Continued GDP growth of around 4% in Russia

The Russian economy is expected to grow at 3.5%, -4% in 2012 and 2013 with limited improvements expected in the areas of structural reform and the investment climate.
Analisis Credito y Caución
Madrid - 29-out-2012

The Russian economy has fully recovered from the 2009 recession and has grown steadily at a rate of around 4% a year on the back of a boom in consumption brought about by higher oil prices. GDP grew 4.0% year-on-year in Q2 of 2012, after 4.9% in Q1, as commodities exports decreased due to lower demand from China and Europe. Domestic demand is currently boosting growth, with a year-on-year increase in retail sales of 8% in May and 7.2% in June. Unemployment is low: standing at 5.4% in July this year. Russia is running a significant trade surplus of US$ 110 billion for the first half of 2012 compared to US$ 99 billion in 2011.

After lower inflation in Q1 of 2012, consumer prices have risen in the last couple of months and, with recent drought conditions leading to higher food prices, inflation reached 5.9% in August. For the coming months, an average of 6% is expected, as inflationary pressures increase again. Therefore the central bank raised all of its policy rates in early September 2012: the refinancing rate was raised from 8% to 8.25%, the first increase since April 2011.

The financial sector has recovered, but is still far from robust

The banking sector was in deep trouble during the 2008/2009 crisis, with liquidity coming under severe pressure as the oil price and the rouble deteriorated sharply. The recession triggered a steep rise in the number of non-performing loans [more than 20% in 2009/10] and massive central bank and government support was pivotal in avoiding a collapse of the system.

However, since then the situation has improved, with more benign oil prices and reduced foreign currency exposure. The central bank has introduced an emergency liquidity support framework and the deposit base has consistently improved. Repercussions from the current Eurozone crisis have, thus far, been weathered without any problems. The non-performing loans [NPL] ratio has decreased from 10% in 2010 to 7% and profitability has risen significantly.

Nevertheless, it is too early to ascribe the qualification robust to Russias financial sector: the 7% NPL ratio is still relatively high compared to other BRIC nations. Moreover, bank credit has grown rapidly [25% in 2011], bringing into question whether the current provisioning would be adequate in the event of an economic downturn - at least for a number of banks. Capital adequacy ratios are declining as credit grows, although they remain at quite comfort-able levels.

Rebound of the fiscal balance

The fiscal position has recovered since 2010, after its severe weakening in 2009 due to decreased revenue and the additional expenditure needed to support ailing banks and business during 2008 and 2009. In 2011 there was a budget surplus of 1.3% of GDP, while for the first half of 2012 a US$ 30 billion surplus was reported. This is the result mainly of higher oil and gas revenues, which constitute around 50% of the budget. However, excluding oil and gas revenues, the so-called non-oil deficit is large: standing at 11.3% of GDP in 2012.

According to new budget rules launched this summer, future government expenditure will be linked to the average oil price: a practise that was abandoned after the 2008 crisis. The aim is to reduce the non-oil budget deficit to 5% of GDP by 2015. This means that, if the threshold oil price is exceeded, the surplus can be used to boost the Reserve Fund and National Wealth Fund. Although a step in the right direction, these fiscal measures may prove insufficient to create strong resilience to oil price volatility.

The Russian Central Bank has also taken measures to better shield the economy against external shocks, by allowing the exchange rate to fluctuate within a band of 8% above or below the central rate. Again, this is a step in the right direction, but could still prove insufficient in achieving strong protection.

Deep structural problems persist

Russia relies heavily on oil and gas production, with oil and gas exports representing 70% of its total exports. 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 good economic times. Today the country is more dependent on its energy resources [i.e. high oil and gas prices] than ever, but state intervention leading to an unfriendly business environment - has deterred foreign investors, hampering vital investment in new exploitation and exploration.

In both the energy and the manufacturing sectors, productivity is still far below that of other industrialised countries. Russias domestic economy is heavily 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. 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.

 The executive and judiciary system lacks transparency, often leading to arbitrary decisions. Widespread corruption, criminal practices and nepotism have raised concerns about the business environment and property rights. Russia ranked 143rd out of 178 in the 2011 Transparency International Corruption index. These factors have all contributed significantly to weakening investment, while necessary reforms have been constantly delayed.

So far, reform efforts remain `lip service´

Russian politics are strongly intertwined with business interests, leading to the widespread nepotism and corruption mentioned above. Since the controversial 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. There is widespread scepticism about the governments willingness to reform the economy away from its energy dependency and improve the investment climate.

A solid liquidity and solvency position

With lower inflation and the currency depreciation in the first half of 2012, the real effective exchange rate has also depreciated, improving Russias competitive position. While this will help boost exports of non-oil products, oil revenues will continue to dominate exports and the overall balance of trade. In the first half of 2012 the current account surplus increased to US$ 58.4 billion, compared to US$ 52.7 billion in the first half of 2011.

However, this large current account surplus also reflects the ongoing lack of investor confidence: capital outflow is high and in 2011 peaked at US$ 80 billion, after US$ 38 billion in 2010, as a result of political uncertainty. This situation is unlikely to change unless the Russian investment climate improves markedly.

Meanwhile the Russian solvency and liquidity position remains robust, with external debt at 24% of GDP and enough foreign exchange reserves to cover imports for more 18 months.

Short-term outlook

The Russian economy is expected to grow at 3.5%-4% in 2012 and 2013 with limited improvements expected in the areas of structural reform and the investment climate, and with oil prices remaining rather high at US$110 a barrel [Brent]. However, economic performance is ultimately linked to the vagaries of the global markets for energy, and the economy is lacking a dynamic export sector like that of the other BRIC nations. Without structural reforms to improve the business environment and investment climate, annual growth rates will probably stagnate in the medium term.

Russia became a member of the World Trade Organisation [WTO] in August this year. In the mid and long term we expect that this will contribute to a modernisation of the economy, as Russian firms gain access to the world market, while foreign competition on the domestic market will increase - requiring more efficiency, innovation and diversification efforts from Russian businesses and an overall improvement to the business environment.

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