Prices in The Fog of War: Actual consumer inflation in Russia may be higher than official data, while actual industrial growth may be lower
Despite fifteen months of efforts to contain inflation, the rate of its slowdown this fall appears extremely low, and inflation expectations have resumed rising. Next week, the Central Bank will once again raise the key rate to at least 20% or higher.
However, even after this, a significant slowdown in inflation should not be expected. The reason for the stubbornness of inflation lies in the contradictory policies of Russia’s economic authorities: while market tools are aimed at combating it, fiscal and regulatory policies work in the opposite direction.
Moreover, actual inflation in Russia may be even higher than what the economic authorities are struggling to contain. The gap between the official consumer price index and an alternative tool – the index used by the ROMIR company – which was 6 percentage points before the war, has doubled in recent years to 12. This suggests a likely underestimation of consumer inflation.
Another key price dynamic indicator, the GDP deflator, may also be understated, as it may not adequately account for prices in military production, which contributes the majority of industrial output growth.
If the inaccurate inflation assessment leads to overestimated income growth, an understated deflator leads to overestimated real output. As a result, it is highly likely that the rate of price growth in the economy is higher than official statistics indicate, while output growth is lower. In this case, the challenge faced by the Russian authorities appears more dramatic than it initially seemed.
Unstoppable inflation
In 2022, Russia’s attack on Ukraine and the sanctions imposed in response triggered a sharp rise in global energy and food prices. Russia benefited from this surge with an additional $180 billion in export revenue (equivalent to 60% of its frozen assets in the West), while central banks worldwide were forced to quickly raise interest rates to curb inflation.
Since then, the situation has shifted. In most major economies, interest rates are now falling or about to start declining. In the October issue of the World Economic Outlook, the International Monetary Fund (IMF) notes the arrival of a period of ‘great easing’: the global economy, according to experts, has successfully absorbed the shocks caused first by the COVID-19 pandemic and then by the onset of the war in Ukraine.
In Russia, however, the opposite is true. At the upcoming board meeting on 25 October, the Central Bank is expected to raise the key rate to at least 20%, analysts believe, with some not ruling out a more significant hike. Despite the Central Bank having declared a battle against inflation nearly fifteen months ago, inflation has not decreased, and inflationary expectations continue to rise.
In September, according to Rosstat, annual inflation was 8.63%, down slightly from 9.05% in August. This decline was not unexpected, considering that inflation began accelerating exactly one year ago. In fact, a more significant reduction had been anticipated. In reality, month-to-month price growth has not slowed but remained at +0.7%, according to Raiffeisenbank analysts. Price dynamics indicators do not yet point to a stable disinflationary trend, as noted by both the Central Bank's analysts in their reports What The Trends Say and Consumer Price Dynamics.
In seasonally adjusted annualised terms, consumer price growth in September, according to the Central Bank, was 9.8% (7.5% in August, 8.7% in the second quarter, and 5.9% in the first quarter). The growth of the core consumer price index (CPI), excluding housing and utilities, fruits and vegetables, oil products, and most transport services, accelerated in September to 9.1% (7.7% in August, 9.2% in the second quarter, and 6.8% in the first quarter). Excluding tourism services, core CPI growth in September was 9.6%, compared to 9.4% in August.
In the first week of October, the CPI grew by 0.14%, and in the second week, by 0.12%. These rates suggest some slowdown in inflation compared to previous months. By the end of the month, annual inflation may be around 8% with seasonal adjustments, the Telegram-channel MMI forecasts. At the same time, an ‘inFOM’ survey, conducted from 30 September to 10 October, recorded a sharp spike in inflation expectations. The median estimate of expected inflation over the next 12 months rose from 12.5% to 13.4%, while the perceived inflation rate (over the past 12 months) increased from 14.4% to 15.3%.
Despite the slowdown in consumer lending, and hence a likely reduction in consumer activity, inflation is not expected to slow down. In the remaining months of the year, additional inflationary pressures will come from several factors: a sudden expansion of the budget deficit, an imminent increase in the utilisation fee on imported cars, and the weakening of the ruble. Next year, these factors will be joined by a sharp increase in utility prices (→ Re:Russia: Long-Awaited Stagflation). Only the increase in the utilisation fee may add between 0.4 to 0.6 percentage points to the CPI, according to Central Bank analysts. The impact of utility tariff indexation is estimated at 0.4 percentage points.
Although most of these new factors, aside from the weakening ruble, are one-off, they could have a secondary inflationary impact in an environment of high inflation expectations, as noted in the What the Trends Say report. To contain this, it will be necessary to further tighten monetary policy: either raise the key rate higher than planned (which is 'very likely') or keep it at the current, already extremely high, level for longer, or apply both measures.
As we have previously noted, the persistence of inflation is due to the contradictory policies of Russia’s economic authorities (→ Re:Russia: Long-Awaited Stagflation). While market tools (the refinancing rate) are aimed at combating inflation, fiscal (increased spending) and regulatory (rising tariffs and fees) policies are working in the opposite direction.
Prices in the fog of war
The longer the Central Bank’s efforts to curb inflation yield no results, the more frequently economists question how accurately inflation is reflected in Rosstat’s statistics. For example, Oleg Vyugin, chairman of the NAUFOR Board of Directors, points to the inexplicable rise in non-oil and gas revenue projections in the budget: with the economy growing by 3%, the taxes paid by companies are expected to increase by 22%. ‘I think the finance and economic experts at the Ministry of Finance have simply calculated well that the real price level is higher. That is why VAT, corporate income tax, and personal income tax will bring in this 22% growth’, Vyugin notes.
An alternative view of consumer inflation is given by the FMCG deflator index, which is calculated by the research company ROMIR. This index is based on a broader basket of goods than Rosstat's, mostly consisting of food and household chemicals. The study involves 40,000 Russians from 240 towns and cities, who scan QR codes from receipts for all goods and services purchased. Around 600,000 purchases are recorded weekly. According to ROMIR, inflation rates have almost always been higher than those reported by Rosstat. However, after the war began, the discrepancy became too significant. In September 2024, ROMIR recorded a 22.1% year-on-year price increase for everyday goods, compared to 10% according to Rosstat. For comparison, in 2020, ROMIR recorded a 2.5% price decrease from the previous year, while Rosstat reported a 3.7% increase. In 2021, ROMIR observed a 19.6% increase, while Rosstat reported only 7.4%, leading to a gap of over 12 percentage points. In 2022, this gap grew to 18 points, and in 2023, it decreased to 13.
Consumer price growth according to Rosstat and ROMIR, 2020-2024, 100 = 2019
The discrepancy between Rosstat and the FMCG index is due to the fact that the latter tracks only everyday goods and does not include durable goods and services. The question of actual inflation largely boils down to whether the weightings in Rosstat’s consumer basket accurately reflect the current consumption structure and income groups. Another factor that may explain the difference between the two indices is 'quality inflation’. Rosstat may not account for the fact that many households have started purchasing cheaper alternatives to their usual goods – either to save money or because these goods are no longer available. ROMIR, unlike Rosstat, tracks the price dynamics of specific SKUs (stock keeping units – identification codes corresponding to individual product units), meaning it monitors particular products from specific brands. For higher-income groups, who are able and willing to maintain their quality of consumption, inflation will be significantly higher and closer to what is reflected in the FMCG index; lower-income groups will 'lower' their inflation by sacrificing the quality of their consumption. However, Rosstat’s methodology will reflect inflation according to the lower scenario.
The report ‘The Russian Economy in the Fog of War’ by the Swedish National Institute for Economic Research (NIER) also highlights a significant divergence between the consumer price index (CPI) and the GDP deflator, which Rosstat uses to assess economic activity in real terms. The CPI is based on a consumer basket that includes both domestically produced and imported goods and services. The GDP deflator, however, accounts for all goods and services produced within the country. Because these indicators measure different things, their values never fully align, with CPI usually being slightly higher. However, recently, the GDP deflator has shown significantly faster growth compared to the CPI.
Dynamics of the GDP deflator index and consumer price index, 2012-2024, 100 = 2011
When presenting GDP estimates, Rosstat noted that the sharp increase in the deflator in 2021 (+19.1%) was primarily due to the global rise in energy prices. In 2022 (+15.8%), it claimed that in addition to the continued growth in energy prices, the main contributing factors were the rise in prices for residential real estate in the secondary market, construction materials, freight and rail transport. In 2023 (+7%), the deflator's growth was mainly driven by wholesale and retail trade, freight and passenger transportation, finance, and insurance. Experts from NIER believe the discrepancy may also be explained by a larger share of GDP now being linked to the state and corporate sectors, thus increasing their weight in the deflator. In simple terms, if the deflator in 2021-2022 was influenced by the recovery of energy prices, then in 2023-2024, when energy prices declined, the rapid rise in prices for armaments – a product not consumed by the public and thus not affecting the consumer price index – might have driven the deflator upward.
Some underestimation of actual inflation, tied to the fact that changes in consumption patterns were not fully reflected by Rosstat, may also have contributed to the emerging gap between the CPI and the deflator. Over the last year (third quarter of 2023 to second quarter of 2024), the average growth rate of the deflator was 12% year-over-year.
However, in reality, it could be even higher. The main growth in industry over the past year and a half was concentrated in military sectors, whose output falls under categories like 'finished metal products, excluding machinery and equipment' (weapons and ammunition) and 'other transport vehicles and equipment' (tanks, infantry fighting vehicles, planes, helicopters, and other aircraft). According to the Central Bank, which analyses industrial growth in its What the Trends Say bulletin, since March 2023, consumer-related industries have shown an average annual growth rate of 7.5%, while investment-related industries have grown by 22%. If the 'heavy' sub-sectors (which include military production) are excluded from investment industries, the growth rate of other investment sub-sectors was 13%.
Thus, the lion’s share of production growth was concentrated in the ‘heavy’ defence sectors, where price growth is the hardest to measure, and their weight in the industrial production structure has increased. As a result, not only the consumer price indices but also the GDP deflator might be understated. If the inflation assessment is inaccurate, this could lead to an overestimation of citizens' income dynamics, while underestimating the deflator could result in overstated figures for real production and GDP growth. Consequently, there is a significant likelihood that the actual price growth in the economy is higher than the official statistics suggest, while the production growth rate is lower. In this case, the challenges facing the Russian authorities appear more dramatic than previously thought.