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Swedbank Baltic Sea Analysis No.

25 y 19 August 2010

Fire, drought, and global softening –
The Russian recovery stumbles
• The global economic crisis has hit Russia harder than other comparable
emerging market economies, and the recovery has been slower. Real GDP
growth in the first half of 2010 was 4.2% and mainly driven by consumption
and inventory restocking. The drought and wildfires have taken a large hu-
man toll and are also leading to economic losses, mainly in the agricultural
sector. Food prices have already started to shoot up and commerce has
been disrupted as a consequence.

• The policy reaction to the deep economic crisis has been forceful and
successful in mitigating the negative impact on households and firms. Fiscal
policy has been expansive and monetary policy loose. However, inflation
pressures could reemerge, and weaknesses remain in the financial sector.
Little has been done to reform the Russian economy and enhance its growth
potential. There has also been a rapid reaction to this summer’s natural
disaster, although the political fall-out could be long lasting. Discontent is
spreading concerning the public sectors ability to respond to emergencies.

• The economic outlook over the next two years is characterised not only by a
rebound from the sharp contraction in 2009, but also by a weakening of the
global business cycle. We expect real economic growth in Russia to reach
4.3% in 2010, following a slowing of momentum in the second half of the
year. In 2011 and 2012, we forecast modest growth rates of 4.3% and 4.5%,
respectively. This is lower than we anticipated in our April forecast. Eco-
nomic policies are expected to remain expansive in anticipation of the up-
coming elections in late 2011 and early 2012. This will cause inflation to in-
crease and reach double digits in 2011. The rate of appreciation of the rouble
will slow as oil price increases level off. Transparency in the banking sector
is limited, which leads to uncertainties. We would suggest that the Central
Bank authorities launch a stress-test exercise along the lines of the US,
Europe and now possibly China to strengthen the trust in the banking sector
and identify remedies.

Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 7740
e-mail: Internet: Responsible publisher: Cecilia Hermansson +46 (0)8-5859 7720.
Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 7730 ISSN 1103-4897
The Russian economy rebounds – but from a
deep trough
Russia has seen a much sharper contraction than other emerging The economic crisis
economies. While China and India saw a mild weakening of economic has hit Russia harder
activity, natural resource-dependent economies such as Russia and than other emerging
Brazil experienced actual declines. In Russia, the global downturn markets
exposed weaknesses in the financial sector, which led to further de-
clines and capital outflows. Despite the very significant base effects in
Russia in 2010, the first quarter year-on-year growth of 3% was
dwarfed by rates in the other BRIC countries. This suggests that Rus-
sia is less poised for a return to a normal economic situation.

Real GDP growth in the BRIC countries

(Year-on-year growth in %)



5 China

0 Brazil

2006  2006  2007  2007  2008  2008  2009  2009  2010 
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1

Source: Ecowin.

It was primarily manufacturing and construction that showed the larg- Manufacturing and
est declines during the downturn in Russia, while services held up construction are the
better. However, manufacturing has made a fairly strong comeback, main drag on eco-
growing in positive numbers since late 2009 and at double-digit levels nomic growth in Rus-
during most of 2010. However, in July the annual growth rate de- sia
clined to 8%. Activity in the construction sector remains depressed.
Only in June 2010 did the sector start to expand in annual terms after
contracting for 17 straight months.

2 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

Sector growth rates, 2006 – 2009
(Year-on-year real growth in %)


Agriculture and fishing
10.0 Extraction
‐10.0 Private services
‐20.0 Public services

2006  2006  2007  2007  2008  2008  2009  2009 
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3

Source: Ecowin.

The widespread droughts and wildfires that have plagued Russia dur- Drought and wildfires
ing this summer have had a devastating human toll, as well as have a devastating
caused significant economic disruptions. More than 50 people have human impact and
been killed directly by the fires, while the mortality rate in for example cause widespread
Moscow has doubled during the summer months, presumably due to economic disruptions
the reduce air quality. Even more have lost their homes and liveli-
hoods. Agricultural production has been most severely hit with wheat
production down by an estimated 30 %, but commerce is also af-
fected. Food prices have shot up reversing, possibly temporarily, the
downward trend of inflation. In big population centres reached by the
smoke, consumption is likely to decrease, and, due to the export ban
on wheat, traders and transporters will see income losses. Other sec-
tors are also affected, albeit to a lesser degree. Car plants have had
to shut down due to the smoke and consumption will likely decline as
many minimize shopping.

On the demand side, it was primarily exports and investments that led Private consumption
the decline in early 2009. From mid-2009 onwards, however, the emerges as the most
economy started to grow again, on a quarterly basis, mainly on ac- important engine of
count of inventory restocking, but momentum started to fade in late growth
2009 and early 2010. Exports are rebounding, but strong growth in
imports limit the impact from net exports. Household consumption is
now contributing to growth, while investments continue to lag. For the
second quarter of 2010, preliminary data suggest that the economic
pace began to pick up again and real GDP growth reached 5.2%
year-on-year. Overall for the first half of 2010, real growth at 4.2%
over the same period last year, is somewhat better than expected, al-
though the annual growth rates are largely an effect of the very low
levels that prevailed during early 2009 (the so-called base effect).

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 3

Demand components of economic growth, 2007 - 2010
(Year-on-year growth in %)


8 7.7 9 9.3 7.7

10 6.6 5.2
‐20 ‐9.4


2007  2007  2007  2008  2008  2008  2008  2009  2009  2009  2009  2010  2010 
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

GDP Investments Exports Consumption Imports

Source: Ecowin.

The rebound in consumer demand is driven by improving labour mar- A stable labour market
ket conditions and a boost in transfer incomes. The official unem- and public support un-
ployment rate has been falling since early 2010 and reached 6.8% in derpin consumption
June, compared with 8.3% the same month last year. The real unem-
ployment level is likely to be higher as the official unemployment sta-
tistics have a limited coverage. A large portion of the fiscal stimulus
program has been devoted to increases in pensions and of the mini-
mum wage, and to other public transfer schemes. As household real
wages and real disposable income have increased, households are
paying off debt. Thus, as the saving rate is increasing, household fi-
nances are stabilizing, and consumption is set to be the main engine
of growth.

Labour market developments, 2005-2010

(In %)



Real wage (annual 
0 growth)
Unemployment rate


Source: Ecowin.

4 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

Business confidence remains muted despite recent improvements in Despite some
sentiment. These improvements are not enough to spur investment improvement in
growth. Quarterly real growth rates in early 2010 remained flat after business sentiment,
falling throughout much of 2009. Also, investments by state-owned investment lags
enterprises failed to take off. Although investments in these sectors--
mainly extraction, electricity, and transport--are under indirect gov-
ernment control, the growth rates were below what was anticipated.
In particular, Gazprom failed to raise investment rates, while invest-
ments in electricity production and railways grew by 25 to 30% annu-
ally in the first quarter. This did not, however, compensate for the
continued stalemate in the rest of the economy.

Business sentiment, 2007 – 2010

Net balance

2007  2007  2008  2008  2009  2009  2010 
Q1 Q3 Q2 Q4 Q2 Q4 Q2

Source: Ecowin.

The consumer inflation rate has been falling, while the exchange rate Inflation rates fall
has continued to strengthen. At mid-2010, annual inflation fell to sharply
5.8%, compared with almost twice the rate the year before. Food
prices have come down (prior to this summer’s drought and wildfires),
and the sharp appreciation of the rouble has lowered the cost of im-
ported goods, a major part of the consumer basket. The exchange
rate dynamics reversed during the spring as the European debt prob-
lems led to falling oil prices and a flight to the US dollar. However, the
still-strong rouble erodes the competitiveness of Russian production.
Domestic producers find it harder to compete with imports, and ex-
porters face an uphill battle to penetrate foreign markets. Thus, the
need to diversify Russia’s economy away from dependence on natu-
ral resources becomes even more difficult to meet.

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 5

Annual inflation rate and the real effective exchange rate, 2005 - 2010
(In %)



Real effective 
0 exchange rate

‐5 Inflation (eop)










Source: Ecowin.

Despite increased lending activity, uncertainty prevails in the financial

sector. Domestic credit started to increase for the first time since late
2008. However, the default by the International Industrial Bank (IIB)
on a 200 million Eurobond indicates that the problems may not be
over. Domestically, nonperforming loans remained slightly below 10%
in the first quarter of 2010, but the lack of credible information and re-
porting systems creates a lack of transparency. It is still unclear how
many loans were restructured during the crisis, and it is difficult to as-
sess future potential credit losses in the banking system. The spreads
between Central Bank policy rates and commercial lending rates re-
main high (see chart on next page), at around 4 percentage points in
early 2010, suggesting an elevated high risk assessments by the
banks. Thus, without growing confidence between lenders and bor-
rowers, funding costs for investments will remain high.

Domestic credit, 2008 - 2010

14.5 60
Annual percentage change

RUB ('000 billions)

12.5 30
12.0 20
10.5 0
10.0 ‐10








Bank loans (left scale) Growth rate (right scale)

Source: Ecowin.

6 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

The policy response has been forceful – but
risks are emerging
The Russian government reacted forcefully to counteract the eco- Fiscal expansion sup-
nomic downturn. Fiscal balances were relaxed by a total of almost 9 ports economic activ-
percentage points of GDP, through discretionary increases in spend- ity, but will be difficult
ing and through lower tax collection. Although the fiscal loosening to reverse
came too late to have an impact on the contraction in early 2009, it
continues to support economic recovery, in particular through income
support to the population and, thereby, through private consumption.
The fiscal stimulus will, however, be difficult to withdraw. Much of the
spending increases came in the form of transfers to the population,
such as a 45% increase in pensions. Although this is likely to have a
direct impact on consumption, it is also likely to be politically costly to
reduce these rates, in particular as elections are coming up.

Budget indicators, 2007 - 2009

(In % GDP)



20 Overall balance
Non‐oil balance
0 Expenditure


2007 2008 2009

Source: IMF.

The large public sector deficit has led to a sharp drop in fiscal re- Fiscal reserves have
serves. Since end-2008, the Reserve Fund (which is dedicated to declined over the last
compensate the budget for swings in oil and gas prices) has lost al- year, while interna-
most USD 100 billion. If the deficits continue at current rates, and oil tional reserves are
and gas prices do not see large upswings, the Russian government substantial
will be forced to increase borrowing again, undermining the role of the
public sector as a backer of the private. The National Wealth Fund,
which serves to guarantee the soundness of the pension system, has
maintained steady balances over the crisis. However, as the funding
for the Wealth Fund is derived from a surplus in the Reserve Fund
(above 10% of GDP), inflows have slowed down since late 2008. As
for gross international reserves, also dependent on oil price and for-
eign exchange interventions by the Central Bank, the balances have
gradually started to increase again after the large decline in late 2008.
Currently, they are equivalent to about 20 months of import; signifi-
cantly above the 3 months that normally is considered being suffi-

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 7

Reserves, 2008 - 2010 (Q2)
(USD billion)
2008 2009 2010 Change
Reserve Fund 137.1 60.5 39.3 -97.8
National Wealth Fund 88.0 91.6 85.5 -2.5
Gross International Reserves 426.3 439.5 461.2 34.9
Source: Ecowin.

Also, monetary policy has been relaxed significantly over the past 12 Monetary policy is
months. As inflation rates have come down and the rouble strength- guided mainly by
ened, the Central Bank of Russia has lowered the policy rate from its effect on the
13% at end-2008 to 7.75% in July 2010. Rates for consumer lending exchange rate
are declining similarly, but the spread remains large. The central bank
has also increased its intervention in the foreign exchange market to
reduce the appreciation pressure on the rouble.

Monetary policy indicators, 2005 - 2010

(In %)











Policy rate Consumer lending rate

Source: Ecowin.

Structural reform initiatives have not been high on the priority list of Much-needed
the government during the financial turmoil. The authorities have, structural reforms
however, indicated that measures to reduce corruption, improve the have been pushed
business climate, and expand investments in the public sector are on forward
the agenda. The government is also relaunching the privatisation
process, whereby minority stakes in 10 state-owned companies will
be put up for sale in 2011-13. So far, more critical and politically diffi-
cult reforms of the civil service and liberalisations of monopolized
markets have not been addressed.

The political reaction to the drought and wildfires this summer could The policy reaction to
indicate a concern by the government about discontent spreading the wildfires has been
through the population. The crisis has exposed the dismantling of rapid suggesting a
crucial emergency institutions such as fire brigades and basic infra- need to limit public
structure that took place in the wake of the fall of the Soviet Union. discontent.
Both President Medvedev and Prime Minister Putin have been criti-
cised, and have reacted by showing a hands-on approach in dealing
with the disaster. An export ban on wheat was imposed to pre-empt
possible shortages and rapid food price hikes. Direct support to af-

8 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

fected regions and farmers has been put in place and it can be ex-
pected that more general stimulus measures will be implemented to
counteract a possible slowdown in consumption. The urgency with
which the policy actions were taken suggests that the government
sees a need to enhance the efficiency of the public sector to meet the
expectations of the population.

Recovery moderates – fiscal resources safe-

guards against renewed slump
Russia: Key economic forecast indicators
(Annual change in %, unless otherwise indicated)

2008 2009 2010 2011 2012

proj. proj. proj.

Gross Domestic Product 5.6 -7.8 4.3 4.3 4.5

Of which:
Private Consumption 10.8 -7.7 4.2 4.3 3.2
Gross Investments 10.7 -15.9 -0.1 7.7 7.0
Exports 0.2 -4.2 15.5 12.0 7.1
Imports 14.9 -29.8 20.0 18.0 5.3

Inflation (%, ave) 14.1 11.7 6.6 8.9 10.0

Inflation (%, eop) 13.3 8.8 7.5 10.0 10.0
Unemployment rate (% of labour force) 6.4 8.4 7.5 7.0 7.0
Current account (% of GDP) 6.2 4.0 4.0 3.8 3.5
Fiscal deficit (% of GDP) 3.5 -5.9 -6.5 -5.0 -4.0
Government debt (% of GDP) 7.8 10.9 12.0 11.5 11.0
Rouble (basket USD/EUR) 35.4 36.1 32.0 31.0 30.0
Oil prices (USD/b) 97.0 62.0 78.5 82.0 90.0

Sources: Ecowin, IMF and Swedbank projections.

While the economic rebound in the first half of 2010 was somewhat The economic rebound
stronger than expected, estimated at 4.2% compared with 2009, we will slow in the second
now believe that the Russian economy will face a slower pace of ex- half of 2010
pansion in the near future. The first half of the year saw private con-
sumption firming up on the back of strong fiscal support, a strength-
ening of the labour market, and inventory restocking spurring growth.
However, with the combination of a weaker global outlook and the
impact of the wildfires and drought, the rebound is set to slow in the
second half of the year. For the year, real growth in 2010 is expected
to reach 4.3%. Compared with our forecast in April, developments in
the first half of the year were better than expected, but the pace of
growth for the remainder of the year is set to slow.

For 2011, real economic growth will be negatively affected by the Fiscal stimulus will limit
global fiscal consolidation but mitigated by the ability of the Russian the negative impact on
government to continue its expansionary economic policies. The elec- growth in 2011 and
tions scheduled for late 2011 (parliamentary) and early 2012 (presi- 2012
dential) make the likelihood of a fiscal consolidation small. We project
that real economic growth will hit 4.3% in 2011 before reaching 4.5%
in 2012. Thus, economic output in Russia will return to the 2008 level
only in the third quarter of 2011. In the medium term, real economic

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 9

growth in Russia will remain below potential unless wide-ranging
structural reforms are implemented.

Real GDP level, 2008 - 2012









2008 2009 2010 2011 2012

Sources: Ecowin and Swedbank projection.

External developments will have a mixed impact on Russia’s econ- The Russian economy
omy. While the world market price for oil has increased steadily since is dependent on exter-
early 2009, we have lowered our forecast of the rate of increase due nal developments, in
to weakening overall global demand. We expect, however, that export particular the world
earnings will continue to provide the authorities with resources to market oil price and
support the domestic economy. Sagging overall growth in the largest capital flows
developed economies will reduce demand for Russian exports other
than oil and will, thus, work against a much-needed diversification of
the production structure. In addition, the volatility of international capi-
tal flows could create problems for the Russian banking sector and
affect credit to households and companies.

The value of oil production and the oil price, 200-2012

8000 120
Value of oil production
(mRUB) 100

4000 Oil price 60
(US$/b, LHS)

0 0
2000 2002 2004 2006 2008 2010 2012

Sources: Ecowin and Swedbank projection.

The economic impact on a national level from the drought and wild- Government action is
fires is mainly short term, and government actions are likely to miti- likely to mitigate most
gate most of the negative effects. Some regions will, however, be negative effects of the
more affected, and the food price increases could raise inflation ex- natural disaster, but
pectations. The most long-lasting impact could be a growing mistrust could face increasing
in public services in general and in the political representatives in par- mistrust.
ticular. It will remain a challenge for Russian politicians to reverse this

10 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

Russian consumers have suffered during the recession, but we ex- Private consumption
pect that government support, a thawing of the credit markets, and a is supported by fiscal
strengthened labour market will provide a firm basis for private con- policy and stable
sumption over the next year. The election cycle will limit the govern- labour market
ment’s willingness to embark on much-needed fiscal consolidation.
This means that the significant increases of public pensions and
spending support for the regions will remain in place. The labour mar-
ket will continue its gradual improvement on the back of a resumption
of confidence in the business sector and with continued public policy
support, and we expect the unemployment rate to drop to 7½% by
end-2010 and 7% by end-2011. The stimulus will safeguard recent
gains made in real wage developments and disposable income,
which further underpin a robust consumption growth.

Demand composition of real GDP, 2005-2012

(In constant 2003 rouble)

20000 Household 

15000 Investments


2005 2006 2007 2008 2009 2010  2011  2012  GDP
proj. proj. proj.

Sources: Ecowin and Swedbank’s projections.

We expect investments will continue to lag in the recovery as the pre- Investments will grow
crisis investment boom has created a significant overcapacity. In par- slowly, well below what
ticular, the construction sector showed strong growth rates in the is need to raise long-
years leading up to the crisis, and it will take some time before de- term growth
mand again will meet existing supply. Low capacity utilisation rates,
combined with high risk aversion in the banking sector, will push back
many large investment decisions. In addition, foreign direct invest-
ment is likely to be constrained by the slowdown in the major econo-
mies. For the long term, i.e., beyond 2012, it will be crucial for the
Russian economy to stimulate more investments, both domestic and
foreign. Russia’s share of investment in GDP has been lower than in
most other emerging countries, and, to raise the long-term sustain-
able economic growth rate, investment needs to expand. Not least
will public investments in infrastructure be important to lure private
business to grow their production in Russia.

The financial sector remains strained despite a resumption of credit to A stabilising financial
the private sector. Even though the IIB recently defaulted on its exter- sector is still plagued
nal obligations, the banking system looks stable and able to service by lack of credible
outstanding debt obligations. In fact, the financial sector is liquid as information
monetary policy is loose, capital inflows continue, and lending is con-
strained. However, the level of uncertainty in the banking sector is

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 11

substantial. There is a need for strengthened banking supervision to
push for increased transparency, reduce connected lending, and im-
prove loan classification and provisioning systems. There is a risk that
bad loans are rolled over (so-called evergreening, or “extend and pre-
tend”) and that they will resurface at a later stage, thereby extending
the slow comeback of credit. A “stress-test” of banks based on inter-
national experiences could serve to reassure markets and provide
guidelines for further actions to strengthen the financial sector in Rus-

Despite falling inflation rates since early 2009, the expansive fiscal Inflations rates are
policy will put upward pressure on prices, and monetary policy is likely to start rising and
unlikely to be aggressive enough to push back. Rapidly increasing hit double digits in
food prices due to the drought and wildfires will lead to a jump in the 2011, while the rouble
inflation rate in 2010 and, possibly, increased inflation expectations. will remain stable
However, the somewhat weaker momentum in the economic recovery
in 2010 and an expected continued strengthening of the rouble will
limit the inflation to around 8% at end-2010. For 2011 and 2012, we
expect inflation rates to reach double digits.

Exchange rate and oil price projections, 2009-2012

100 25

RUB vs USD/EUR (reversed)

50 31
0 37
2009 2010 proj. 2011 proj. 2012 proj.

Oil prices  Rouble basket (right scale)

We do not expect any significant policy reversals over the forecast The policy response is
period. The overarching goal of Russian policymakers is likely to likely to continue to be
be to stabilize the economy while boosting domestic purchasing expansive due to up-
power in the run-up to the elections in late 2011 and early 2012. It coming elections and
will be key to support labour market developments and, thereby, despite rising inflation
sustain positive wage developments. The primary tool will be a
continued expansive fiscal policy. Despite the large and successful
fiscal stimulus undertaken to mitigate the impact of the global fi-
nancial crisis, the government is unlikely to embark on any major

It is also unlikely that monetary policy will address the increasing Monetary policy rates
inflation rates. Limiting inflation will not be the primary goal, al- to stay low
though the Central Bank of Russia is discussing and preparing for
the introduction of an inflation-targeting regime instead of the cur-
rent policy of a managed exchange rate float. Instead, monetary
policy rates will be kept low not only to prevent market rates from
increasing and thus denting growth prospects, but also to limit ap-

12 Swedbank Baltic Sea Analysis No. 25 • 19 August 2010

preciation pressures on the rouble, which would make Russian
companies less competitive.

We also do not expect any significant reform initiatives. Even the Significant structural
recent renewal of the privatisation process can be expected to reforms are unlikely
have a limited impact, as majority control in most cases will be before the elections
maintained by the government. The authorities are, moreover,
unlikely to undertake reforms that could cause political controver-
sies. The most urgent of such reforms would be to make the public
sector and civil service more efficient, and to increase competition
in sectors that in many regions now are shielded.

Both the upside and downside risks to this scenario derive mainly Risks are evenly
externally, and we consider them to be evenly balanced. However, balanced, but the
due to the still weak and largely unknown situation in the Russian impact from a negative
banking sector, the impact from negative developments, such as shock could be more
renewed capital outflows, could be substantial. Domestically, the severe
largest risk is a rapidly increasing inflation rate. Once higher infla-
tion rates become entrenched, they will entail significant losses
and require contractionary policies to reverse, which, in turn, will
hurt growth and income levels over the medium term.

Magnus Alvesson

Economic Research
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ISSN 1103-4897

Swedbank Baltic Sea Analysis No. 25 • 19 August 2010 13