putin will move toward market orientation or support a more statist set of policies. Notably, Mr. Putin has cited China and South Korea as examples of favorable growth environments. China, in particular, has relied heavily on state direction of the economy, while South Korea relied on state protection of favored industries in the early stages of its industrial development. As such, Putin’s comments suggest a good deal of government involvement in economic management. On the other hand, Russia is set to join the World Trade Organization (WTO) this year. Membership will require more openness on trade-related issues. The most pressing challenge that Mr. Putin will face in the coming years is the level of investment as a share of GDP. Currently, it is inadequate for generating strong growth. Moreover, the level of investment in the energy industry, while rising, remains insufficient to substantially boost production. Boosting investment, in part by generating more foreign direct investment, will be critical. Geographies 35
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Page 7 and 8: Figure 1. Use of ECB's deposit faci
Page 9 and 10: Figure 2. Economic Sentiment Indica
Page 11 and 12: competitiveness is based on product
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Page 15 and 16: Figure 3. Average price of regular
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Page 25 and 26: hardly been eliminated. From the hi
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Page 33: grew, but at a slower rate than in
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Page 41 and 42: India’s recent economic interest
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Page 45 and 46: Yield curves (as on April 6, 2012)*
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