04.09.23 Review

Pre-Election Standstill with a Plus Sign: Recovery growth has been hit by structural constraints

The broad-based economic recovery that economic statistics reported in the first half of 2023 appears to have hit a wall. After three months of production growth at 1.3% in June and July, the momentum has come to a halt. Analysts differ in their assessments, debating whether this is merely a slowdown or a complete stoppage of growth. August surveys regarding market sentiment indicate an increase in new orders, but structural constraints have prevented a response to the stimulus provided by budget injections, credit growth, and wage increases. Procurement and resale prices are on the rise. The euphoria witnessed in surveys during the spring is fading. The devaluation of the ruble has forced the Central Bank to take a ‘crisis’ step by raising the key interest rate to a prohibitive 12%. This makes the likelihood of industrial stagnation during the current winter the baseline expectation. At the same time, the Russian economy received support from Rosstat. The agency revised its figures for 2022, and according to the new data, neither the war nor Western sanctions led to even a minimal decline in annual industrial production. This aligns perfectly with the official doctrine, which claims that both factors have only strengthened the Russian economy, something that will come in handy for Putin during his upcoming election campaign but will not alleviate the economic challenges posed by structural and sanctions-related constraints.

In August, Rosstat thoroughly revised its data for 2022-2023. As a result, instead of experiencing a decline of 0.6%, industrial production in 2022 now shows growth. In the manufacturing industry, the assessment changed from -1.3% to 0.3%, and in mining, it increased from 0.8% to 1.3%. In some categories, the values have increased dramatically. For instance, in the category of 'Other metallic products,' which includes a significant portion of military production, Rosstat initially saw growth of 7%, but is now reporting 15.3%. Generally speaking, according to the new data, the war and Western sanctions have not led to even a minimal decline in industrial production.

This picture perfectly aligns with the official propaganda narratives, which claim that sanctions (and the war) have only bolstered the Russian economy. Now, Vladimir Putin will likely use these claims even more boldly during his so-called pre-election campaign, despite the confusion of analysts who have many questions about this reassessment. For example, the MMI Telegram channel points out that in August 2023, the volume of cargo loaded by Russian Railways was 103.7 million tonnes (the same as in August 2022), while in the Augusts of the 'non-crisis' years of 2019 and 2021, it reached 109.1 million tonnes. Explaining the 5% decrease in shipments is not so straightforward, especially given that in 2022-2023, the railway transported a significant amount of heavy weapons and ammunition.

However, Rosstat's reassessment has not impacted evaluations of the current trend. If the pace of industrial production growth from March to May was 1.3% compared to the previous month, then in June and July, the production volume remained unchanged. Thus, current (yet unrevised) Rosstat estimates indicate a pause in the intensive economic recovery. The Centre for Macroeconomic Analysis and Short-Term Forecasting (CMACSF) has also observed a 'halt in growth' in this data, stating: 'While in June, the slowdown in industrial growth was primarily due to a reduction in the intensity of mining while manufacturing continued to grow, in July, growth ceased in both sectors.' However, the Centre takes a more modest view in its assessment of the scale of the preceding growth. The CMACSF experts refer to the recalibration of the data by Rosstat as 'planned' and also plan to revise their own data in the near future.

The volume of industrial production according to data from Rosstat, CMACSF and the Higher School of Economics, 100 = monthly average for 2019

The Industrial Intensity Index, calculated based on Rosstat data by the Centre for Development at the Higher School of Economics (HSE), also indicates a slowdown. However, experts at the centre have noted that the recovery growth may not have reached its peak yet: the surge in the index in May was substantial, so its stagnation during the summer may not necessarily signal a change in the trend. Experts have highlighted that 'the intensive recovery of recent months is almost entirely due to the dynamics of manufacturing, where pre-crisis production levels have already been significantly exceeded,' and this potential has not yet been fully tapped. Moreover, the future dynamics will depend on the extraction of natural resources, which has seen a decline in recent months, and in growing sectors where pre-war levels have not yet been reached (such as automobile manufacturing).

A much sharper assessment of this recent data has been provided by the MMI Telegram channel: 'The overheating of industry has reached its limits (partly due to the catastrophic shortage of labour), a matter which has been further compounded by the deliberate tightening of export sanctions.'

August surveys paint a picture of 'euphoric cooling' - a gradual deterioration of indicators that were at historic highs in the first half of the year but have now declined to favourable levels. The Purchasing Managers' Index (PMI) for Russian industry, calculated by S&P Global, stood at 52.7 points in August, compared to 52.1 in July and 52.6 in June. From November 2022 to May 2023, the average value of the index was 53.1 points. This may indicate a slowdown in recovery growth (a value above 50 points means that more business managers indicated an improvement in the economic situation rather than a deterioration).

Since the start of the full-scale invasion of Ukraine and the imposition of sanctions, S&P Global's business sentiment survey had only recorded a decline in business activity in Russia in March and April 2022. The index had risen above 50 points in May. From November to May, it averaged just slightly above 53 points, a level last seen in the Russian economy at the beginning of 2017. The average value for the past few months was 52.5 points. The analysts at S&P Global note that the growth in new orders accelerated to a three-month high in August, forcing companies to actively sell off their inventories. At the same time, there has been an intensification of inflationary pressure due to the recent depreciation of the ruble, with procurement and resale prices standing at 17- and 16-month highs, respectively.

A similar picture is depicted by the Central Bank's monthly business monitoring. The Business Climate Index (BCI) in August dipped to 5.2 points, down from 6.2 in July and an unusually high 8.8 in the second quarter. The decline in the index is primarily driven by the reduced assessments of current business conditions across most sectors of the economy. The shortage of labour is hindering companies' efforts to ramp up production. Current assessments for production volume have now declined for the second consecutive month and are now at a negative level. The shift in sentiment is evident, yet the composite index's value still remains relatively elevated. In the non-crisis year of 2019, its average value stood at a mere 3.5 points, and over the past decade, it averaged just 1.4 points. The chart below provides a clear visual representation of how these high (euphoric) ratings serve as a compensatory measure in the wake of the preceding shock (a catastrophic decline in the indices). However, neither steep declines nor surges in the index truly reflect the real economic dynamics.

Central Bank Business Climate Indicator, 2007-2023

As Re:Russia has previously reported, as early as the beginning of summer, the Russian economy had entered a phase of 'overheating' as a result of the fact that the industrial sector could not keep up with the powerful budgetary and consumer impulses due to structural constraints (lack of investment opportunities and skilled labour). The devaluation of the ruble has exacerbated the situation by increasing the cost of imported capital goods and components for businesses, which had already risen due to logistical and sanction-related constraints. These circumstances, coupled with concerns about rampant inflation on the eve of the presidential elections due to the ruble's weakening, has prompted the Central Bank, under pressure from the Kremlin, to raise the key interest rate from 8.5% to 12%. Such a high value for the key rate is deemed 'crisis-level'. It was only from December 2014 to May 2015 that it reached similar or higher levels (due to the crisis associated with the sharp drop in oil prices) and in March-May 2022, following the imposition of Western sanctions on Russia. Raising the rate to a prohibitive level for the second time in 18 months clearly indicates that the Russian economic problems associated with sanctions have by no means been resolved. And, with some temporal lag, this 'prohibitive' rate will inevitably impact the production capacity of businesses.

Thus, this shift in trend — from the recovery growth at the beginning of the year to stagnation — now appears to be the baseline scenario for the new business season and the pre-election period. However, in Rosstat's statistics, the overall picture still appears relatively favourable: after recalibration, the production volume figures for May (when the industrial sector reached a plateau) have already surpassed the pre-war production peak of December 2021.