Economics Russia in 2013 Growth Moderates Amid High

Economics Russia in 2013: Growth Moderates Amid High Inflation Evgeny Gavrilenkov, Chief Economist September 2013 1 INVESTMENT RESEARCH

Sluggish economic growth in 1 H 13, but there is a chance for a rebound in 2 H 13 § Domestic demand weakened in 1 H 13, eroded by high inflation and high interest rates. Retail sales grew 5. 9% and investments rose 6. 7% in 2012. In 7 m 13, retail was up 3. 8% and investment was reportedly down 0. 7% y-o-y (in July alone, investment was up 2. 5%). Both numbers should look better in 2 H 13 as inflation subsides and lending rates will slowly come down. § Economic growth decelerated largely because nominal private consumption, which in the past was fueled by rapidly expanding consumer lending, decelerated, as households are paying a rapidly growing proportion of their income on interest payments. § Apart from that, government interventions on money markets, which fueled devaluation expectations, had a negative impact on economic activity. § The CPI edged up 0. 8% m-o-m in July. This compares with 1. 2% a year earlier, bringing y-oy inflation to 6. 5% as of August 1, versus 6. 9% at end June. Over the first 26 days of August, inflation was at 0. 1%, versus 0. 2% in the same period last year. Thus, y-o-y inflation slowed to 6. 4%, from 6. 5% at the beginning of the month. YTD inflation also slowed to 4. 5%, versus 4. 7% a year earlier. In our base case, y-o-y inflation will come down below 6% at end 2013. § We see GDP growing around 2. 5% in 2013. Retail sales expanded 4. 3% y-o-y in July and 3. 8% in 7 m 13. Our forecast for annual consumption growth is around 4. 0%, as we expect it to rebound in 2 H 13 as inflation decelerates. The investment statistics are biased: investment growth was too strong in 1 Q 12, which created a high-base effect. This effect will gradually evaporate by year end, and investment growth should accelerate in 2 H 13, bringing the annual figure to around 3. 5%. September 2013 2 INVESTMENT RESEARCH

Industry stagnates amid decelerating domestic demand Industrial output growth decelerating as generally expected, January 2006 = 100% Source: State Statistics Service, Sberbank Investment Research September 2013 Retail, manufacturing and import growth, y-o-y Source: State Statistics Service, Sberbank Investment Research 3 INVESTMENT RESEARCH

Basic sector dynamics (as well as GDP) have not been revised upward despite changes in wholesale trade Source: State Statistics Service September 2013 4 INVESTMENT RESEARCH

The wealthier the country, the slower the growth expected Source: IMF September 2013 5 INVESTMENT RESEARCH

Russia’s indebtedness is low compared with peers GDP per capita and gross public debt in East European countries and the FSU, 2012 Source: State Statistics Service, Sberbank Investment Research September 2013 GDP per capita and external debt in East European countries and the FSU, 2012 Source: State Statistics Service, Sberbank Investment Research 6 INVESTMENT RESEARCH

The massive liquidity absorption by the Finance Ministry destabilized money markets in mid 2012, R bln Note: Injection of liquidity (+), absorption of liquidity (–) Source: Finance Ministry, Central Bank, Sberbank Investment Research September 2013 7 INVESTMENT RESEARCH

Credit rates grew in 2012 amid increased and domestic Sovereign borrowing, but both stabilized in 2013 Source: Central Bank, Finance Ministry September 2013 8 INVESTMENT RESEARCH

Nominal interest rates: the margin between banks’ lending rates and their borrowing costs have narrowed Source: Central Bank September 2013 9 INVESTMENT RESEARCH

Real interest rates turned positive in 2012, but some moved back to negative territory as inflation accelerated Source: Central Bank September 2013 10 INVESTMENT RESEARCH

Although external debt has grown, foreign debt payments are bearable, $ bln Source: Central Bank September 2013 11 INVESTMENT RESEARCH

The Central Bank and the Finance ministry intervene on the money markets jointly but without much coordination Since 2009, the forex market is more volatile The Finance Ministry has become an important than the ruble money market as monetary player on the money market, R bln policy has changed Source: Finance Ministry, Central Bank Source: Central Bank September 2013 12 INVESTMENT RESEARCH

The Central Bank has again increased long-term lending to banks against illiquid collateral in July 2013 Source: Finance Ministry, Central Bank September 2013 13 INVESTMENT RESEARCH

Oil price and domestic inflation are key determinants of the exchange rate moves in the long run Source: Central Bank, Bloomberg, Sberbank Investment Research September 2013 14 INVESTMENT RESEARCH

New equilibrium has yet to emerge Source: Central Bank, Sberbank Investment Research, Bloomberg September 2013 15 INVESTMENT RESEARCH

Flat currency band looks unreasonable amid high inflation Source: Central Bank September 2013 16 INVESTMENT RESEARCH

Internal regulations force the Central Bank to support the ruble if it moves away from the median of the band Source: Central Bank, Sberbank Investment Research September 2013 17 INVESTMENT RESEARCH

Central Bank refinancing banks and absorbing liquidity at the same time by buying forex Source: Central Bank, Sberbank Investment Research September 2013 18 INVESTMENT RESEARCH

Real and nominal dynamics of major GDP components are different Public consumption as % of GDP Public consumption and investments as % of GDP Source: State Statistics Service, Sberbank Investment Research September 2013 Source: State Statistics Service, Sberbank Investment Research 19 INVESTMENT RESEARCH

Private consumption and net exports as % of GDP Source: State Statistics Service, Sberbank Investment Research September 2013 20 INVESTMENT RESEARCH

Inflation accelerated in 2 H 12 amid moderate money supply growth, but should decelerate in 2 H 13 Source: State Statistics Service, Central Bank September 2013 21 INVESTMENT RESEARCH

Annual inflation gradually returns to a more “normal” level as last year’s base effect evaporates Annual inflation versus refinancing rate Monthly inflation, m-o-m Source: State Statistics Service, Central Bank September 2013 22 INVESTMENT RESEARCH

Utility tariff indexation has a limited impact on CPI, January 2009=100% Source: State Statistics Service September 2013 23 INVESTMENT RESEARCH

Consumer lending grew too fast in 2011 -12 Consumer lending expanded more than 40% in 2011 and early 2012, which also contributed to an acceleration in inflation, y-o-y Consumer credits still grow too fast Data: January 2009 -May 2013 Source: State Statistics Service, Central Bank September 2013 24 INVESTMENT RESEARCH

Bank credit/GDP ratios remain low and are set to rise, albeit moderately Source: Central Bank, State Statistics Service September 2013 25 INVESTMENT RESEARCH

Nominal consumption growth decelerates despite stable and even accelerating growth of nominal income… Nominal income and retail sales, y-o-y Consumer credits and deposits, y-o-y Source: State Statistics Service, Central Bank September 2013 26 INVESTMENT RESEARCH

… as interest rate on consumer loans are too high Household income structure Nominal interest rates on retail loans Source: State Statistics Service September 2013 27 INVESTMENT RESEARCH

Interest paid on retail loans/income ratio started to grow exponentially Source: Central Bank, State Statistics Service, Sberbank Investment Research September 2013 28 INVESTMENT RESEARCH

Population by age group, ’ 000 people, scenarios forecast Source: State Statistics Service September 2013 29 INVESTMENT RESEARCH

Consumption supported by consumer lending was a key driver of economic growth Consumer credit supported consumption Source: State Statistics Service, Central Bank Private consumption was a key driver of economic growth, but its share in nominal GDP did not increase Source: State Statistics Service, Central Bank September 2013 30 INVESTMENT RESEARCH

Even though outstanding consumer debt is low relative to GDP, a problem emerged, as interest rates are too high Consumer loan growth outstrips the expansion of corporate loans Source: State Statistics Service, Central Bank Loans/GDP ratios are growing Source: State Statistics Service, Central Bank September 2013 31 INVESTMENT RESEARCH

The budget will remain in good shape, but the fiscal rule being introduced is problematic § One of the risks associated with the idea of reintroducing the fiscal rule from 2013 and replenishing the State Reserve Fund is that the government plans to continue to borrow on the local market even in the case of a budget surplus. A “borrowed safety net” is costly and does not seem reasonable, as it crowds out other borrowers. § The budget ran a surplus in 7 m 13, but will most likely turn into a small deficit by year end. As rates are high, the government’s borrowing plans are well behind plan, implying limited possibility to replenish the State Reserve Fund this year. Ruble depreciation will keep the breakeven oil price relatively unchanged. § The breakeven price in 2012 was around $110/bbl. It is impossible to calculate the future breakeven price of oil accurately, as it depends not on budgetary expenditures alone but on revenues as well. The latter is a function of the exchange rate, which itself depends on the current oil price. Hence, the future breakeven oil price is a function of the future oil price, so modeling depends on statistically cofounding and unpredictable variables. Meanwhile, the flexible exchange rate policy makes the budget more resilient to external shocks. § Rebuilding the State Reserve Fund to up to 7% of GDP by 2015 has become the real objective (albeit elusive) of state macroeconomic policy. It looks as though the rule will either be modified or outright abolished, as it was not even applied de facto in 1 H 13. September 2013 32 INVESTMENT RESEARCH

Russia’s breakeven oil price has risen substantially in recent years but seems to have stabilized as the ruble started to float Budgetary policy was generous in the past decade, and the State Reserve Fund shrank in 2009 -10 before returning to growth in 2011. Source: Finance Ministry, Sberbank Investment Research September 2013 Source: Finance Ministry, Sberbank Investment Research 33 INVESTMENT RESEARCH

The budget breakeven oil price is only a theoretical concept and is a function of the oil price itself, not expenditures alone Source: Sberbank Investment Research September 2013 34 INVESTMENT RESEARCH

Case study: the trade balance would remain highly positive and the budget deficit would be limited if the oil price were to stay at $80/bbl Note: Data from January 2007 to June 2013 Source: Central Bank, Finance Ministry, Sberbank Investment Research September 2013 Source: Central Bank, Finance Ministry, Sberbank Investment Research 35 INVESTMENT RESEARCH

The budget may look better than the government expects, R bln Source: Finance Ministry September 2013 36 INVESTMENT RESEARCH

Budget expenditures in 2013 -16, R bln Source: Finance Ministry September 2013 37 INVESTMENT RESEARCH

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