Protracted recovery in Russia

Despite a rather difficult business environment, Russia remains a growth market, and as such provides good opportunities for exporters.
Analisis Credito y Caución
Madrid - 17-out-2011

After years of fast and well spread GDP growth, based wholly on spending high oil and gas revenues and an externally funded consumer boom, the Russian economy was severely hit in 2009 by sharply falling oil prices and the global credit crisis, which constrained banks and corporates access to external financing. At the same time, domestic credit conditions tightened and exports decreased. Household consumption, investments, industrial output and construction activities all slowed significantly, with GDP declining by 7.2% in 2009.

In the years before the economic crisis, Russias corporate sector and its huge oil and gas producers had rapidly accumulated foreign debt. It had done so by borrowing from western banks and capital markets to raise capital, bond issues and bank credits, often borrowing heavily against their shares.  But then the situation changed. Foreign banks stopped lending, investors withdrew, and stock prices fell. Illiquidity, falling asset prices and slowing domestic demand caused cash flow problems in all sectors, especially for smaller companies and banks. Smaller banks, of which there are more than 1000 in Russia, were particularly hard hit.

The recovery began in Q4 of 2009, based on inventory restocking, retail sales and increased oil output. In 2010 the global rebound triggered higher energy prices on the world market, and the Russian economy recovered at a real growth rate of 4.0%. However, according to the Russian Statistics Office, economic growth slowed down to 3.4% year-on-year in Q2 of 2011 after 4.1% in the first quarter, as the growth in industrial production cooled down to 4.8% [5.9% in Q1]. Economic growth is currently expected to exceed 4% in 2011 and 2012 but, given the severe contraction during the crisis, this means that the recovery will be protracted.

Monetary policy shift to combat inflation

After its low point in mid 2010, inflation has increased, reaching 9% in July 2011: well above the central banks target rate of 6-7%. Inflation is fuelled by governmental measures to stimulate domestic consumption and government-sponsored wage increases have led to rising imports of foreign durable and non-durable consumer goods.

After pumping additional liquidity into the economy to combat problems in the private sector [to encourage bank loans for consumers and businesses and thus revive investments] since the beginning of 2011 the central bank has again shifted its priority on monetary policy that of curbing inflation: the refinancing rate has risen twice - in February and April - and now stands at 8.25%.

After almost a decade of budget surpluses resulting in public debt falling to 7% of GDP and accumulated Reserve and Welfare Funds [US$ 184 billion = 15% of GDP], the fiscal position has strongly weakened since 2009 due to decreased revenues and a additional expenditures to support ailing banks and corporates during the crisis. The government has spent a total of US$ 250 billion on various rescue measures, with almost US$ 100 billion of this dedicated to help ailing banks and major companies. This resulted in sizeable fiscal deficits in 2009 [5.8% of GDP] and 2010 [4.0% of GDP].

As the authorities did not seize the opportunity during the windfall years to strengthen Russias economic structure and enhance its non-oil potential, the 2009 downturn has exposed structural weaknesses that werent apparent during economic good times. Today the country is more dependent on its energy resources [i.e. high oil and gas prices] than ever: oil and gas contributing to 30% of GDP, 50% of the budget and 75% of exports. But output of oil and gas is stagnating due to high levies and capacity constraints, and oil exports have hardly increased after years of under-investment in new production capacities and pipelines. Growing state intervention leading to an unfriendly business environment - has deterred foreign investors, hampering vital investment in new exploitation and exploration.

Low productivity and high corruption

In both the energy and the manufacturing sectors, productivity is still far below that of other industrialised countries. Russias domestic economy is strongly monopolised, with market-oriented and competitive small and medium-sized businesses contributing only about 15% of GDP. Instead, state-controlled giants or private companies loyal to the state dominate the economy.

The executive and judiciary system lacks transparency, often leading to apparently arbitrary decisions. Widespread corruption, criminal practices and nepotism have raised concerns about the business environment and property rights. Russia ranked 154th out of 178 in the 2010 Transparency International Corruption index. All this has contributed significantly to weakening investment, while necessary reforms have been constantly delayed.

A lack of reform effort and market orientation is hindering the emergence of a strong, competitive private sector except for the main oil and gas producers. Politics is strongly intertwined with business interests, causing widespread nepotism and corruption. Since the Yukos affair in 2003, state control over strategic sectors [energy, cars, metals, aerospace, defence] has grown considerably - even more so during the economic crisis.  The Kremlin has gained an absolute grip on the energy sector, now consisting of state-run companies or state-loyal corporations. The Russian authorities have even forced some foreign investors to sell their stakes in oil/gas fields, leading to a further concentration of economic power.

Russia remains vulnerable to external shocks

Economic growth is currently expected to exceed 4% in 2011 and 2012, fuelled by higher commodity prices, government expenditures, credit growth acceleration and increased domestic consumption. Consumption confidence is higher and retail sales have crept up since their slump in January 2011. However, the rebound remains fragile, as a slowing in the global recovery would curb demand for Russian commodities.

The government has finally taken measures to reduce the fiscal deficit, which will decrease to 3.3% of GDP in 2011 and 3% in 2012. Inflation is expected to remain high in 2011 [9.1%].  However, the central bank has left the refinancing rate unchanged for the time being because of the danger of an economic slowdown due to the worsening debt crisis in Europe and growing uncertainty over the US economy. In the short term, real interest rates [nominal interest rates minus inflation] will continue to be negative.

In the forthcoming years Russia will continue to be a mono-culture largely dependent on the output and the export of oil and gas [75% of all exports]. The performance of the economy is ultimately linked to the vagaries of the global markets for energy, and the economy is lacking a dynamic export sector of the other BRIC nations. The IMF concludes that without structural reforms to improve the business environment and investment climate growth will slip below 4% in the medium-term. Investments are still too low, especially for the modernisation and diversification of industries. Fixed asset investments increased only 2.2% in the January-May 2011 period. This will not change until comprehensive reforms will make the economy more attractive for investments.

Banks remain vulnerable, despite diminishing tensions over liquidity [lower interbank tariffs, lower capital outflows] and massive fiscal programmes to support the ailing financial industry and the debt-loaded corporate sector. The recession has triggered a steep rise in the number of non-performing loans [more than 20% in 2009/10]. In the short term the financial sector will remain weak and will need time to deleverage and recapitalise. Therefore the banking sector is in urgent need of reform and this fragile structure will continue to limit business opportunities in Russia. Russias external position is in good shape, with solid liquidity and solvency ratios. While Russia is overly dependent on oil and gas exports, oil prices are expected to remain quite stable in the immediate future.

Russias growth market provides business opportunities for exporters

Despite a rather difficult business environment, Russia remains a growth market, and as such provides good opportunities for exporters. Demand for foreign products is high, e.g. British exports to Russia increased 51% year-on-year in 2010, while imports from Germany increased 27.8% in the same period and 42.6% in Q1 of 2011. However, suppliers need to be mindful of the risks of doing business in Russia. For example, without assistance, a foreign supplier will find it almost impossible to get a true picture of its Russian business partner, not least because of the size of this market. Therefore we advise companies to agree securities with their Russian customers, ideally with an additional protection through trade credit insurance.

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