21.11.23 Review

Crisis genre: The Russian economy is able to recover successfully from crises, but sees almost no growth in the long term

The Russian economy grew at an annualised rate of 5.5% in the third quarter, after an increase of 4.9% in the second quarter. In both cases, this is recovery growth from the lows of 2022. Within the past ten years, such high dynamics were only witnessed at the peak of the post-pandemic recovery. At the same time, while at the end of 2021 the economy showed no signs of overheating, in 2023 inflationary pressure has forced the Central Bank to raise the key rate sharply. More expensive credit will lead to a serious slowdown in growth in the coming quarters, so, in fact, the high growth rate in the third quarter will not give the economy any gains in the long term. This is a fairly typical situation. Over the past ten years, the Russian economy has demonstrated the ability to cope with crises quite well, but after recovery it sees hardly any growth at all. In an inert scenario (i.e. if nothing extraordinary happens), GDP will grow at a modest rate over the next two years, and it will be able to return to a balanced growth trajectory of about 2% per year no earlier than 2026, according to forecasts from the Central Bank. The regulator underscores that the normalisation of budget expenditures is a condition for this scenario. But even if this forecast comes to fruition, Russia's GDP will grow by only 20% in 2026 compared to the level of 2011 and will be 8 percentage points lower than it would have been if Russia had not started a war.

According to preliminary estimates by Rosstat, Russia's GDP saw an increase of 5.5% on the same period of 2022. Within the past ten years, such high dynamics were only witnessed at the peak of the post-pandemic recovery: in the second quarter of 2021, year-on-year growth was 11.2%, in the third quarter it was 5%, and in the fourth quarter it was 5.8%. At the end of the first nine months of 2023, GDP growth, according to calculations by the Ministry of Economic Development, is up 2.9% on the same period of 2022. At the end of the year, growth may reach 3%, according to Minister for the Economy Maxim Reshetnikov (his estimates have been echoed by Vladimir Putin). In 2021, by comparison, the economy grew by 4.7%, which was the highest result since 2008. However, in both cases, this is not the progressive growth of the economy, but is recovery following a crisis. 

The highest recovery dynamics in the third quarter of 2023 were seen by wholesale (+23%) and retail trade (+11%), manufacturing (+10%) and construction (+8%). In the first nine months of 2023, mining, wholesale trade, non-food retail and transport freight have yet to recover to pre-war levels. Manufacturing, construction, agriculture, public catering and paid services are significantly above the level of two years ago.

In 2021, the situation was different. The highest rates in the third quarter were seen by transport passenger turnover (+49.0%) — which is perhaps natural during post-quarantine recovery — but the contribution of this sector to overall GDP is quite small. Of the large sectors of the economy, the highest levels of growth were demonstrated by mining (+9.4%), wholesale and retail trade (+6%), while manufacturing industries grew by a modest 3.7%. In other words, the recovery was more evenly spread then. 

While in 2021 the main driver of growth was the recovery in external demand for raw materials and the realisation of pent-up domestic demand from 2020, which supported income growth and relatively low lending rates, in 2023 this growth has been primarily driven by budget expenditure and also private consumption. The growth of the manufacturing industry was driven by defence needs and forced import substitution due to the imposition of sanctions, while construction growth was also supported by military needs and preferential mortgage lending. According to estimates by Alexander Isakov, chief economist for Russia at Bloomberg Economics, if we exclude the financial sector, GDP grew by 7.4% in the third quarter of 2023: manufacturing and wholesale trade grew by about 3 percentage points each, while retail and construction grew by 1 percentage point each.

At the same time, unlike the recovery in 2021, when the economy showed no signs of overheating, the accelerated recovery that has taken place in 2023 has caused a surge in inflation. The Central Bank was forced to raise its key rate sharply, to 15%. 'The economy is overheating, deviating upwards from the trend by 2.5% of GDP, and further growth is constrained by supply-side barriers: lack of available labour and limited logistical opportunities,' Gazprombank's Centre for Economic Forecasting has noted on the current situation. Without removing these bottlenecks, budget stimuli will not be able to create additional output and will have a greater impact on the redistribution of resources between economic sectors.

In other words, after the rate increase, manufacturing companies (primarily the defence industry) will continue to grow thanks to government orders and preferential loans. As Re:Russia has previously written, the dynamics of the construction sector will be supported by the programme of preferential mortgages, which the authorities are unlikely to decide to get rid of before the presidential election. However, in this sector too, government support leads to an increase in prices, no less than to an increase in construction volumes. Other sectors will slow down sharply in the coming months as a result of tight monetary policy, which the Central Bank intends to adhere to for several quarters. Alexander Isakov from Bloomberg Economics expects GDP to contract by 0.1-0.2% quarter-on-quarter in the fourth quarter of 2023 and the first quarter of 2024, i.e. the economy will experience a 'nano-recession'. The Central Bank forecasts a less rapid slowdown — up to 1.5% - in the fourth quarter.

Over the past ten years, the Russian economy has mainly been a story of recovery from crises. In total, there were three of them during this period: in 2014-2016 — due to a sharp decline in commodity prices, in 2020 — due to a pandemic, and in 2022 — due to the full-scale invasion of Ukraine. After the first crisis, the recovery was the most gradual but also the most confident; after the second, it was the most abrupt but linked to external factors (such as the rise in raw material prices); and in the third, it was fuelled by budgetary resources and defence orders but it was quickly choked off. In other words, the Russian economy copes well with crises, but the problem is that they happen too frequently in Russia (once every three or four years) and so the economy hardly grows after its recovery from the crisis.

The chart presented below illustrates several scenarios for the dynamics of the Russian GDP. The upper curve represents the Central Bank's forecasts for the growth of the Russian economy made on the eve of the war and published in February 2022. They assumed modest but steady growth rates of 2% annually. As a result, the economy was expected to grow by an equally modest 28% by 2026, compared to figures from 2011. The next branch represents the government's forecasts, assuming a growth rate of 2.2% annually after the turbulent recovery in 2023, indicating a gradual slowdown in the economy. In its current baseline forecast, the Central Bank expects the Russian economy to grow by 0.5–1.5% next year and by 1–2% in 2025. In 2026, according to the Central Bank, it may enter a "trajectory of balanced growth" at 1.5–2.5%, if tightening credit and monetary policy and limiting budgetary expenditures help overcome its imbalance. Central Bank Chair Elvira Nabiullina has specifically emphasised that raising the interest rate may not be sufficient for this if budgetary expenditures continue to rise. In its October forecast, the World Bank also paints a scenario similar to the Central Bank's, but with a lower estimate for the growth rate of the Russian economy in 2023. Both forecasts suggest that the vigorous recovery in 2023 will turn into a sharp slowdown in the next period. As a result, the economy in 2026 will be up by only 20% on 2011’s figures and will be 8 percentage points lower than it would have been had Russia not started the war. It would also mean that the average growth rate of the economy within this 15 year period has remained at 1.2% per year, about two and a half times lower than the average growth rate of the world economy.

Russia's GDP in 2011-2021 and variants of its dynamics in 2022-2026 — with and without war, %, 100 = Russia's GDP in 2011