At the end of April, the Central Bank's board of directors decided to keep the key rate at 7.5%, while announcing an improved forecast for Russian GDP and inflation: they do not expect a decline, and growth is likely to reach 0.5-2% with annual inflation at 4.5-6.5% in 2023 and 0.5-2.5% in 2024 when inflation will return to the target of 4%. The previous forecast assumed a range from a 1% decline in GDP to an equal increase. In the quarterly report on monetary policy published on May 11, the regulator explained in more detail its decision and the arguments behind the improved forecast.
In the second quarter, GDP is expected to grow by 4.2% according to the Central Bank, after a decline of 2.3% in the first quarter of this year. However, this sharp change is explained by the low base effect of last year, when GDP contracted by 4.1% in the second quarter of 2022. In the future, growth is expected to be modest, with the Central Bank even anticipating a 0.5% decline in GDP by the end of the fourth quarter.
Weak exports and imports are working against the Russian economy, and the main driver of growth should be domestic demand, primarily from households who have previously followed a savings-oriented behaviour model. Experts at the Central Bank noted in their April report on ‘Regional Economics’ that consumer demand is recovering slowly although few have been able to overcome the decline of 2022. Nevertheless, in the first quarter of this year, citizens began to spend more actively, directing 89.4% of their income to consumption, compared to 86-88% in the years before the invasion of Ukraine, as noted by the Telegram channel MMI. The Central Bank justifies its forecast by noting that, in real terms, average wages in January 2023 reached the level of February 2022.
Government demand will also be high and support investment activity. Business investments will remain at the level of late 2022 due to ‘restrictions on investment imports, the closure of several joint projects with Western companies, and restrictions on access to technology.’ The most significant investment growth will be in industries requiring deep restructuring, such as construction, manufacturing, agriculture, retail trade, and water supply. Investment activity has led to record levels of production capacity utilisation (80.2%). Thus, it is possible that companies are operating at the limit of their capabilities.
The improved forecast is tied to the observed increase in business activity across various industrial sectors at the beginning of 2023, as reported by Bank of Russia: ‘The production of investment goods has increased significantly (finished metal products, transportation equipment, non-automotive machinery, electrical equipment, computers, electronics, optics, etc.). One of the most significant growth factors is the increased demand from the construction industry. According to the Bank of Russia's estimates, the volume of construction work has reached its highest level in the last five years.’
However, the Central Bank acknowledges that government procurement advances and intensive infrastructure investments aimed at expanding new transport corridors are important drivers of economic dynamism. At this stage, the Central Bank relies on the parameters outlined in the budget, which means that it does not take into account the current deficit growth. However, it still considers fiscal policy a risk factor. The Central Bank has identified other risks in the positive scenario including the possibility of extended sanctions, labour market tension, and accelerated import recovery.
According to the Central Bank's forecast, the economy will continue to recover throughout 2024 and may return to the level last seen in the fourth quarter of 2021. Government demand will decrease against the backdrop of fiscal policy normalisation. Budget expenditures are expected to be at 29.1 trillion rubles in 2023, 29.4 trillion in 2024, and 29.2 trillion in 2025. Private investment will decline. In 2022, large inventories were stockpiled, which are yet to be sold off. Businesses will be cautious about building up new inventories as they have to deal with products from new brands, the demand for which is not yet evident. A cautious attitude towards new brands is one of the reasons for weak consumer demand.
According to the Central Bank's expectations, the impulse towards recovery will dissipate in 2025: ‘Part of the adaptation processes will be completed, investment activity will return to its long-term level, replenishment of stocks will resume, but these will remain at a level below the long-term average.’ The GDP growth rate will stabilise in the range of 1.5-2.5% with inflation at 4%. Prior to the war, the regulator had predicted an annual growth rate of 2-3% for 2022-2024.