08.12.22 Review

Sustained Unsustainable Stagnation: the Russian economy is supported by technological regression, the production of shells and military uniforms

Russian industry halted its decline back in late spring and has been in a steady state of "unstable stagnation" for about half a year now, where the characteristic "unstable" means the quality of stagnation and the weak predictability of its further fluctuations. Such a crisis profile is usually called L-shaped. However, even this result was achieved by increasing production for the war needs and "technologically regressive import substitution": the termination or reduction of import supplies opens up opportunities for domestic analogues, even if they are seriously inferior to imports in terms of "price-quality" parameters. This effect is reflected in statistics as an increase in production in optics and electronics, the automotive industry, and transport engineering. The most impressive successes the economy shows are in sewing clothes for the mobilised and in the manufacturing of "metal products", which are used in the destruction of Ukrainian infrastructure.

According to Rosstat, the industrial production index fell by 2.6% in October compared to October 2021, after a 3.1% year-on-year decline in September. The Center for Macroeconomic Analysis and Short-Term Forecasting (CMASTF) defines the state of the Russian economy as "unstable stagnation". Basically, this means that the contraction of economic activity observed in the spring of this year has halted, and the economy from month to month demonstrates multidirectional fluctuations around the achieved level. At the same time, at the end of last year, the economy was recovering after the lifting of anti-COVID restrictions, therefore the effect of last year's high base will intensify in the coming months, and in annual terms, the scale of the economic contraction will increase.

The CMASTF recalculates the Rosstat figures taking into account seasonal and calendar factors, and in addition, it does not include data on the most "closed" items (related to the defense industry). This approach, among other things, allows us to see the economic trends better, as they are less distorted by the direct state order. As a result, according to the CMASTF estimates, the Russian economy fell much deeper in the spring and summer than the Rosstat data suggests, and was recovering more intensively in the autumn.

The volume of Russian industrial production, according to Rosstat and CMASTF estimates, 2019–2022, 100% = 2019

Overall, the Rosstat data paint a quite optimistic picture. According to the results of the first ten months of 2022, the industrial production index, based on the federal service estimates, is approximately at the same level as a year ago. In October, according to the CMASTF assessments, output decreased by 0.2% compared to September. Rosstat, on the other hand, speaks of an increase of 0.7%, even after seasonal and calendar factors were excluded. 

Maintenance of the protracted war in Ukraine is playing an increasing role in the economy, experts believe. "The October result is better than we predicted (we were expecting [from Rosstat] -3.6% year-on-year)," the MMI Telegram channel, founded by Kirill Tremasov, director of the Central Bank's Monetary Policy Department, comments on Rosstat data. — "The main reason is high numbers in processing. Mostly in the components related to military expenditures." In addition, the clothing industry grew by 11.9% year-over-year in October, and finished metal products ( except machinery and equipment) went up by 4.7%. "About 80% of clothes produced in Russia are overalls and uniforms," says Oleg Buklemishev, director of the Center for Economic Policy Research at the Economics Department of Moscow State University. — "An increase in metal products is also must be connected with the military preparations. Defense companies are working four shifts." 

According to Rosstat, the biggest growth in October occurred in the production of computer equipment, electronic and optical devices: +18.3% in annual terms. In ten months, this category grew by 6.3%. Rosstat data shows that 46.3 thousand laptops and tablets, as well as 62 million integrated electronic circuits, were produced in Russia in October. This result, however, is not connected with the breakthrough of domestic computer technology, but with a sharp reduction in its imports. Consumers are now forced to buy "domestic" products, despite the lower quality and higher price, because there is no other alternative.

A similar situation can be observed in the automotive industry: a recovery jump in the production of passenger cars (+35% compared to September) against the background of a decline in the output of trucks (-11%). In general, in annual terms, the industry has nearly halved (45.2%). As a result, due to the cessation of foreign brand assembly, "AvtoVAZ" got an opportunity to increase the production of simplified models (with minimal use of imported components). In both cases, we are facing the "technologically regressive import substitution" effect predicted by the famous economist Branko Milanovic. In the conventional sense, "import substitution" is when domestic industry learns to produce something previously available exclusively from imports. In this case, the artificial limitation of imports leads to the situation when the products which previously lost competition with imports now hold the largest share of the market. There is a similar picture in the transport machine-building, which demonstrates growth caused by the need to replace fallen imports.

According to the October results, the CMASTF has identified five major industry trends: 

  • The decline in oil production has resumed; before that, a noticeable reduction was recorded in March and April (by 6.7% in two months); later, the industry regained about two-thirds of this reduction. In October, there was a decrease of 0.8% against September; on a year-on-year basis, production declined by 3.6%. 

  • Gas production, on the other hand, is recovering. In October, the growth compared to September was 2.5% against 1.1%. In the previous months, gas production decreased by 13% compared to the prewar level. The year-on-year contraction amounted to 2.2%.  

  • The output of construction materials has slightly increased: +0.6%, while before that the index was losing 2% per month. The cumulative reduction since February is estimated at 8.5%.

  • The woodworking industry seems to have reached the bottom, the index has not changed for two months after a decline of nearly 25% over the previous period. The annual decrease totaled 19.7%. 

  • In the production of machinery and equipment, the index is already slightly higher than in February: +0.1%. Over the month the growth reached 4.4%. 

As a result, for the second month in a row, CMASTF speaks of an "unsustainable stagnation." "We are skeptical about Rosstat's seasonal smoothing; according to our estimates, the industrial production index fell by 7% in March-May, rebounded by a couple of percent in June-July, and is fluctuating at these levels," the MMI Telegram channel agrees with this conclusion.