05.10.23 Review

Inertia of Overheating: The slowdown in Russian industry has begun, but will only reach its peak in late autumn

The cycle of intensive recovery growth in the Russian industrial sector has come to an end, yet the reduction in production output remains minimal for industry as a whole compared to last month. The number of sectors that are in the red in terms of output includes wood processing, construction materials, and pharmaceuticals, which were showing signs of growth earlier in the summer. However, the military-industrial complex remains a stabilising anchor for industry. Meanwhile, the Purchasing Managers' Index (PMI), which reflects the sentiments of sales managers, is still demonstrating fervent optimism, which can be interpreted as a sign of renewed growth but is more likely the inertia of 'overheating'. In the meantime, the Central Bank's successes in combating 'overheating' remain limited, with inflation showing no signs of slowing down. This has led experts to discuss the possibility of a new key interest rate hike. However, the main impact of its past and any future increases will affect industry with a lag of two to three months.

The cycle of intense recovery growth in the Russian industrial sector, which had been ongoing since the end of last year, has come to an end. According to Rosstat data, industry has entered a soft recession, with August marking the third consecutive month in which production volume saw a slight decline. In August, the decline was 0.3%, and in the three months since the May peak, it was 0.5%. A slightly more positive assessment of industrial production dynamics comes from the Center for Macroeconomic Analysis and Short-Term Forecasting (CMASF), which has ties to the government. Its analysts have currently only observed a 'suspension of growth’. CMASF came to the same conclusion a month ago, but then analysts recalculated the data for 2022-2023 (this was in response to Rosstat recalibrating its data, as Re:Russia has previously reported) and improved the assessment for July. However, CMASF still produced more modest estimates for months preceding August than Rosstat, so the level at which its experts recorded the 'suspension' was almost equivalent to the assessment of the federal service. HSE analysts see a slightly more intensive decline for the second consecutive month, and moreover, they have a more restrained assessment of the results of the recovery period. They believe that industry has not yet reached the peaks of December 2021.

Industrial production volume, according to data from Rosstat, as estimated by CMASF and HSE, 100 = the average monthly value for 2020

Last month, the experts at CMASF observed that the intensive recovery of recent months was largely driven by the dynamics of defence-related manufacturing, where pre-crisis production levels have already been noticeably exceeded. Future dynamics largely depend on continued growth within this sector and on the extraction of natural resources, where a decline has been recorded in recent months. Oil extraction saw a further decline in August as did the production of coal and metallic ores. Gas extraction, on the other hand, increased by 5.8% compared to July, after an average decrease of 4.1% during the second quarter. Overall, the extractive sector (which accounts for approximately one-third of total industrial production) declined by 6.2% in August compared to the previous month, following a 4.7% decrease in July. Manufacturing industries are still growing, with a 3.2% increase in August compared to the month before. However, the analysts at CMASF note that these growth rates are slower than they were before. Growth in the investment goods category has ground to a halt, but the production of durable consumer goods continues to grow, albeit at a slower pace.

A month ago, the CMASF experts noted that the sectors that are yet to recover to pre-war levels could still contribute to the overall dynamics of industrial production. This includes automobile manufacturing, in particular. However, in August, growth in the automotive industry sharply decelerated, with a 1.1% increase compared to +8.6% in July and an average of +4.8% for the first half of the year. Wood processing, pharmaceuticals, and construction materials are in a state of severe decline, despite showing weak growth at the beginning of the summer. Meanwhile, industries associated with the defence sector such as metal product manufacturing, optics and electronics, as well as railway engineering, aviation, and shipbuilding, continue to buoy industrial indicators, preventing them from declining further.

The results of the Central Bank's efforts to combat 'overheating,' manifested in a sharp increase in the key interest rate, are likely to reach the real sector in late autumn, and it is unlikely that they will affect defence industries at all (as Re:Russia has previously reported). However, it is worth noting that these efforts have not yet yielded sufficient results. At the next meeting of the Central Bank's board of directors on October 27, the regulator may raise the key interest rate even higher, up to 15%, the MMI Telegram channel predicts. According to its estimates, annual inflation has already accelerated to 13.5%, which is higher than the current key rate (13%).

Meanwhile, the results of S&P Global's September survey still demonstrate tremendous optimism. The S&P Global Russia PMI for manufacturing index soared to 54.5 points, up from 52.7 in August (a value above 50 points indicates an increase in economic activity, while below 50 points indicates a decline). This is the largest increase since January 2017. However, the results of the summer surveys indicated cooling: in July, the value was 52.1 points, and in June, it was 52.6. From November 2022 to May 2023, it averaged 53.1. The analysts at S&P Global attribute the surge in September to a sharp increase in the number of orders (the growth rate is once again at its highest level since 2017) and the desire of manufacturers to build up their stockpiles. The latter is clearly driven by concerns about a further depreciation of the ruble. Business expectations for the coming year have also improved. The main constraint remains the shortage of labour. The pace of job creation in September was the highest it has been since the end of 2000.

Some see this as a positive signal that industrial production growth may yet resume, but it is more plausible to interpret these unusually high values as manifestations of 'overheating.' Demand is at an extremely high level, and sales have not yet declined despite the rise in selling prices.