- Posted by Jon Hellevig
- On January 31, 2020
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Russia’s New Government Set to Abandon Austerity. GDP Growth Expected to Accelerate. But, Those Global Uncertainties…
There’s a lot going for the Russian economy as 2020 kicks into its second month. Russia’s government reshuffle is seen as removing austerity constraints and speeding up the financing of Putin’s ambitious national development programs. In his speech to the National Assembly, Putin signaled the end of austerity on social spending, Russia being the only country in the developed world, which is now seriously increasing social spending (among other things, increasing pensions double the rate of inflation and initiating massive child support programs) while everyone else is cutting. We expect that the Central Bank will have to follow suit and end its financial austerity in order to finally slash – Russia’s globally record high – real interest rates in line with the rapidly sinking inflation. Russia’s manufacturing industries will continue to grow above global averages fueled by the national development programs and on the strength of the now maturing import substitution programs. With new gas pipelines opened end of 2019 to China and Turkey, Russia’s energy exports will stay strong no matter what happens in the global economy. Because of the overall strong economy and the concurring huge reduction of influx of new young adults to the labor market due to the effects of the demographic crisis in the 1990’s, the labor market will be increasingly tight putting upwards pressure on wages, which will increase consumption.
Due to Russia’s globally by far lowest debt levels across the economy and strong government finances, the ruble should remain stable. Indeed, the ruble seems to have successfully decoupled from the dollar domination as it has shown remarkable strength through the financial upheavals and global tensions of the past few years. This in turn, in addition to the weakening global economy, should keep inflation pressure in check, notwithstanding all the growth-boosting stuff on the domestic front. It is possible that emerging market currencies, and the ruble with them, would come under attack in connection with a potential global financial market hysteria (including a drop in oil price) connected with the coronavirus outbreak. Even so, the fundamentals for the ruble are so strong, that it should recover soon again.
Russia’s expected to grow faster than the West
Potentially, this all could translate into 2-2.5% GDP growth or even 3% at best. But with all the global uncertainties there is no firm basis for making those forecasts. The IMF’s forecasts for 2020 GDP growth are for the global economy 3.3%, the US 2.3%, and the Euro Area 1.3%, among which Germany 1.1%. The forecast for Russia is 1.9%. Considering that Russia will reach 1.4% growth in 2019 against IMF forecast of 1.1%, they are probably underestimating 2020, too.
We are on a firmer ground on predicting that the Russian economy will be in the absolute top of the developed world, and grow 1 to 2% over those of Western Europe.
Russia now has a good chance to reach a trajectory of growing 3% above the Euro Area average. Considering also the very real potential that during the next ten years, EU – or at least the old Western Europe – could actually have negative growth, it is reasonable to expect that in one decade, Russia’s GDP PPP per capita could reach the European average level.
Gloomy outlook for global growth
In 2019, the global economic environment was dominated by the US trade wars against China and other countries, including the sanctions against Russia. Although, a truce of sorts was achieved between USA and China end of year, we should expect more of the same in 2020 and going forward. With a global slowdown and the terminal incapability of the West to generate real growth – other than temporary relief by rigging the financial markets – the role of non-market methods (trade wars, trade tricks, black diplomacy, financial rigging) to prop up the ailing economies will indubitably grow. The other big global danger is a derivative of the market rigging, that is, debt. The big concern is how long the Western economies can go on by no other means than financial engineering and ever-growing debt leverage? It is already clear that no amount of debt seems to be able to produce any meaningful growth while stupendously increasing inequality to the point that the social fabric is disintegrating, the mass protest in France being but one very visible manifestation of that. By now, we cannot be far from the final biggies, hyperinflation and an epic financial crash followed by a meltdown of the real economy.
The most recent blow to the world economy was delivered by the coronavirus originating in China. How bad the actual disease crisis will get, nobody knows, but there are already economic repercussions from it by way of both mandatory and voluntary restrictions to mobility of people and goods. That has the potential on having a big impact on global trade.
Climate change is also a big concern. We do not mean that because the climate would be changing any more than it ever has done in billion years, and not because there would be any evidence of man-made climate change. What we mean is that the policies adapted based on the climate alarm seem to be adding just one more layer of economic inefficiencies, taxes, costs, malinvestments and misguided economic decisions. This is certainly a threat for the Western economies over the near future. Having said this, we must point out that contrary to the spurious climate change ideology, there are real fundamental problems to the ecology (environmental pollution and destruction and loss of organic life), which must and will be countered with the potential of added economic value.
On balance, we consider that Russia’s geopolitical and geoeconomic position has strengthened during the last few years, which remove some of the country risks formerly associated with Russia.
Austerity, no austerity, or some austerity? That’s the question
Most Russians seemed relieved by Putin’s recent government reshuffle as former PM Dmitry Medvedev was not thought to be delivering on the economy any longer. Although Russia ran a stellar macroeconomic balance sheet, the Medvedev government was too cautious and austerity-minded for being able to translate that into solid economic growth and improving living standards for the people. Medvedev is sadly known for having in 2016 told a group of clamoring grandmas complaining about their pensions: “There’s no money, but you just hang in there!” It therefore came as such a relief, when the new PM Mikhail Mishustin first thing said: “There’s enough money for everything the president wants to accomplish.” Mishustin is the former – hugely successful – tax chief, so he knows what he is talking about. Tax collection doubled in real terms under his ten-year tenure while the tax burden on the economy remained low in a global comparison. Russia’s total tax burden at 31.1% remained low especially when compared to OECD countries. A comparably low tax burden also adds to Russia’s strength relative to most developed countries in case of a global downturn, as Russia would be left with more fiscal flexibility.
The vignette “There’s no money” perfectly summarizes what Medvedev’s austerity government represented. If anything, Russia had money running triple surpluses (trade surplus, current account surplus, budget surplus) and with international reserves reaching record highs together with a solidly strengthening sovereign wealth fund. (For details, see this link). There would have been ample room for stimulus – with real money, and into the real economy, instead of US and EU style money printing stimulus squandered on the financial markets – but the Medvedev government locked it all away.
With Russia’s amazingly low debt levels, Russia would also have had ample room to dip into additional borrowings to finance much-needed growth. See this report.
Evidencing how Russia’s debt is the lowest in a global comparison on the level of all economic actors: government, corporate, household.
In addition to the promising policy statements of the new PM Mishustin, the key appointment of Andrey Belousov as the first deputy PM – No. 2 in the cabinet – signals the end of unnecessary austerity. Belousov had a one-year stint in 2012/2013 in the cabinet as the minister of economic development, but was soon ensconced to the presidential administration in the capacity of chief economic advisor. It is said, that Belousov is more statist believing in the government’s crucial role in directing economic processes and a proponent of increased government spending and a greater government role in the economy. We shall hope so. At least that would put paid to the talk of more privatization we heard from the Medvedev government in its last gasp.
In particular, Belousov is seen as a key architect of the large-scale national projects, which Putin has ordered to be implemented. The national projects amount to a half a trillion dollar spending program (2/3 government financed, 1/3 private) reaching until 2024 with the aim of upgrading the country’s infrastructure, modernizing the economy, boosting exports of manufactured goods and improving standards of living, health, and skills of the population and strengthening the demographic development. These investments provide direct stimulus over the years in form of the direct spending, but more importantly, they will boost the Russian economy by the new capacities and capabilities that the investments deliver.
Central bank austerity
Medvedev and his cabinet was not the worst austerity culprit, however, as that title goes to the Russian central bank and its chief Elvira Nabiullina. Ever since the financial crisis in the wake of the Ukrainian cataclysm in 2014, the Russian CB has maintained unnecessarily and punitively high interest rates, which have strangled economic activity. After the initial shock, the Central Bank has been very slow in cutting the steering rate even when domestic inflation slowed to record lows and Western interest rates turned negative.
To wit, the CB has cut rates but very slowly remaining all the time seriously behind the slowing inflation. The primary real interest rate (CB key rate minus inflation) has remained at the level of 4% ever since 2014, even going up to levels of 5% compared to the running inflation in 2015 and 2016. By running inflation, we mean the rate of predictable inflation based on the latest months as opposed to the cumulative past 12-months’ inflation. The CB made the serious error in its interest rate policies to be guided by the past 12-months instead of looking forward. The inflationary peak caused by the onset of the Ukrainian crisis and collapsing oil prices was limited to the period of September 2014 through March 2015, after which inflation was rapidly tamed and showed a going forward rate of 5%. But, guided by the rear-mirror view, the CB kept the interest rates astronomically high. (About this topic, read more here).
Presently, annual inflation stands at 2.5% (both the running rate and cumulative), but the CB’s key rate still towers at a mind-boggling 6.25%. That’s a 3.75% primary real interest, a level you would maintain in an emergency situation, but not in a healthy economic environment that Russia has today. We therefore see room for a rapid cut of at least 2%. Indeed, if the CB does not intend to run counter to President Putin’s insistence to take all efforts to rapidly boost economic growth and people’s living standards, the CB has to give in. (The excessive interest rates are especially taking a toll on Russia’s birth rates, which Putin recently identified as one of Russia’s biggest challenges). For the interest rate cuts to have any effect, they would have to be made upfront, with at least 1.5% within the next half a year.
We stressed above that we speak about a primary real interest rate, because the actual real interest rate for businesses and households is yet much higher. That would be the primary interest rate plus the notoriously high margins that Russian banks charge for their loans.
The Russian central bank has failed in creating anything close to normal borrowing conditions for small and medium sized business, for this to happen the primary real interest must be seriously slashed. With the same measure, household mortgage rates should be brought down from present levels of 9.5% to 6%.
To be fair, the Central Bank is also widely credited for finally reining in Russia’s notorious high inflation. However, the CB should not be given too much credit for that either. In our opinion, the decisive contribution to knocking down the inflation came from supply side mechanisms. At the end of the analysis, inflation is always and everywhere a supply side problem. (Except for in cases of reckless government deficit spending and money printing schemes). Russia’s inflation problem was mainly due to imports of food, machinery and consumer goods and the corresponding dollar (euro) economy, as domestic ruble prices were overly sensitive – and always only on the upside – to imports dominated in dollars and forex market fluctuations coupled with currency speculation. There had been a rapid growth of domestic manufacturing and agriculture from 2000 to the onset of the crisis in 2014, which already seriously helped Russia to wean off from imports (We wrote about this in a seminal report from 2014). The decisive strike against the dollar (euro) then came after Russia in response to Western sanctions in 2014 banned food imports from those countries. As a result of Russia’s actions, domestic food production and manufacturing increased further as well as imports shifting to countries with a lower cost level. By these economic processes – and also active de-dollarization policies by the government – cheaper supplies increased, and more expensive Western brands lost their hold over the Russian purchase manager and consumer, as a result of which domestic prices decoupled from the dollar (euro), and inflation pressures yielded.
With growth stimulating interest rates, the Central Bank would have aided the supply side growth to tame the inflation, instead of exacerbating the situation.
Billionaire tycoon Oleg Deripaska – joining a growing chorus of critics – recently came out with harsh criticism of central bank policies. He questioned the excessive inflation clampdown and called for a growth-oriented and poverty-fighting rate policy. By putting an end to CB’s financial austerity, Russia could reach annual GDP growth at levels of 5% according to Deripaska.
The rates will go down, but will it be enough and fast enough, that remains to be seen. Let’s hope the Central Bank will keep its cool and not let a potential turmoil on the global markets deflect it from interest rate cuts. No significant increase in inflation pressure would follow even if the ruble would depreciate in connection with a potential global market turmoil.