09.11.22 Review

Forecast Fog: the Russian Central Bank has improved its forecast for the Russian economy, but admits that reality could worsen it

Russia's GDP will fall less in 2022 than the Central Bank expected back in July, but the pace of its recovery in 2023-2025 will also be more moderate than predicted, according to the Russian Central Bank's new Monetary Policy Report. The economy will contract by 3-3.5% in 2022 and another 1-4% in 2023, the Central Bank assumes. However, the uncertainty remains quite high, so the probability of this scenario does not exceed 25%, according to the regulator. As for the more negative scenario, which also has a 25% probability, the economy will not start recovering throughout the whole forecast period — until the end of 2025

GDP will now occur in mid-2023 (rather than at the end of 2022, as was expected in spring), as follows from the Central Bank's "Monetary Policy Report", published on November 8. At the same time, the fourth quarter of 2023 will see a slight increase — up to 1.5% in annual terms (the previous report expected 1-2.5%). In 2024, weak recovery growth will continue (an increase of 0.5-1.5% year-on-year in the 4th quarter), and in 2025, the growth rate of the Russian economy will stabilize in the range of 1.5-2.5%, the Central Bank expects. 

This baseline forecast assumes that household consumer incomes will decrease by 3-3.5% in 2022 and remain at the same level in 2023, and will recover only in 2024, with lending support. Gross fixed capital formation will not decrease much in 2022, since it was supported by previously approved investment projects, but in 2023 the reduction may reach 3-7%, because many investment projects have already been adjusted for the next years, and the budget support will play a lesser role as a result of gradual budget consolidation (i.e. reduction of the budget deficit). In 2024 gross capital formation will grow at a restorative pace amid an increasingly resilient adaptation of the Russian economy.

The physical volume of exports in 2022 will decrease by 15-16%, and in 2023 — by another 7.5-11.5% due to the oil embargo coming into force. In 2024, the reduction will slow down to 1-3%, and in 2025 a slight increase to 2% is possible because of the ongoing recovery of non-oil and gas exports and exports of services, the Russian Central Bank expects in its base forecast. The reduction in the physical volume of imports in 2022 will reach 22.5-23.5%, while in 2023 it may even show some growth (+0.5%; in 2024, with the growing development of new trade relations, import recovery will accelerate to 3-5% of the annual growth).

However, the Central Bank itself estimates the probability of this basic scenario at 25%. The real course may turn out to be higher or lower with equal probability. In the more negative scenario, the decline in the 1st quarter of 2023 would exceed 10% by the 1st quarter of 2022, and in the 3rd quarter, the economy would fall 5% by the 3rd quarter of 2022, i.e., to its current level. In this scenario, the economy will not move to recovery over the entire forecast period until the end of 2025. This may happen if the preconditions of the baseline forecast are not met, implying a barrel price of $70 in 2023 and $60 in 2024, maintaining the discount on Russian oil at current rates, and a slowdown in the pace of Russian export reduction.  

In addition, the risks of accelerating inflation prevail in the medium term, the Russian Central Bank notes. Among the pro-inflation risks (and therefore the risks of the baseline forecast), the Central Bank highlights further tightening of sanctions. Supply-side constraints could increase due to equipment supply problems and slow restocking of finished goods, raw materials, and components if negative import trends worsen, the report said. Another pro-inflation risk, according to the Central Bank, could be a global recession, which would weaken demand for Russian oil and gas, leading to a devaluation of the ruble. An increase in the labor market deficit (as a consequence of mobilisation) may be more severe than in the basic scenario, which will increase cost pressures on enterprises, while high inflation expectations, especially those sensitive to exchange rate fluctuations, may serve to boost consumer demand due to accumulated savings. Moreover, an additional expansion of the budget deficit could require a key rate increase to return to the 4% inflation target in 2024. 

Among the disinflationary risks, the Russian Central Bank has highlighted the continued high saving propensity of the population amid growing overall uncertainty, as well as the duration of Russians getting used to the new supply structure in consumer markets, which may restrain demand in a larger volume and for a longer time than expected in the basic scenario. At the same time, a faster adjustment of the economy, accompanied, among other things, by an active import recovery, may help to offset supply shocks more quickly, and a record agricultural harvest in 2022 may have an impact on domestic market prices even if the export difficulties persist.

According to the basic Central Bank's forecast, inflation in 2022 will range between 12-13%, and the dynamics of inflation in 2023 will continue to be affected by the delayed military mobilisation effects (through the possible strengthening of labor flows between different industries and regions, the shortage of personnel in certain specialties and the pro-inflationary wage pressure).

At the same time, even though the economy adapted faster than expected to the new conditions, as the effects of inertia are exhausted (including the reduction of existing stocks and the termination of previously concluded contracts), supply shocks may become increasingly prominent, being more persistent and longer lasting than previously expected. This, however, could lead to higher rates of price growth. Given all these factors, the Russian Central Bank assumes that the annual inflation rate in 2023 will range above the target level of 5-7%, and will return to figures near the 4% target level only in 2024.