26.07.23 Review

As an inevitable economic slowdown approaches, enterprises are adjusting their expectations, leading to a moderation in the business climate

In July, the business climate indicator, calculated by the Central Bank based on an extensive survey of enterprises, declined compared to the anomalous levels of the previous month. The indicator, which reflects the current business environment, dropped significantly from 6.4 to 2.2 points. Short-term business expectations have been steadily deteriorating for three consecutive months.While manufacturing industries, especially those involved in government contracts for the military-industrial complex, continue to exhibit optimism, the overall business sentiment has worsened. This decline in sentiment is likely a response to the considerable weakening of the national currency and its expected impact on prices. Businesses’ increased import-related costs and the corresponding price surges are expected to put pressure on demand. Moreover, the recent one percentage point interest rate hike by the Central Bank will inevitably lead to a slowdown in growth, as indicated by the latest conjunctural survey results. Although this deceleration is anticipated, against the backdrop of signs of economic overheating, it is not viewed as critical at the moment. The situation may change if external conditions deteriorate further and import costs rise due to stricter sanctions and their enforcement.

In July, the Central Bank's Business Climate Indicator (BCI) experienced a decline, falling to 6.2 points from the exceptionally high 8.8 points recorded in June. Nevertheless, the BCI remains relatively strong, approaching levels close to the ten-year peak. These BCI values were typically associated with the recovery growth observed in spring 2021 and were previously only seen during the period from 2011 to 2013. It is essential to bear in mind that the BCI represents the balance between assessments of 'improved' and 'deteriorated' conditions compared to the previous month. Thus, in July, there were fewer enterprises reporting an improvement in the economic situation compared to June, but they still outweighed those reporting a deterioration. Both assessments of current business conditions and short-term expectations regarding production and demand worsened in July. 

In July, the indicator assessing current business conditions dropped to 2.2 points from 6.4 points in June. Only representatives from the agricultural and electric power industries noted a slight improvement in current conditions. Meanwhile, the indicator for short-term expectations experienced a less drastic decline but has been gradually decreasing for the third consecutive month, returning to the standard levels observed in the years before the crisis. Most aggregated industries displayed diminished optimism, with the construction sector showing the most noticeable decline. On the other hand, expectations among enterprises in the manufacturing sector, especially those producing investment goods like finished metal products, transportation equipment, non-automotive machinery, electrical equipment, computers, electronics, optics, etc. have improved. This improvement could be attributed to the expansion of the military-industrial complex's production base and the ongoing efforts for import substitution.

Central Bank Business Climate Indicator, 2002-2023

Production volume ratings have decreased across all economic activities, with the trade sector experiencing a particularly sharp decline. The automotive retail sector was the most significant underperformer this month, as its ratings returned to the negative zone after a brief improvement in July. Experts from the Central Bank attribute this trend to the heightened volatility of the ruble, which has led consumers to adopt a more cautious approach. Typically, a significant depreciation of the ruble stimulates the purchase of expensive imported goods, including automobiles. However, as the Central Bank has noted, in this instance, citizens have shifted their purchasing behaviour from goods to currency.

Enterprises frequently pointed to a shortage of workers, including both skilled specialists and manual labourers, as a primary factor limiting their production activity. This acute labour scarcity is particularly challenging for the Russian military economy, as it faces a significant labour shortage in areas experiencing growth. This scarcity is, in part, due to the departure of over 1 million workers from the workforce as a result of mobilisation and emigration. However, a more significant cause lies in the incomplete restructuring of the labour market. On one hand, the manufacturing sector, especially those serving the military-industrial complex, is experiencing increased demand for labour. On the other hand, market regulations aim to prevent unemployment, making it difficult for companies to conduct layoffs and facilitate labour flow between sectors. As a result, the high demand for labour has pushed wages upward, further exacerbating the economy's overheating.

Expectations regarding future production volumes in most industries were also lower than those in June. In the construction sector, ratings reverted to the level observed in July 2022. Developers anticipate a slowdown in production activity due to the high supply of housing in the primary market. According to the analytical centre 'Dom.RF,' the volume of unsold new buildings in Russia has increased by nearly 20% in a year, accounting for 70% of all ongoing construction (60% in Moscow). Despite this increase, analysts from state corporations argue that such a level is still deemed 'acceptable.' The most positive expectations regarding production remain in the manufacturing sector.

The balance of demand assessments has decreased, returning to levels observed in the spring. The agricultural and electric power sectors were the only industries that perceived an improvement in demand, while the trade sector experienced the most significant deterioration. Nevertheless, companies in the trade sector evaluated future demand positively. Industrial enterprises also demonstrated some positivity. Conversely, construction and transportation companies rated future demand negatively.

'The dynamics of the BCI suggest that the initial strong boost the economy received from budget expenditures is now starting to fade, signalling that the overheated economy is transitioning into a slowdown phase,' the MMI Telegram channel stated when commenting on the results of the enterprise survey. ‘Returning to the economy's natural growth trend is a positive process. Attempting to artificially accelerate growth with a low three percent unemployment rate could lead to a crisis.' Signs of economic overheating became evident in early summer. The Central Bank's recent trend review acknowledged that the growth rate of demand, spurred by a ‘significant budgetary boost and active credit expansion’, has fallen behind the growth rate of supply, which is constrained by labour and production capacity shortages. This overheating has already led to an acceleration of inflation, prompting the Central Bank to respond by raising the key interest rate.

In the coming period, the weakening ruble is expected to exert pressure on demand. The Central Bank's commentary on consumer price dynamics in June noted that although the devaluation has had a limited impact on prices thus far, it is anticipated to have a more pronounced effect. For instance, car dealers, according to a survey by 'Vedomosti,' plan to increase prices by an average of 5-10%, despite having already risen by 13% since the beginning of the year. Similarly, a survey conducted by 'Kommersant' suggests that home appliances and electronics will experience a price increase of 10-15%. The decline in enterprise optimism observed in July is likely a response to the deteriorating economic conditions associated with the ruble devaluation. The increase in the key interest rate will add credit restrictions to this, virtually guaranteeing a slowdown in the recovery growth, which the July survey results foreshadow. This slowdown is not critical for the economy at present, unless external conditions worsen further, leading to higher import-related costs due to stricter sanctions and their enforcement.

The Central Bank's Business Climate Indicator (BCI) represents the modified difference between responses of 'the situation has improved' and 'the situation has deteriorated.' The composite indicator is formed from two components: an assessment of the current business climate and an assessment of the expected business climate. Business leaders are asked to evaluate changes in demand and production volumes at the time of the survey and over the next three months. For both demand and production volumes, the Central Bank calculates separate composite indices. The comprehensive survey covers approximately 14,000 enterprises across all major economic sectors. Previous periods' data are also included, based on complete information with questionnaires received after the preparation of operational data.