The always brilliant Edward Hugh of Russia Economy Watch reports:
According to the latest report from the World Bank collapsing industrial production, rising unemployment and ongoing capital flight will reduce Russia’s gross domestic product by 7.5 percent this year and restrain “intraregional trade flows and transfers,”. The Bank also highlighted that “Remittances to the broader CIS region are expected to decline for the first time in a decade, by 25 percent”.
Neil Shearing of Capital Economics forecasts a contraction of 10% this year, zero growth in 2010 and fears that Russia may be facing a kind of “lost decade”, since it may well not recover the 2008 level of output till 2014, and there are still clear downside risks attaced even to this estimate.
Shearing identifies three main factors which may contribute to the lost decade. First and foremost, he notes, the banking sector remains under enormous strain. While official estimates put bad debt at around 12% of total loans this year, Shearing thinks the true figure is likely to hit something closer to 20%. On this basis, he estimates that the banking sector could require up to $60bn in additional capital – far more than the $30bn that has so far been allocated by the government.
Second, by using so much ammunition this year, authorities leave little scope for further policy stimulus. Monetary policy is somewhat hamstrung as we have seen earlier, and fiscal policy will have to be tightened over the coming years in order to rein in a ballooning budget deficit. Indeed, Laura Solanko of the Finnish Central Bank’s Transition Economies Centre calls this “the largest fiscal stimulus ever” in the Russian context.
As Solanko points out, the current crisis has hit oil and gas exports particularly hard, leading to a 47% decline in export duties and a 53% decline in proceeds from taxes on natural resource extraction during the first four months of 2009. The drop in general economic activity has further reduced proceeds from all revenue sources. General government revenues in January–April were 20% lower than a year earlier. If current trends continue, Solanko estimates that general government revenues may drop to close to 35% of GDP this year – down from around 50% in 2008.
Meanwhile, government expenditure has increased dramatically at all levels. In January–April this year, enlarged government expenditure increased by 23% to RUB 4,140 billion. The expenditure at the core of the Russian fiscal system, the federal budget, increased by an astonishing 37% compared with the same period a year earlier. Even taking the fairly high inflation into account, this equals a 20% increase in federal expenditure in real terms. Relative to GDP, general government expenditure has risen to 37% and federal expenditure to 23% of GDP, against 28% and 16%, respectively, a year earlier.
To sum up, public sector expenditure has nominally increased by 23%, and relative to GDP by a whopping 9 percentage points compared with the first four months of 2008. The sheer magnitude of such a fiscal stimulus is huge. During the 1990s, Russia’s public sector shrank dramatically, its GDP share decreasing by 12 percen-tage points to 26% of GDP in 1999. The current fiscal stimulus has shot public expenditure back to the level of the early 1990s.
As the automatic stabilisers in the Russian fiscal system are small, the expenditure increase largely reflects expenditure on anti-crisis measures and advance transfers to the regions by the federal government. The government’s anti-crisis measures announced by mid-March 2008 alone would increase federal expenditure by some RUB 2,000 billion, or 15%, in 2009. Roughly half of that is directed to strengthening the financial system, and the other half to supporting the real sector.
The current federal budget foresees a deficit of 7% of GDP, a figure only slightly larger than last year’s surplus – and only slightly smaller than the total assets of the Reserve Fund. This im-plies that most of the Reserve Fund will be exhausted by year end and the Russian government will have to reenter the domestic and external bond markets in 2010 at the latest.
And we should never forget that Russia remains in the grip of a pretty vicious credit squeeze. Bank lending to companies fell 1.5 percent in May compared with April, while retail loans dropped 1.9 percent. Overdue bank loans reached 4.6 percent of the total in May, versus 4.2 percent a month earlier. And while many Russian corporates may be restructuring their debt, the only deepening their longer term exposure to currency correction risk. As in the case of Moscow-based steelmaker OAO Mechel, who, according to Bloomberg, just agreed to refinance $2.6 billion of loans in the biggest foreign-debt restructuring by a Russian company since the credit crisis began. Such refinancing is not coming cheap – the rate was 6 percentage points over the London interbank offered rate – but even more to the point this type of restructuring may only to a certain extent postpone the inevitable, since the new debt now becomes due in December 2012. This is fine if everything is all hunky-dory come 2012, but if it isn’t…..
As the OECD put it in their latest report on Russia
“The main threat to credit growth now appears to be solvency problems, arising from the declining capacity of borrowers to repay bank loans,” the bank said in an economic report released today. “The challenge is to maintain capital adequacy and prevent a sharp curtailing of lending flows.”
Lastly, Neil Shearing points out there remains little external support for the economy. With the global recovery likely to disappoint, export demand will remain weak. Oil could fall to $50pb by early-2010. As ING say:
“Oil price dynamics pose additional risks to RUB. Last week, oil prices plunged below the technically important EMA-200 level of US$63/bbl, indicating a potential further drop to US$47-54/bbl. If this happens, the RUB looks destined to weaken as well, given its greatly strengthened correlation with oil prices over the past two quarters”.
And if oil does drop back to this range, and the ruble does weaken, and non performing loans rise above the 20% mark (pushed by that very same ruble weakening, and the rising unemployment), and the Russian Federal Government has to start issuing bonds in 2010, well watch out, is all I can say, since trouble will surely be in store. This is very much knife edge touch and go stuff from here on in. Grit your teeth everyone.