27.06.23 Review

Best of the Worst: Russian entrepreneurs’ optimism reflects their social attitudes rather than the realities of the business climate

Similar to the large-scale surveys conducted by the Central Bank, studies of the well-being of small businesses reveal that the level of optimism among Russian entrepreneurs is at an abnormally high level. If their estimates are to be believed, the 'economic situation' and 'business climate' in the first quarter of 2023 are significantly better than in the pre-war period. However, the picture drastically changes when it comes to specific business parameters: the evaluations of demand and profitability have only recovered half of the losses experienced during the crisis in 2022. The number of small business owners whose income has declined quarter-on-quarter is growing, as is the proportion of those who are resorting to borrowing. One of the factors contributing to declining profits is the rise in labour costs. Thus, the assessments of the overall economic situation appear disconnected from more specific evaluations and seem to reflect the respondents' social attitudes towards 'overcoming difficulties,' which they perceive as less significant than they had initially appeared after the full-scale invasion of Ukraine and the imposition of sanctions.

Business climate surveys in Russia, which are published monthly by the Central Bank and analysed by Re: Russia, demonstrate an incredible level of optimism within the business community regarding the current economic situation and the prospects for the Russian economy. These figures are approaching 10-15-year highs and far exceed the assessments given by entrepreneurs in the second half of 2021 when the economy was growing at a rate of around 6% per year after the lifting of COVID-19 restrictions. However, the question remains as to what extent the Central Bank's sample may be biassed, particularly in terms of enterprise size or the weight of small, medium, and large businesses in the economy.

In this regard, the longitudinal study (based on surveying the same respondents) of small businesses conducted by FOM can serve as a good control for the much larger Central Bank survey. The latest (eighth) wave of the FOM survey was conducted from April to May 2023 and involved more than 700 entrepreneurs who gave their assessments of the situation in the first quarter of this year.

Indeed, as indicated by this data, the full-scale invasion of Ukraine significantly worsened the condition of small businesses in Russia. At that time, 51% of business owners responded that the conditions for conducting business had deteriorated, which is 21 percentage points higher than at the end of 2021 when small entrepreneurs felt an improvement in the business environment thanks to the end of the COVID-19 epidemic and the booming economic recovery. 66% of respondents stated that the situation in the economy as a whole had worsened after the start of the war (up 8 percentage points from the end of 2021), while 46% and 32% mentioned a decrease in demand and a lack of profitability, respectively.

However, as demonstrated by the graph of the dynamics of assessments of various aspects of the business environment compiled by Re: Russia based on FOM's research data, the situation, as perceived by small business owners, began to noticeably improve in the second and especially the fourth quarter of 2022. As a result, assessments of the business climate and the overall economic situation in the first quarter of this year were better than during the pre-war period when the economy was growing at a record pace of around 6% per year. The most impressive growth can be observed in the most abstract indicator, the 'economic situation,' which, according to the entrepreneurs surveyed, was twice as good in the first quarter of 2023 as it was before the war. This aspect of the FOM findings is fully consistent with the Central Bank surveys: according to entrepreneurs, the situation in the Russian economy has almost never been as good as it has been since the start of the full-scale invasion of Ukraine and the imposition of extensive international sanctions on Russia.

However, when it comes to the specific parameters crucial for any business, such as demand and income, it becomes apparent that the current assessments have only recouped half of the crisis-related losses in 2022. Interestingly, while the 'bottom' of the demand was reached in the second quarter of last year, the income reached its peak, and the 'bottom' was observed in the fourth quarter. In March 2023, the number of small business owners whose income decreased compared to the previous quarter continued to rise, with 40% of entrepreneurs reporting this, compared to 32% in the previous quarter. Almost one-third of entrepreneurs (29%) had to resort to borrowing, marking the highest level since the longitudinal study began and up 5 percentage points from the end of 2022. The proportion of entrepreneurs who noticed an increase in demand over the past quarter was close to an all-time low for the longitudinal study, with only 17% reporting such an increase (the minimum of 16% was recorded in the first quarter of 2022, coinciding with the start of the war in Ukraine).

Indices of entrepreneurial assessments of the economy and business climate, based on FOM surveys, 2021-2023

Thus, the overall assessments of the economic situation and the business environment appear to be detached from practical evaluations and, to a greater extent, reflect respondents' social attitudes towards 'overcoming difficulties.' In reality, the actual problems faced by businesses are seen by entrepreneurs as the 'best of the worst.'

The FOM survey also confirms that for many entrepreneurs, declining profitability is linked to increasing operational costs: from the second half of 2022, expenses for rent and wages have been on the rise (despite the economic downturn). In the first quarter of this year, the salaries of employees increased for 34% of the entrepreneurs surveyed, while the number of employees increased for only 10%. Salary growth estimates for employees are comparable to the figures seen at the end of 2021, despite significantly lower demand. Similarly, 15% of respondents started paying more to rent workspace (compared to 12-13% in the pre-war period).

The increase in labour costs is associated with systemic problems in the labour market, which has been a topic of conversation among economists recently. One of these problems is a labour shortage exacerbated by the autumn mobilisation. At the end of 2022, 44% of entrepreneurs surveyed stated that mobilisation had negatively affected their business and, in the first half of 2023, the number of small enterprises significantly impacted by mobilisation remained almost unchanged at 43%.

However, small businesses have been hit harder by sanctions than by mobilisation. At the beginning of 2023, 63% of entrepreneurs surveyed reported experiencing difficulties related to sanctions. When asked to compare the effects of mobilisation and sanctions in terms of their impact on business, 42% responded that sanctions were more significant, compared to 35% who suffered more as a result of mobilisation. While half of respondents (50%) claimed not to have experienced any effect from mobilisation, only 35% said the same in response to a similar question about the sanctions.