RUSSIA Monthly Economic Developments August 8, 2013 Financial market volatility has once again increased in response to concerns about the phasing out of Quantitative Easing (QE) in the United States (US). However, the initial strong reaction by financial markets was tempered by assurances from the Federal Reserve that it intends to start slowing down the pace of its purchase later this year only if the economy continues to improve and when unemployment rate falls below 7 percent. The European Central Bank also assured markets that rates will remain low for longer. Monetary conditions in high-income countries are projected to remain accommodative and supportive of growth. Global growth is expected to improve, despite softer than anticipated activity in the second quarter. Growth is currently driven by accelerating growth in the US, which is likely to benefit in the second half of the year from a recovering housing market and employment growth. But there are also early indications of improving activity elsewhere: First, the latest Purchasing Manager Indices (PMIs) indicate that the UK services sector expanded at its fastest pace in more than six years. Also Euro Area PMIs achieved a first, albeit faint, rise in activity for 18 months, sustained by the rebound in German business activity, while the downturns in France, Italy and Spain eased in July. Second, industrial production growth has been accelerating and has reached growth rates of 3.8 percent and 5.9 percent in the Euro Area and Japan respectively. In contrast, growth in developing countries has been slowing, even though it remains relatively strong. Q1 growth in developing countries came in at 4.6 percent, down from 5.5 percent in Q4 2012, thereby registering the slowest quarterly growth rate in more than a year. The latest industrial production figures suggest further slowing, with industrial production growth falling to 2.9 percent in May, down from 8.0 percent in January. Also, prospects for a quick recovery look slim, with PMIs in developing countries remaining weak. China’s PMI stood at 51.3 in July, unchanged from June and just marginally above a 20-month low of 51.1 in April. Excluding China, the developing countries’ PMI fell below the critical 50 level for the first time since the end of 2011. Global crude oil prices strengthened in July, driven by a pick-up in demand as refineries are back from annual maintenance and the peak power demand of the summer season is in full swing. Meanwhile supply disruptions continue with losses in exports from Libya, Nigeria, Iraq, Sudan and the Yemen, amounting at times to around 1 million barrels per day. Despite these disruptions, gains in global crude oil supply were made in non-OPEC supplies, which accounted for the global month-on-month increase in July. Brent prices broke out above the three month resistance level of US$105/barrel in early July and prices have settled every day within a range of US$105-110, with a high of $110/barrel on August 1. Logistical bottlenecks are leading to higher US as well as Russian crude prices. The US still lacks sufficient pipelines to bring oil from producing regions to key refineries. Lower Urals exports are pushing medium sour crude oil prices higher, while oilfield maintenance in Russia is also thinning the country’s Sokol and Vityaz supplies to the Far East. Recent price increases notwithstanding, the World Bank expects oil prices to average US$102/barrel in 2013 (and US$101/barrel in 2014), down from US$105/barrel in 2012. 1 Figure 1: Global economic activity, percentage growth, Figure 2: Crude oil prices $/barrel 3m/3m, saar US$/bbl 125 15 60 10 40 115 5 20 0 0 105 -5 -20 -10 -40 95 -15 United States Developing -60 World Euro Area Brent Urals -20 Japan (right axis) -80 85 2011M01 2011M07 2012M01 2012M07 2013M01 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Source: Datastream and World Bank Prospects Group Source: Datastream and World Bank Prospects Group In June, industrial performance in Russia recovered slightly, but economic activity in the non-tradable sectors deteriorated notably, as did investments. Industrial production expanded marginally by 0.1 percent (y-o-y) compared with a 1.4 percent contraction in May. The driving factor for this turnaround was increased growth in the extraction of mineral resources of 3.1 percent compared to 2.3 percent in May. Also, aggregate manufacturing output fell at a notably slower pace at 1.2 percent in June (y-o-y) compared with a 4.4 percent decline in May. This month’s contractio n was largely due to negative contribution from machine building (0.8 ppt), metals (0.3 ppt), and food production (0.3 ppt). Electricity, gas and water production and distribution contracted by 0.8 percent compared with a 0.5 percent growth in May. Economic activity in major services sub-sectors was bleak during June. Construction sharply contracted by 7.9 percent (y-o-y) compared with a 1.7 percent growth in May. Retail trade growth inched up slightly, but wholesale trade fell by 1.9 percent (y-o-y) compared with a 0.7 percent growth in May. The volume of paid services to the population contracted by 0.4 percent in June (y-o-y) compared to growth of 0.9 percent in May. Investment activity was also significantly lower in June, decreasing by 3.7 percent (y-o-y) compared with growth of 0.4 percent in May. No positive shift could be observed in July’s forward -looking business confidence surveys. The seasonally-adjusted HSBC Russia Manufacturing PMI index plummeted to 49.2, its lowest reading since December 2009. Key PMI indicators (output, new orders, and employment) fell below the 50 point mark, indicating weakening domestic demand. The Services PMI Business Activity index also slightly decreased from 48.8 in June to 48.7 in July. On the positive side, the New Export Orders Index registered a 14 months high, indicating potential slow strengthening in external demand. Inflation decelerated further in July, with the 12-month Consumer Price Index (CPI) declining to 6.5 percent from 6.9 percent in June. However, the 12-month CPI still slightly exceeds the Central Bank of Russia’s (CBR) end-year target of 5-6 percent. Meanwhile, the headline CPI increased from 0.4 percent in June to 0.8 percent in July, due to an increase in prices for transport services. Overall, food inflation remained the main driver for inflation, but slowed down from 8.0 percent in June (y-o-y) to 6.8 percent in July. Core inflation also retreated from 5.8 percent in June (y-o-y) to 5.6 percent in July, remaining close to the upper end of the targeted corridor. Credit growth to households continued to cool down in June, credit growth to enterprises remained at the same level. Credit growth to households has been slowing for the past seven consecutive months to 33.9 percent in June 2013 from 42.7 percent in October 2012. Credit growth to firms registered growth of 11.8 percent in June, the same as in the previous month. CBR’s foreign reserve position remained steady in July. Reserves marginally decreased by US$1 bln to US$512.8 bln in July. Yet, CBR reserves adjusted for currency swaps with commercial banks increased from US$507.2 bln at end-June to US$511.5 bln at end-July. Here a decrease in reserves from the CBR FX market interventions of US$4.2 bln was offset by a US$7.6 bln increase in reserves due to euro appreciation and growth of gold price. The amount of CBR FX interventions was the highest since the beginning of the year, indicating pressure for ruble depreciation. 2 On July 12 2013, the Board of Directors of the CBR decided to broaden CBR’s monetary policy instruments with a 12- month floating rate lending facility secured by non-market assets. The minimum auction rate for the new facility was set at the level of 5.75 percent, (+25 bp to the auction repo rate). Actual interest rates for loans provided by the new facility will float with CBR’s repo rate during the life of the loan with the spread to auction repo rate remaining constant. The CBR expects that the new instrument will improve interest rate management and will strengthen the interest rate channel of the monetary policy transmission mechanism. The first auction was conducted on July 29. Thirty-one banks participated in the auction with bids up to 7.25 percent. The demand at the auction was below expectations: Banks borrowed only RUB306.8 bln out of RUB500 bln offered. Figure 3: Russia high frequency indicators, Figure 4: Russia CPI Inflation by components, percent, y- growth rates, percent, y-o-y o-y) 20 10 industrial production manufacturing 9 15 retail trade 8 10 fixed investment 7 6 5 5 4 0 CPI 3 food -5 2 non-food 1 services -10 core-CPI 0 Jan-2012 Apr Jul Oct Jan-2013 Jan-2012 Apr Jul Oct Jan-2013 July Source: Rosstat, Haver Analytics, World Bank team Source: Rosstat, Haver Analytics, WB team On July 18 the Ministry of Finance published a medium-term budget policy document. The document, Key directions of the budget policy for 2014 and for the planning period of 2015 and 2016 is based on the following principles of medium term planning: (1) Budget parameters are in full compliance with expenditure commitments, simultaneously optimizing such commitments and increasing expenditure efficiency; (2) Risks of imbalances of the budget system are to be minimized; (3) Sustainability of the federal budget increases and its dependence on external factors shall decrease in the long run; (4) For new expenditure commitments efficiency analyses are to be performed; (5) Program budgeting to improve budgetary outcomes and outputs shall be applied. The 2014 budget is to be the first budget with the application of program budgeting principles and by 2016 about 90 percent of all federal budget expenditures are expected to be covered by program budgeting. The document contains a medium-term budget forecast and, for the first time, long-term budget parameters for 2020, 2025, and 2030. Overall, a gradual fiscal consolidation is envisaged, with the key assumption that a reduction in the non-oil federal budget deficit will occur over time:  Consolidated budget revenues are projected to decrease from 36.9 percent of GDP in 2013 to 34.4 percent in 2016;  Consolidated budget expenditures are projected to decrease from 37.6 percent of GDP in 2013 to 34.9 percent in 2016;  The consolidated budget deficit is expected to shrink from 0.7 percent of GDP in 2013 to 0.5 percent in 2016;  By 2020 the consolidated budget deficit is projected to turn into surplus (0.1 percent of GDP), in 2025 a zero balanced budget is forecasted and for the outer year of the projection, 2030, a 0.3 percent deficit;  The non-oil federal budget deficit is projected to decrease from 9.6 percent of GDP in 2013 to 7.8 percent of GDP in 2016, and to 6.0 percent of GDP in 2030 Preliminary numbers for the H1 2013 fiscal outturn are almost unchanged on a year-to-year basis, but improved in comparison to the previous months. Preliminary numbers showed the federal budget at a surplus of 1.0 percent of GDP in H1 2013, the same as for H1 2012. The non-oil deficit for H1 2013 was lower at 8.9 percent versus 10.5 percent in H1 2012, and it declined in June further to 5.6 percent of GDP from 7.3 percent of GDP in May. Simultaneously, the federal budget surplus increased in June from 2.5 percent of GDP in May to 3.2 percent. Federal budget oil revenues registered a lower outturn at 9.9 percent of GDP in the first six months of 2013 compared with 11.5 percent of GDP during the same period a year ago. However, this decline in oil revenue was compensated by a decrease in federal expenditures from 21.1 3 percent in H1 2012 to 19.1 percent of GDP in H1 2013. Overall, during January-June the average oil price (around USD106.5 per barrel) remained considerably above the cut-off price determined by the fiscal rule for 2013 (USD91 per barrel). Russia’s total unemployment rate increased in June for the first time since January 2013 fol lowing the seasonally adjusted unemployment trend since March 2013. Total unemployment increased from 5.2 percent in May to 5.4 percent in June, seasonally adjusted unemployment reached 5.8 percent in June from 5.5 percent in May. Unemployment climbed to its highest level since the end of 2011, despite summer being traditional the period with high labor demand. Real wages (about 40 percent of total income) grew in June by 6.0 percent (y-o-y). Real pension growth was in line with average for first six month of the year, at 2.5 percent (y-o-y). After a slowdown in growth of disposable income since March and a decline (both in annual and monthly terms) since May, June growth was positive again at 2.2 percent (y-o-y) and 6.9 percent (m-o-m) with seasonal adjustment. As reflected in the real sector section above, income growth acceleration has been partly translated into household expenditure growth with retail trade growth inching up in June to 3.5 percent (y-o-y) from 2.9 percent in May, mainly driven by non-food trade. However, services to the population are still in negative growth territory, contracting in June another 0.4 percent (y-o-y), at the same pace as a month ago. Preliminary poverty statistics published by Rosstat for Q1 2013 suggest a slight increase in the number of poor people compared with Q1 2012 from 19.1 million (13.5 percent of population) to 19.6 million people (13.8 percent of population). The World Bank estimates that poverty in Russia was almost flat during 2012. However, recent high food inflation has likely contributed to the Q1 2013 increase. Figure 5: Russia unemployment rate, percent Figure 6: Russia real growth rates of consumers’ incomes and expenditures, percent, y-o-y 10 real wages real disp. income Total 14 Seasonally-adjusted retail trade services 12 9 10 8 8 6 4 7 2 0 6 -2 -4 5 -6 2006 2007 2008 2009 2010 2011 2012 2013 Jan-2011 July Jan-2012 July Jan-2013 Source: Rosstat, Haver Analytics, World Bank team Source: Rosstat, Haver Analytics, World Bank team Источник: Росстат, Haver Analytics, команда Всемирного Банка Compiled by a World Bank team consisting of the following members (in alphabetical order): Dilek Aykut, Damir Cosic, Olga Emelyanova, Birgit Hansl, Mikhail Matytsin, Stepan Titov and Theo Van Rensburg. 4