Experts have been debating whether Russian industry showed a slight upturn or a slight decline in January, but resolving this dispute does not change the overall picture. Industry has been stagnating for more than half a year. This situation is largely determined by the mining sector, the performance of which is determined by the decline in Russia's raw material exports. Stimulating domestic demand, as demonstrated in the second half of 2023, does not yield sufficient results in import substitution and leads to rising prices. Industry is largely supported by budgetary stimulus and defence industries, to which it is largely directed. However, there are limits here as well. Some 'defence' enterprises have slightly reduced output in recent months. Improving industrial performance through new budget injections is unlikely, and there is still room for the situation to worsen. So far, high revenues from the previous period have helped businesses to survive the sharp increase in the Central Bank's interest rate. In 2024, this effect will come to an end, and in a number of industries profitability has long been below the cost of capital. In general, however, industry is experiencing deflation, which could lead to a revenue downturn in most sectors, experts warn.
According to Rosstat data for January, industrial production in Russia increased for the first time in six months, albeit by only 0.7% when seasonally adjusted. The Ministry of Economic Development also reported growth in output. Calculations by the Higher School of Economics (Vladimir Bessonov's group) show a similar rise, but from a lower level and after a noticeable decline. This is more indicative of a picture of more volatile stagnation. Experts from the government-aligned Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF), believe it is premature to speak of a resumption of growth based on one month's results. Additionally, a one-time factor played a role: the output in the electricity sector significantly increased due to cold weather. According to CMASF experts' own assessments based on a narrower basket of goods, there was a slight decline in January (-0.3% compared to December). Macroeconomists from Raiffeisenbank, for example, have also noted the continuation of stagnation, expecting industrial production growth rates to remain near zero.
There are three growth drivers for the Russian industry: exports (mainly raw materials), budget stimulus, and growth in domestic private consumption. A significant contribution to stagnation comes from the unfavourable situation in the extractive sector, which is associated with export restrictions, as noted by the experts from CMASF. The reduction in export volumes is also the main cause of the weak dynamics of such an indirect indicator of economic activity as transport turnover, suggest analysts from the MMI Telegram channel: -4.8% year on year in February after -4.4% in January. Overall, extraction volumes have been consistently declining since the beginning of the war, and the momentum that the sector had in 2023 in goods for intermediate demand has worn off.
Simultaneously, the demand impulse created by the war, namely budgetary stimulus (→ Re:Russia: Loss of Momentum), which propelled industry last year, is gradually fading away. Some segments of the manufacturing sector, where the defence industry dominates production, have even slightly reduced production volumes in recent months, according to CMASF experts. For example, their assessment indicates a 2.2% decrease in the production of finished metal products (including weapons and ammunition) in January compared to the previous month, and a 3.4% decrease in December. Compared to the peak value in September 2023, metal product output has already dropped by 12%. However, some machinery sectors, also associated with the war, continue to support production. Still, further production growth through military orders is unlikely.
Domestic private consumption is supporting industry due to a noticeable increase in wages caused by acute labour shortages (→ Re:Russia: Record Labour Shortages). However, this impulse is unable to provide any substantial increase in output for the industrial sector as a whole. In January, growth was demonstrated in food production (+0.9% compared to December, +3.5% over three months), as well as in furniture manufacturing. Production of non-food items and goods with long-term demand decreased. Most likely, this reflects the impact of the Central Bank's tight monetary policy.
The long-term (over six months) stagnation in industry indicates that its intensive growth in the first half of 2023 was a result of a combination of recovery after the slump in 2022 and the impetus from the military sector. The recovery phase has ended. Import substitution has been observed in certain commodity groups but does not have wide-ranging effects. In a previous review ('Analysis of Macroeconomic Trends'), the experts from CMASF noted that although statistics show ongoing investment growth, the supply of investment goods decreased by 7.8% from August to December, indicating a contraction of enterprise plans to expand output.
Regardless of whether the January data is interpreted as slight growth or negligible decline, it does not change the overall picture. Moreover, this situation has persisted for six months after the Central Bank's sharp interest rate hike: industry has not entered a decline. This is partly facilitated by the same budgetary demand, which is affected by inflation but not interest rates. In addition, economic experts believe that the interest rate hike is helping companies survive on high incomes from the previous period. However, this temporary factor is also nearing its end. Although 'high profitability remains in some sectors, allowing them (thus far) to adapt to high interest rates,' profitability in mechanical engineering has long been below the cost of capital. Overall, deflation is observed in industry, which could lead to income declines in most sectors, the authors of the CMASF review caution.
The dynamics of Russian industry and the economy as a whole in 2023 have presented economists with a series of puzzles. The effects of sanctions and the extraordinarily high income from energy exports in 2022 have intricately merged. In 2023, these incomes were transformed into a powerful budgetary impulse, primarily affecting industry and construction. Some of it, however, also reached the labour market. However, the situation is gradually returning to normal. The arithmetic of Russian growth is fairly simple. The limits of stimulating private domestic demand were demonstrated in the second half of 2023. Significant demand growth does not yield a sufficient response from import substitution, resulting in rising prices. Thus, contraction in the external sector (extractive industries) cannot be compensated for through this magic mechanism, as proponents of militarised isolationism had hoped. It will have to be offset by budgetary spending and defence production. Without the defence sector, industry would likely already be in decline. The government, of course, intends to maintain its funding at a high level. However, such redistribution is increasingly being manifested as a direct deduction from citizens' well-being and business investment opportunities.