Economists divided on prognosis for Russian economy

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Economists divided on prognosis for Russian economy
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Russian President Vladimir Putin meets with the head of the Federal Financial Monitoring Service (Rosfinmonitoring) Yury Chikhanchin at the Kremlin in Moscow, Russia, June 27, 2022.

Mikhail Metzel | Kremlin | sputnik | via Reuters

Russia’s economy shrank in the second quarter – the first full three months since the country invaded Ukraine – and economists are divided on whether it can continue to withstand the onslaught of long-term international sanctions.

Russia’s economy contracted 4% year-on-year in the second quarter, although this was less than the 5% expected by analysts. The Central Bank of Russia expects the slowdown to worsen in the coming quarters, bottoming out in the first half of 2023.

It comes as Moscow struggles to recalibrate its economy in the face of a barrage of sanctions imposed by Western powers in response to the war, which have disrupted trade and virtually ostracized Russia from the global financial system.

“There have been signs of stabilization in many sectors over the past couple of months, but we don’t expect the slowdown to bottom until the second quarter of 2023 and believe the economy will stagnate at best through what’s next,” said Liam Peach, senior emerging markets economist at Capital Economics.

The immediate impact of the sanctions was mitigated by swift action by the CBR to deploy capital controls and raise interest rates sharply. The measures have stabilized domestic markets and even seen the ruble become one of the best performing currencies in the world so far this year.

Subsequently, fiscal stimulus and substantial interest rate cuts also took effect, mitigating the short-term impact of the sanctions. Late last month, the central bank shocked with a 150 basis point cut in Russia’s key rate, taking it to 8% and marking the fifth consecutive cut since it launched an emergency 9-point hike. 5% to 20% at the end of February.

“The slowdown could have been much deeper, but the central bank took immediate action to prevent a financial crisis from setting in. It also appears that the resilience of the Russian energy sector has cushioned the impact of Western sanctions” , added Peach.

However, many economists see the long-term damage to Russia’s economy as far more serious, as a drain of business and talent gradually squeezes economic activity, along with a lack of access to critical technologies.

Meanwhile, the sanctions have hit some sectors of the economy hard, with manufacturing output dropping 4% quarter-on-quarter and production in import-dependent sectors falling more than 10%.

Consumer demand also weakened sharply; retail sales fell 11% quarter-on-quarter after March’s sharp inflationary shock, while consumer confidence plummeted and monetary conditions tightened.

“The third quarter is likely to be another weak quarter, albeit a weaker contraction than the second quarter. Declines in retail sales and manufacturing have eased, inflation has eased and monetary conditions have eased. are relaxed,” Peach said.

“Even so, the economy still faces severe headwinds, including limited access to Western technology and an impending ban on providing insurance for the transportation of Russian oil, which we believe will lead to a drop in production. 10% next year.”

Capital Economics does not expect Russian GDP to bottom out for about a year.

Wading, not drowned

August 24 will mark six months since global sanctions were first imposed on Russia in response to its February 20 invasion of Ukraine. There are now over 11,000 international sanctions against the country.

Although many economists are focusing on long-term structural threats to the Russian economy – which the government and central bank are working to counter – the more immediate collapse predicted by some has not materialized.

“Despite the onslaught of sanctions and the predictions of many observers, the Russian economy has not imploded and, although facing a 5-6% contraction this year, is not in danger of collapse or likely to experience any form of economic or financial crisis,” said Chris Weafer, CEO of Moscow-based Macro-Advisory.

“However, it faces 5-7 quarters of low single-digit declines and a long list of challenges which, if not addressed effectively, will keep growth close to stagnation for many years to come.”

In a research note on Friday, Weafer suggested the Russian economy is “floundering, not drowning.”

Macro-Advisory estimates that the Russian state accounts for more than 60% of GDP, while small and medium enterprises account for less than 25%. This imbalance restricts growth in normal times but also insulates the economy in times of crisis, he added.

“Government, business and people are used to economic crises (this is the fifth since 1991), and support structures, for employers and in social spheres, are well developed,” Weafer said.

Meanwhile, business confidence, after falling sharply in March and April, has returned to long-term averages for manufacturing and services.

Weafer also disagrees with recent assessments that the economy is on a long road to “forgetting”, arguing that the mass exodus of Western businesses from Russia would not be as damaging to Russia. activity as is generally assumed.

“Most of those exiting are either small businesses (as in the fashion retail sector) or have sold to local buyers. Of the top 50 foreign-controlled businesses, only three have closed completely,” a- he declared.

“Three others have sold to local buyers and another 10 have said they plan to sell to a local buyer. The others are staying. We calculate the impact on GDP at less than 1% because the operational assets will remain in the country .”

This contrasts sharply with the “catastrophic” blow projected by a Yale University study published last month, which analyzed high-frequency consumer, trade and shipping data. The authors of the study say that the sanctions and the exodus of more than 1,000 global companies are “crippling” the Russian economy.

But Weafer is far from convinced. “There is a lot of skepticism about Russia’s so-called resilience and ability, if not willingness, to invest in localization, especially given how little has been done in areas such as technology, engineering and specialist services over the past twenty years,” Weafer added.

“But as previous crises have shown, Russia usually tackles these issues when it has no other choice, and usually only then.”

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