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Regular version of the site

Ghost of Recession

Why it is haunting Russia's economy

"The Canterville Ghost", Valentina and Zinaida Brumberg. 1970

This year, a slowdown is expected in the Russian economy. According to some forecasts, the country will enter recession in 2021 or possibly even earlier. However, according to the HSE Centre for Business Tendencies Studies (CBTS), there are no noticeable signs of recession at the moment. Instead, by the end of this year, Russia's GDP may have increased by up to 1.4% compared to 2018. While not bad, this is far from the world's leading performance. This article looks at what keeps Russia's economy from picking up pace and why slowdowns are a possibility, according to the HSE CBTS.

From Depression to Optimism

The CBTS uses data from periodic surveys of businesses and from analyses of the current macroeconomic situation. In particular, they use the Economic Sentiment Indicator (HSE ESI) as a composite index based on the following types of Rosstat's monitoring data:

 business activity in the real economy and services (surveys of more than 20,000 heads of businesses in the production industry, construction, services, and commerce);

 consumer expectations (surveys of 5,000 Russians aged 18 and older).

The ESI has a mean value of 100 and can range between 90 and 100 when the economic sentiment of industries and consumers is normal.  An index substantially higher than 100 suggests optimistic and favourable sentiments, and one which is substantially lower than 100 indicates pessimistic sentiments and expectations of a looming crisis.

The CBTS has monitored ESI on a quarterly basis since 2012. The peak of optimism was registered in 2012 and the lowest trough occurred in late 2015 and early 2016. The most recent second-quarter 2019 ESI stands at 97.5.

According to HSE experts, while this ESI value means a certain decline in business confidence, it cannot be interpreted as the economy slipping into a 'negative zone' since key indicators of company performance such as production, demand and the financial bottom line do not confirm a downward trend.

Georgy Ostapkovich, Director, HSE CBTS:

There are no signs of the economy slipping into recession; a real recession similar to that of 2015 – early 2016 is not a possibility in the coming period.

By the end of 2019, GDP growth can be expected to range from 1.2% to 1.4%, but it would take considerable effort to surpass the relatively high growth rates observed in the second half of 2018 – it is be a challenge but still doable. But even these growth rates will be less than half the global average.

Over the past five years, the average annual growth rate of Russia's GDP just slightly exceeded 1%, while the global average stood at 3.3% – 3.5% during the same period. Thus, Russia's share in the global production of goods and services continues to decline, bringing the country's ranking by nominal GDP (USD) down to the middle of the second dozen.

In relation to the global GDP, Russia's economy has stagnated in the five recent years. Indeed, protracted stagnation, according to classical economic theory, can cause even more damage than a short-term recession.

Drivers for Industry

It is unlikely that any developments capable of accelerating the country's GDP to the global average will occur before 2022, when the twelve National Projects – government-financed programmes scheduled to continue until 2024 – are expected to bring tangible returns.

Based on the first six months results of 2019, all major industries show positive but slow growth, ranging from 100.1% in construction to 102.6% in the production sector. The production sector contributes the largest share of value added to the GDP (about 30%), making this sector the main driver of the country's economy.

Georgy Ostapkovich, Director, HSE CBTS:

Extractive industries, defence sector companies with secure state funding and major industry leaders which are directly or indirectly affiliated with the government and thus enjoying preferential treatment in accessing contracts, funds and subsidised loans, drive industrial growth.

Services Taking a Dive

An exception from the general trend, paid services have recently been on a downward turn: nearly one-quarter of service sector companies have reported a decline in the number of customers. Real estate brokers are experiencing the highest rates of decline, while insurance, hospitality and dental services have declined at lower rates than the rest of the sector.

Georgy Ostapkovich, Director, HSE CBTS:

This is fairly easy to explain. As disposable incomes decrease, the first thing consumers will do is to cut down on luxuries and non-essential expenses such as vacations, tourism, spa treatment, home refurbishment and insurance, causing the total volume of paid services to decline; should household incomes continue to shrink, the downward trend will spill over into retail.

Pressure from "Bubble"

At the moment, the situation in retail is both quiet and contradictory. On one hand, declining incomes and high inflation have slowed down consumer demand, but on the other hand, demand is still being driven by growth in consumer lending.

While a boost in lending is good for consumer demand, it can carry risks for the economy if taken to excess and, according to the Russian Ministry of Economic Development, could lead to a recession in a couple of years.

Georgy Ostapkovich, Director, HSE CBTS:

Consumer loans have two serious drawbacks. First, excessive consumer lending diverts resources from investment lending to the real sector of economy. Second, consumer loans eventually come to maturity and need to be repaid; whether borrowers will be able to repay them is often a big question with unpredictable social consequences.

Currently, the situation is not critical yet. The proportions of issued and overdue (by more than 90 days) loans are within reasonable limits, comparable or even lower than those in Europe and particularly in the U.S. However, the emergence of a financial bubble cannot be ruled out, therefore the Ministry's concerns may be somewhat premature, but not unfounded.

Banks Not Biggest Culprit

In terms of a potential recession, however, excessive consumer lending is not the key contributing factor. External shocks can have a greater impact, such as negative shifts in global prices of Russia's main exports, a new global financial and economic crisis (since global economic development runs in cycles), and further worsening of the geopolitical situation.

But CBTS researchers find such developments unlikely and have not considered a negative scenario based on these factors. Instead, they recommend paying closer attention to domestic signals, and the banks are not their biggest concern. On the contrary, the country's banking system is believed to operate 'at a large margin of safety, being capable, if necessary to meet the need not only for consumer loans but also for business loans'.

Georgy Ostapkovich, Director, HSE CBTS:

Apparently, the problem is not that consumer lending diverts a certain amount of funds from investment lending, but that entrepreneurs, especially those in private business, are wary of financial risks due to the high uncertainty in the economy and an unfavourable business climate in the country. But this is not the Central Bank's problem.

Dangerous Uncertainty

For businesses, uncertainty means, in particular, a lack of predictable rules of the game and fear of unpleasant surprises from the government. Russian entrepreneurs have suffered from uncertainty for a long time and almost as badly as from the biggest pain of recent years, namely low demand for products and services.

Georgy Ostapkovich, Director, HSE CBTS:

Monitoring studies reveal that many company CEOs are unsure about the actual state and immediate prospects of the Russian economy. This may partly be the reason behind the growing number of pessimists who do not expect any tangible improvement in business and the investment climate. In 2015, just over 25% of industrial company CEOs were pessimists, but by 2018, their proportion had increased to 44%.

High uncertainty is also the reason why some business owners struggle with making long-term business plans and feel forced to use management schemes that invoke the wandering ghost of a recession instead of boosting economy. To minimise potential loss, businesses shorten their planning horizons and cut down on investment, particularly investment in innovation, the number of employees, and wages, and some choose to move partially to a shadow economy.

IQ

Author: Svetlana Saltanova, September 13