Crisis? What Crisis?: Russia`s Economy at the end of Q3 Reviewed by Momizat on . [caption id="attachment_5426" align="alignnone" width="615"] The third quarter "net errors and omissions" are almost twice the USD 3.7 bln in foreign direct inv [caption id="attachment_5426" align="alignnone" width="615"] The third quarter "net errors and omissions" are almost twice the USD 3.7 bln in foreign direct inv Rating: 0

Crisis? What Crisis?: Russia`s Economy at the end of Q3

The third quarter "net errors and omissions" are almost twice the USD 3.7 bln in foreign direct investment to Russia in the last five quarters.

The third quarter “net errors and omissions” are almost twice the USD 3.7 bln in foreign direct investment to Russia in the last five quarters.

Students of British history will not soon forget the glib remark by Prime Minister Jim (a.k.a. “Sunny Jim”) Callaghan, following a 1979 return from the Caribbean to a nation beset by winter strikes, increased inflation and a faltering economy.

“Crisis? What Crisis?,” said Callaghan. And voters soon gave him the boot.

Now in the face of rising food prices, economic challenges and sanctions, it appears that Russian President Vladimir Putin may be mirroring Callaghan’s mistake…

Fast forward to  October 13, 2015. Vladimir (“Sunny Vlad”) Putin is attending the seventh annual VTB Capital “Russia Calling!” Investment Forum in Moscow and announcing that the Russian economy was at last “stabilising.”

Putin pointed to a capital inflow of USD 5.3 bln registered in the third quarter — Russia’s first quarterly inflow for five years — as proof of the economy’s strength and that the country`s problems were a sign of the past.

This was surely a very slender reed to hold onto and it is therefore worth examining before we allow other facts to intrude on the president`s concept of economic reality.

First, as has been previously highlighted in another article, Russia has experienced net capital outflows since 2010 of more than USD 400 bln, according to the Russian Central Bank. Russia has suffered a total net capital outflow of about USD 550 bln since Putin gained power in 1999,  with net outflows every year except in 2006 and 2007. Independent research suggests that government figures underestimate the magnitude of the problem, and assert that the actual total may be higher than USD 1 tln.

The president was formally correct in stating that some money was entering the country, albeit somewhat misleading about its magnitude as well as its underlying nature, given that most of the third quarter inflow of USD 7.1 bln was marked by the central bank as “net errors and omissions.” This points to illicit flows – largely arising from the manipulation of customs declarations by Russian corporates — that the Russian authorities cannot locate or tax.

In essence, the amount was a balancing figure to reconcile currency inflows and outflows. The third quarter “net errors and omissions” are almost twice the USD 3.7 bln in foreign direct investment to Russia in the last five quarters.

The inflow is also a signal of “hard times” given the absence of substantial direct foreign investment as well as medium to long-term lending which the country`s corporate and municipal sectors were reliant on foreign banks to provide. Given sanctions, western financial banks have been reluctant to engage in anything other than 90-day lending. In other words, lending is extremely short-term and to no more than a handful of well known, long established Russian companies, who are “good for their money” i.e. Gazprom.

To this, we can add the poor general condition of the Russian economy at large. Indeed, contrary to the president`s warm words was the reality as the country’s economic contraction accelerated from 2.2 percent year-on-year in the first quarter to 4.6 percent in the second, according to official data.

The news is almost uniformly bad:

  • The country`s principal source of revenues – oil – saw its price drop by one-quarter between July and September. As a result, Russian oil companies have reduced their investment programmes  – a major contributor itself to the country`s fixed investment –  by 30 percent.
  • The manufacturing sector saw its annual decline leap to 4 percent.
  • Exports of goods and services – much touted by the Russian government as likely to massively benefit from the sharp ruble depreciation – have fallen by 40 percent from August to August.
  • Construction and retail sectors saw their output decline by 9 to 10 percent in the period.

The scale of the problems has fed into revised estimates of by how much the Russian economy will fall this year. Standard & Poors, the credit agency, recently revised its GDP fall from a 2.6 percent decrease to 3.6 percent in 2015 and its estimated increase of GDP of 1.9 percent in 2016 to a far more modest 0.3 percent. The Russian Central Bank has revised its estimates of the Russian economy declining in 2015 by 3.9 to 4.4 percent, as well as a further contraction in 2016.

Overall, the above remains difficult to square with Putin`s assertion at the conference that “opportunities are opening up in other sectors: for engineering, agriculture, processing and so on.”

With private demand in the doldrums, economic thinking would dictate that the state must pick up the slack. But that is becoming increasingly difficult to achieve given government finances are also coming under strain from a combination of falling budget revenues: oil accounts for 40 percent of state revenues, as well as for the burgeoning cost of military and security expenditures with a new conflict in Syria to now finance.

The two things that ultimately did for “Sunny Jim” Callaghan would be unemployment and inflation. I have previously commented that unemployment in Russia has not really shifted significantly earlier in the year due to a number of factors – one of which is that firms have been reluctant to reduce payrolls due to government pressure. This has led to an adjustment falling on the workforce as a whole with paycuts, some approaching 30 to 40 percent, and dropping of bonuses. This may be about to change with the numbers of unemployed set to increase quite sharply in coming months.

Inflation may have peaked but still remains at significantly elevated levels and high food prices are directly impacting the public, particularly the poorest in society. To give just one example: some 90 percent of fruit consumed in Russia is imported. Sanctions imposed by the Russian government on EU imports and the fall of the ruble has led to fruit prices soaring by 17.4 percent over September last year. Inflation has therefore cut into people`s real living standards.

Therefore, both unemployment and inflation have had a significantly adverse economic impact on people`s consumption in today`s Russia. That is the economic cost. With parliamentary elections next year, there may yet be a political cost to be borne.

Photo courtesy of Aivazovsky (Wikimedia Commons).

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