August 25, 2009
Chief Economist’s View of Troika Dialog Group
A growing number of countries are demonstrating either signs of stabilization or even recovery, so that not only did 2Q09 look much better than the first quarter for the entire global economy, but most recent leading indicators also provide some optimism. Even though news flow remains mixed, it now looks as if positive sentiment dominates, which is a stark contrast with what was seen several months ago, when the majority of forecasters kept downgrading their outlooks. Most recent leading indicators for Germany and France suggest that the service sector in the former and manufacturing in the latter expanded in August. Existing home sales in the US jumped 7.2% in July, pointing to a recovery in economic activity and improvements in the financial sector.
It appears that government efforts in many countries to stimulate economies have had some results, even though the effect may be relatively short-lived ? the US government, for instance, announced that it plans to withdraw the “cash for clunkers” program and it is not completely clear how the advanced economies will develop after stimuli are withdrawn. Meanwhile, the “cash for clunkers” plan also worked well in many European countries where demand for vehicles kept the industry afloat, justifying the massive increase in government spending. China’s fiscal stimulus has already delivered positive results.
Russia’s economic performance demonstrated signs of improvement in mid-year as well. Industrial output, for instance, grew strongly in June and July (up a respective 4.5% and 4.7% m-o-m, non-seasonally adjusted, while seasonally adjusted growth was also visible, albeit a bit slower). Investments and retail sales also showed signs of m-o-m stabilization.
However, as opposed to Western countries, Russia’s stabilization originated not from the state’s efforts, but largely on its own. The government did not directly stimulate consumers as in the West. In the case of the automobile industry, subsidies went directly to a producer (AvtoVAZ), which kept producing cars even though people displayed limited enthusiasm in purchasing, as the vehicles remain incorrectly priced. As a result, stocks began to rise again even though production fell by around 60%. In recent years, production and sales continued to rise amid soaring consumer lending, which together with ruble appreciation helped to over-inflate domestic prices. Given that devaluation in November 2008 ? January 2009 was rather modest so that domestic prices remained relatively high, it is not surprising that car production has been suspended several times (including in August 2009).
Meanwhile the Russian version of support for the automobile industry (with money going from the budget straight to the producer, and consumers omitted from this scheme so that prices remained too high for them) should be better interpreted as a “clunkers for cash” scheme. Even though it was budgetary money, it was eventually the taxpayers that paid for unsold cars.
The government announced that next year it would start subsidizing consumers instead of giving subsidies to producers, i.e. switch from “clunkers for cash” to a Western-style “cash for clunkers” scheme (Russians are supposed to enjoy R50,000, or around $1,500 in this version of a trade-in purchase). Even though it will probably not be very timely, it is better late than never. This scheme may boost industrial growth even more next year.
Russia is going to increase federal budget expenditures by around 30% this year, which is more or less in line with what other governments are doing, though the difference between Russia and other countries is that such increase in expenditures is “normal” for Russia, while for Western countries it is an exception. We have reiterated many times in the past that Russia’s double-digit inflation stems from a permanent “fiscal stimulus” so that budgetary expenditures have kept rising by around 25-40% every year and the economy has become used to it. That said, this year we see almost no increase in fiscal stimulus relative to previous years. Hence, it follows that Russia’s stabilization and/or recovery this year looks more natural as it is more market-based, meaning that it should be more sustainable than in other countries. Russia’s recovery may be slower than was expected, but government stimulus can accelerate growth next year (if it is eventually targeted properly, i.e. directed toward consumers). It appears that so far m-o-m recovery in industry in mid-year (amid relatively stable domestic demand) was largely caused by increased exports, such as gas, not by internal factors. Next year, domestic factors will start playing a more important role.
There are certain risks to this scenario, and too much government spending (especially if it occurs “overnight”) is one of them. We analyzed government draft budget proposals for 2010-12 and characterized state budgetary policy as “unsustainable” as expenditures look excessive and incorrectly allocated. How the budget is being executed this year gives another illustration of such inefficiency.
According to most recent amendments the government is going to spend around R10 trln from the federal budget in 2009, while only R4.7 trln was allocated in 7m09 (i.e. R670 bln per month), meaning that R5.3 trln (around R1.1 trln per month) is going to be spent in the remaining five months. The fiscal deficit, which slightly exceeded R920 bln in 7m09, is supposed to reach R3.4 trln by year end (thus the deficit should reach R2.5 trln in August-December) meaning that the economy will be attacked by excessive government spending ? most likely a major attack will come in late November or early December. Should the government keep spending in August ? December by about say R0.7 trln per month as up till now, so that the economy was able to stabilize, then total expenditures would not exceed R8.2 trln, which means that the deficit would be under R1.6 trln.
Even though in reality the budget deficit may be smaller than the planned R3.4 trln (as revenues may be more than expected if the oil price remains at current highs) an enormous inflow of ruble liquidity is what one can expect at year end. This can obviously create a storm on the forex market and translate into high inflation in January-February 2010, which is Russia’s usual problem. It looks as if the economy will once again receive money at year end that it does not need, while the financial system (the forex market in particular) will experience volatility, which is also not needed.
Even though the ruble currently appears to be in equilibrium, as the balance of payments remains strong and there is no need for artificial appreciation or depreciation (as some commentators suggest), the massive inflow of ruble liquidity may fuel even more speculation and extra volatility as a result. This potential volatility, however, would be short-lived and likely evaporate in mid-1Q10 as government spending will not be that generous next year.
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