08.03.23 Review

An Illusion of Growth: even if the central bank improves its forecast for the Russian economy, the quality of growth will remain low

With each passing month, the official forecasts for the dynamics of Russian GDP appear increasingly optimistic. In the upcoming review ‘What the Trends Say’, the central bank’s experts do not rule out the possibility that the regulator will once again revise the baseline forecast, which currently predicts 1% growth by the end of the second year of the war. However, the experts remain sceptical about the quality of the aforementioned growth, as it will be primarily fuelled by the government’s generous cash injections into the country’s military needs and into the country’s ability to adapt to the unprecedented international sanctions. The experts from the Bank of Russia acknowledge that, while external demand remains depressed, the expansion of energy supplies to Asia continues to be hindered by logistical constraints, rather than the sanctions themselves. In the coming years, ‘replacement investments’ into the economy will be oriented towards two goals:  maintaining the standard of the country’s technological capabilities, and developing new infrastructure. It is crucial to note that these efforts will not equate economic development.

According to the authors of the upcoming ‘What the Trends Say’ review, published by the Bank of Russia’s Research and Forecasting Department, if the economy does not experience any new shocks, Russia’s GDP may surpass the central bank’s baseline predictions in 2023. A month ago, the central bank had already improved its forecasts for the Russian economy in the medium-term, allowing for a change at the end of the year ranging from a 1% decline to a 1% increase. However, Bloomberg, citing its own sources, reported that the government may be pressuring the central bank to issue more optimistic predictions for the economy. Prior to this, the regulator had predicted a decline of 1–4%. Despite potential GDP growth, the authors of the review warn that the quality of this growth will be low. 

At the start of this year, the expansion of domestic demand as a result of sky-high budget expenditures has been the primary driver of economic growth. In January and February, the budget deficit reached 2.58 trillion rubles, amounting to 88% of the budget deficit allocated for the entire year of 2023. For comparison, over the past 12 months, the deficit amounted to 6.4 trillion rubles. These cash injections have led to growth in industries servicing government procurement, as well as closely-related sectors of the economy.  

The MMI Telegram channel, which was founded by Kirill Tremasov, the Director of the central bank’s monetary policy department, has written that ‘6.4 trillion rubles is a substantial budgetary boost. It is due to these massive government expenditures that the economy has been attempting to grow since mid-2022. If the period of large-scale injections is now over (as might be indicated by the gradual decline in average daily budget spending since mid–February — Re: Russia), then the dynamics of economic growth will begin to weaken, albeit with some lag. In the event that the government is significantly dialling back its spending, the economy may experience a downturn.’ 

Furthermore, the authors of the review note that an increase in income as a result of a nationwide staff shortage has also contributed to the country’s economic growth. The shortage is a result of emigration, ageing, natural population decline, and ‘partial mobilisation’. According to the central bank, 1 in 2 businesses has experienced a shortage of personnel (Re: Russia has previously analysed the labour market here). Additionally, indicators of consumer activity and confidence are on the rise, as people are saving less and spending more, the analysts from the central bank explain.  

Inflation levels have been impacted by both the substantial cash injections from the government and rising wages across the country that do not reflect an actual increase in productivity. The Bank of Russia’s experts acknowledge the possibility of ‘a steady increase in inflation, requiring an active response in the form of monetary and credit policies.’ An example of this might be maintaining a high key rate (currently at 7.5%) or even raising it further.

Although there has been a growth in domestic demand, external demand has remained stagnant. Even though sanctions against Russian energy suppliers have so far not had the intended impact (as previously discussed in a number of Re: Russia’s articles, such as this one or this one), the volume of export products is still lagging behind the levels of late 2022. Mining production has been declining, and this has consequently affected the output levels in the closely-related manufacturing, trade and transport industries. The central bank’s analysts caution that this will impact GDP in the second quarter and beyond. 

Logistical restrictions have hindered the expansion of supplies to Asia, which in turn has hampered the growth of Russian GDP. China, India, and Turkey already receive two-thirds of Russian commodities exports. Without these restrictions, China’s recovery in business activity could have supported the growth of Russian GDP. However, the central bank analysts do not expect any significant developments in this area over the next few quarters. For example, the newly modernised Eastern branch of the Russian Railways will be able to increase its carrying capacity by only 15% in 2024. It will then be necessary to expand the throughput of Russia’s seaports. In 2022, the cargo turnover of the seaports in the Far Eastern basin increased by only 1.5%, while an increase of 40% is required in order to have any significant impact.

In short, the authors of this review suggest that the growth of GDP will be maintained through ‘replacement investments’ necessary to sustain the country’s current level of technological development. However, the ongoing ‘structural transformation’ (a term which first appeared in the 'military’ edition of the ‘What the Trends Say’ review, released in April 2022) of the economy does not involve real development, but instead relies on ‘reverse industrialisation’. This term, which was also proposed by the central bank, implies import substitution of outdated technology. To achieve better quality growth, the analysts conclude that ‘the replaced technologies need to become the foundation for further national technological development.’ Although this may be possible, it is not very likely. The experience of other countries under broad sanctions does not bode well for the likelihood that Russia will enter a period of growth, as the necessary prerequisites are lacking, namely: ‘ the creation of favourable conditions for financial and direct investments’, ‘development of human capital’, ‘provision of social mobility’, and others.