07.04.23 Review

Out of Sync Under Sanctions: positive trends in industrial production fail to transform into full economic recovery

Over the past few months, the Russian economy has seen a steady increase in the output of goods and services when measured by basic types of economic activity, while industrial production has appeared to stagnate following its contraction in the initial months of the war. This effect is somewhat unusual: typically, economic recovery after a crisis involves the synchronous growth of these two indices. In this case, growth in the service sector, construction, and transportation has not been supported by industrial growth, which is a crucial component of the real sector of the economy. Additionally, the dynamics of industrial production appear to be out of sync, as certain sectors have been crippled by sanctions, while others are experiencing the positive effects of import substitution or are being stimulated by government interventions. As a result, the ‘positive dynamics’ observed in some sectors of the economy have failed to transform into full, sustainable economic recovery. In the near future, the performance of the Russian economy will depend on the demand for Russian raw materials, the dynamics of the mining sector, and budget expenditures.

We still have a contradictory and unclear picture of the dynamics of the Russian economy. On the one hand, government officials have been exuding maximum levels of optimism and expect others to follow suit, as reported by Bloomberg’s sources at the end of 2022, the Kremlin demanded the central bank improve its economic forecast for the upcoming year. On the other hand, the quantity of publicly available statistics has drastically decreased, and economic analytical centres no longer make their materials public. For instance, the HSE Development Centre stopped publishing articles on its website in the summer of 2022, and the CMASF's review of the state of the industry was not released in March 2023.

However, the government’s official optimism has primarily been challenged by an absence of evidence indicating full economic recovery. Typically, after a contraction in the economy caused by an external shock, individual sectors begin to grow against the background of a newly achieved equilibrium. Then, new sectors join this growth and, as a result, all or most of them move into the recovery phase, utilising the productive capacities created before the crisis. However, this has not been the case for the Russian economy, where some economic sectors remain persistently weak, some have been growing, and others are in the midst of a cycle of growth and decline.

Moreover, an unusual trend has recently been observed in the Russian economy — the output of goods and services by basic types of economic activity, including industrial production, trade, services, construction, and agriculture, has been growing consistently, while growth in the industrial sector has been unsteady. Typically, the intensity index of the output of goods and services by basic types of economic activity synchronously rises and falls along with the dynamics of industrial production, experts from HSE have pointed out in their monthly operational report on the dynamics of industrial production. According to these experts, industrial production, which has been the sector hit hardest by sanctions, has yet to recover and join the upward trend in the real sector of the economy. This trend has been the result of a number of industries demonstrating improved figures.

The real sector of the economy started to rebound in October, following the collapse of the intensity index in the first months of the war and subsequent stagnation. However, since then, its growth has been driven primarily by construction, transportation of goods, wholesale trade, and agriculture. Specifically, the construction sector saw an 8.4% YoY increase in February, thanks to the extension of the state's subsidised mortgage programme. Rail transportation of construction cargo and cement also increased by 19.7% YoY. The transportation of goods has surpassed its pre-war and pre-pandemic levels. However, experts note that these improved figures should not be seen as an indicator of economic recovery, but rather as a consequence of sanctions and the subsequent restructuring of foreign trade flows. The volume of paid services rendered to the population has reached its highest level since 2018, but this has largely occurred as a result of the decline in foreign tourism and the increase in demand for maintenance and repair of cars and household appliances.

When it comes to industrial production, some sectors (such as electrical equipment and railway transport) have been able to recover and even to grow after the period of recession. The reason behind this growth was the need to boost domestic production in response to sanctions. The hardest-hit sectors of the economy include natural gas and gas condensate extraction, wood processing and products, chemical products, rubber products, motor vehicles, and machinery and equipment, not included in other groups. The mineral industry observed a partial recovery in the summer after a decline in April 2022, but then the process began to stall.

The dynamics of Russia’s manufacturing industries’ have also demonstrated some inconsistencies. Although they made a significant contribution to the increase of the output index in basic economic activities seen in February 2023, their dynamics appear to depend largely on the volume of government orders and the performance of the defence industry. For instance, the increased production of radar and communication equipment contributed to February’s growth in industrial production, along with an increase in oil production. To add to this, February marked the first month of recovery in the manufacturing sector, thus it is still too early to identify a conclusive trend.