Higher growth expected in Russia in 2014

The re-election of the Russian president has prolonged political stability but also led to increased repression. The presidential election and the December 2011 parliamentary elections were fraught with irregularities, although arguably these did not materially affect the outcome. This has however triggered a protest movement, albeit relatively small in number and limited to the main cities. Nevertheless, the movement is not tolerated by the administration, which has rushed a number of laws through parliament to oppress it, including a stricter treason law and the obstruction of foreign funded NGOs. Despite these measures, spontaneous protest and demonstration have not completely disappeared, although they are still relatively small in number. And while, according to opinion polls, presidents popularity has decreased, it still remains relatively high and there is no imminent challenge to his rule as opposition parties still struggle to gain wider support.

Despite efforts by the USs President improve ties with Russia relations have deteriorated in the last two years over certain issues, including human rights, US missile defence plans, Irans nuclear programme, the civil war in Syria and recently the Snowden affair. US-Russian relations reached a low point when, in August, the USs President cancelled a summit with the Russian President. However, despite the strain, there is no immediate danger of a further deterioration in the relationship as both sides share some important common interests in international politics that will guarantee further cooperation: e.g. containment of Islamic terrorism and the prevention of nuclear proliferation.

Economic growth will pick up again

In the first half of 2013 Russian economic growth was modest: 1.7% year-on-year compared to 3.4% in the same period last year. There are a number of reasons. Sluggish demand for oil and gas, particularly from the Eurozone, meant that exports were down by more than 2% year-on-year, and this was coupled by a lower oil price. At the same time, rising labour costs have damaged both the competitiveness of Russian industry and the Real Effective Exchange Rate, which measures a countrys international competitiveness as costs and prices change.

Fixed investment decreased 1.4% in the first half of 2013 as company profits declined 27% because of the lower exports and higher labour costs. Private consumption was also weaker than in 2012. And, while retail sales continued to grow above 3% in the first half of the year, this did not match 2012s 6.8% rise.

However, growth is expected to pick up in the second half of 2013, thanks to an improvement in exports, expectations of a good harvest and the beneficial effect of lower inflation on consumer purchasing power. After growing 2.6% this year, Russian GDP is forecast to increase 3.5% in 2014.

Inflation to decrease in the coming months

Consumer price inflation increased 6.5% in August: down from a peak of 7.4% in May. In the first half of 2013 inflation was pushed up, to some extent by the weaker rouble but more prominently by wage increases of 13% [compared to 14.6% in the first half of 2012]. This years inflation of 6.6% is expected to fall to 5.4% in 2014 and, as this decrease is already underway and approaching the Central Bank of Russias inflation target rate of 5-6%, there is speculation about an interest rate cut from the current benchmark interest rate of 8.3%. However, the impact of an interest rate cut remains to be seen, as real interest rates are already low.

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 fell 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.

The financial sector has recovered since then, with the banks achieving improved capital adequacy ratios. The non-performing loans ratio decreased from 10% in 2010 to 7% in 2012, and profitability has risen significantly. Nevertheless, it is too early to ascribe the qualification `robust´ to Russias financial sector: a recent stress test conducted by the central bank suggests that, in the event of an external shock comparable to the one of 2009, 50% of the banks would fall below the capital-adequacy requirements.

Bank credit growth continues to be abundant, with a 35% increase in lending to households and 27% to the corporate sector from May 2012 to May 2013. However, since January this year, the central bank has been holding back credit to curb this excessive growth - and thus inflation - with a policy of providing minimal liquidity.

Fiscal balance turning into a small deficit

The fiscal position has recovered since 2010, after its sharp weakening in 2009 due to decreased revenue and the additional expenditure needed to support ailing banks and business during 2008 and 2009. After two years of budget surpluses, it  will turn into a small deficit of 0.2% in 2013. However, as oil and gas revenues constitute around 50% of the budget, the  so called `non-oil deficit´ is large: standing at 10.6% of GDP in 2012. Therefore Russia has adopted a three year budgetary framework to achieve a balanced budget in 2015, including fiscal tightening.

According to new budget rules introduced last year, government expenditure will be linked to the average oil price: a practise that was abandoned after the 2008 crisis. Accordingly, the government should not spend more than 1% of GDP, calculated using an oil price of US$ 91/barrel Brent [running up to US$ 96/barrel Brent in 2016]. If the threshold oil price is exceeded, the surpluses are to be used to boost the National Reserve Fund [NRF] and National Wealth Fund [NWF]. The assets in the NRF should not be used for government spending unless they reach 7% of GDP [they currently constitute 4.2% of GDP]. The government recently announced that, out of the NWF, US$ 14 billion will be spent on infrastructure investment designed to spur economic growth.

Deep structural problems persist

Russia relies heavily on oil and gas production, with oil and gas representing 77% 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 [e.g. by prudently investing higher oil revenues in order to diversify the economy away from the dominant oil and gas sector], the 2009 downturn 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 exploration and exploitation.

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 has so far hindered the emergence of a strong, competitive private sector except for the main oil and gas producers. Moreover, the executive and judiciary system lacks transparency, often leading to apparently arbitrary decisions, and Russia´s bureaucracy is notoriously cumbersome.

Reform efforts remain subdued

Only bold reform measures in all those areas would lead to sustained long-term economic growth. Yearly growth rates above 3%-4% cannot be expected while an increase in oil production is hampered by oil firms struggling with depleted oil fields and more difficult extraction, while investment remains relatively low, reflecting the dismal Russian business climate.

Although the administration seems to recognise the urgent need for reforms, it also has to cope with the vested interest of close allies and supporters. The government has voiced its opposition to corruption, but any sweeping plan of action has yet to materialise. The current privatisation programme does not look ambitious enough, given that the Russian state controls 50% of the economy. Progress with reforms will therefore be limited as long as the oil price remains high.

Benefits of WTO entry in the longer term

Russia became a member of the World Trade Organisation [WTO] in August 2012. In the longer term we expect that this will contribute to the modernising of the economy, with Russian firms gaining access to the world market and foreign competition on the domestic market increasing forcing Russian businesses to become more efficient and innovative and to diversify. The average agricultural tariff has decreased from 13.2% to 10.8% and that of manufactured goods from 9.5% to 7.3%. However, more sensitive reductions, on cars, aircraft and pork - will not take effect until 2019/20.

The current account surplus is decreasing

In 2012 the current account surplus amounted to US$ 23.6 billion, or 3.5% of GDP, but is expected to slip to 2.9% of GDP this year and 1.6% of GDP in 2014, as robust domestic demand spurs continued growth in imports. Russian banks have borrowed heavily abroad, but this is only partly offsetting the continuation of the large net outflows in the non-financial sectors, which totalled US$ 80 billion last year. This is unlikely to change unless the Russian investment climate improves markedly.

Still a difficult business environment but improvements are underway

Because of Russias robust economic performance Crédito y Caución expects continued growing demand for many imported products and services: ranging from food/agriculture to chemicals/pharmaceuticals, metals, machinery, consumer electronics and IT.

However, Russia is still a young market economy and the major weaknesses in the legal system lead to arbitrary court decisions that limit the abilities of foreign investors and exporters to defend their rights and their contracts. Moreover, harsh import restrictions and bans, tax and customs administration, and price regulations are hampering the business environment.

At a corporate level, there is little transparency of groups and their ownership/shareholder structure, with legal entities often based outside Russia. Accurately assessing the creditworthiness and financial strength of Russian buyers can be problematic because obtaining reliable financial data remains an issue. The official accounts are simply tax accounts, which do not show the consolidated results, and usually tend to show minimal net profit and fixed assets. It is not uncommon for multiple financial statements to be prepared for different parties, each showing substantially differing figures.

This all adds to our challenge as a credit insurer to obtain a true picture of the real financial strength of Russian companies. Crédito y Caución meets that challenge through extensive meetings with Russian buyers, analysis of different types of accounts [tax accounts, consolidated management statements] and our in-depth understanding of Russian trade sectors. Indeed, our presence `on the ground´ and regular contact with buyers play an essential part in our analysis of risks and opportunities in key industries.

While Russian companies generally trail behind their western counterparts, with their opaque and complex corporate structures, we are seeing an increasing familiarity with trade credit insurance, and an acknowledgement of the need to improve their corporate governance and disclose the information we require.

Notably, while the use of trade credit has increased over recent years, as a percentage of the volume of trade credit transactions in Russias domestic market we have seen a reduction in overdue credit payments.

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