27.11.23 Review

Non-market Undercooling: Despite the Central Bank's key rate hike, the economy is being generously supported by budget funds and remains overheated

The Central Bank's business climate indicator, which reflects business sentiment and reliably predicts economic dynamics, remains at fairly high levels. Experts expected it to deteriorate after a sharp increase in the Central Bank's key rate, which is usually a harbinger of a significant economic slowdown. Instead, Rosstat has reported record rates of economic growth, and entrepreneurs are optimistic about the future. However, this is not evidence of favourable economic conditions, but rather of their increasingly non-market nature. As data from the Central Bank show, many companies are continuing to increase lending, while others — especially those related to meeting military needs — are receiving extensive budget support. Moreover, preferential mortgage lending, which is also subsidised by the government, has only slightly slowed down, and state-owned companies are demanding new cash injections from the government. As a result, the Central Bank's rate hike has not yet had a 'cooling' effect on the economy, which is still overheating. The market interest rate is playing an increasingly small role in the budget-militaristic economy.

According to the November survey of enterprises, the composite value of the Central Bank's business climate indicator has improved slightly for the third consecutive time after declining from March to July of this year. The indicator is based on a survey of 14,000 enterprises and, as long-term observations show, is a good predictor of economic dynamics. The survey is conducted during the first half of the month, but encourages managers to assess the dynamics of the situation the previous month. After collapsing in February and March 2022, the indicator rose steadily and reached decade-high levels by the spring of this year. However, the same extremes were seen in the spring of 2021 during the recovery from the Covid crisis and in 2010 following the 2008-2009 crisis. Such high valuations thus reflect business sentiment in the phase of intensive economic recovery after a crisis. After this, in both 2021 and 2023, a decline in the index was observed, even though the economy continued to grow. In other words, it predicted a slowdown in the pace of growth.

Business Climate Indicator of the Central Bank and output dynamics in key sectors of economic activity, 2019–2023

At the same time, the recent growth in the composite index has been driven by the expectations of businesses, while their assessments of current conditions were almost at zero (this means that an equal number of enterprises surveyed said that conditions had improved and worsened). But this is also quite consistent with the picture of post-Covid recovery. As the growth rates return to pre-crisis values, they slow down, the improvements from month to month are no longer felt and are 'spread out' across the economy — growth continues, but it is now concentrated in certain sectors and industries. As it stands, Rosstat has reported record economic growth rates (+5.5% in the third quarter compared to the same period last year, following 4.9% in the second quarter), but analysts are increasingly expressing doubts about these figures ('Nonsense, of course — manipulation with deflators in military production,' wrote the authoritative Telegram channel MMI).

The fact of the matter is that macroeconomic conditions this year are significantly different from those in 2021. Since August, the Central Bank has begun a cycle of sharp interest rate hikes in response to signs of economic overheating, one of which, as Re:Russia has written, was accelerating inflation. This leads one to expect a deterioration in entrepreneurial valuations of the economy in response to higher credit costs following a base rate hike. But, as we can see, this is not happening: business expectations are on the rise.

In October, in addition to agriculture and electric power, the most positive assessments were noted in manufacturing—specifically among producers of investment goods, which include finished metal products, transportation vehicles and equipment (excluding automobiles), electrical equipment, computers, electronics, optics, among others. Military production is hidden within these sectors. The most pessimistic assessments were found in mining, as well as among producers of consumer goods and retail trade.

Expectations for production volumes over the next three months were higher than in September in almost all sectors. The most noticeable improvement in estimates is observed in retail trade and services. More restrained expectations were seen in mining and automotive retail. The latter is to be expected. 

Dynamics of prices and credit availability according to business estimates, 2019-2023

In reality, as the Central Bank survey shows, credit availability has fallen sharply (as is evident in the second graph) but not by as much as it did in early 2022. That said, as Re: Russia has previously written, despite some cooling, actual credit issuance remains at high levels. In October, according to the Central Bank, demand for loans from businesses grew by 2.3%, or 1.6 trillion rubles, following a 2% rise in September. Companies probably continued to increase their borrowing due to expectations of a possible tightening of monetary policy at the next meeting of the board of directors on 15 December, the Central Bank analysts suggest. However, there are other factors, such as high budget spending, which ensures continued optimism in war-related industries, and the continuation of preferential lending programmes. Major state-involved enterprises are seeking preferential loans from the government. In November, the heads of Russian Railways, AvtoVAZ, Aeroflot, Roscosmos, among other companies spoke on this topic at a round table in the Federation Council. The government, on the whole, supported their requests.

Thus far, the persistently high level of the Central Bank's interest rate has had a noticeable impact only on the dynamics of consumer lending. In October, lending grew by 1.1% after an increase of 1.5% a month earlier. According to Kommersant, major banks have exhausted their financing limits for preferential car loans, and will no longer issue them in 2023. The dynamics of mortgage lending has also slowed down (to 2.9%, from +4.2% in September), but the level of lending is still high, the Central Bank’s analysts note. At the same time, the authorities are discussing the extension of the most popular preferential mortgage program, which accounts for a significant portion of lending in the primary housing market. Therefore, it is likely that this pro-inflationary factor will continue, although to a lesser extent due to the tightening of consumer loan issuance (previously, people took out both a mortgage and consumer loan together, and this model had a strong inflationary effect).

Against this backdrop, assessments of current and expected inflation rates, while no longer deteriorating, remain at high levels. In other words, just as the Central Bank had feared, judging by enterprise surveys, so far, due to too wide non-commercial lending from the budget, the increase in the base rate has too weak a cooling effect on the economy. In this situation, even a further hike of the key interest may not be enough to cool it down. However, the time lag of the influence that the rate has on the economy has not yet been exhausted. Nevertheless, the overall conclusion remains unchanged: the role of market stimuli in such a budget-militaristic economy is diminishing.

The values of the business climate indicator represents the modified difference between the answers 'the situation has improved' and 'the situation has worsened'. The composite indicator is formed of two components — assessment of the current business climate and assessment of the expected business climate. Heads of enterprises are asked how they evaluate changes in demand and production volume at the time of the survey and over the next three months. Additionally, the Central Bank calculates composite indices for demand and output. The survey covers about 14,000 enterprises across all key types of economic activity. Indicators for previous periods are reflected on the basis of complete data, taking into account the questionnaires received after the preparation of operational information.