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By HaleStewart October 14, 2014 7:47 am
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Russia: The Next Big Problem Economy

     Jim O’Neill of Goldman Sachs coined the term BRICs in 2001 – a term which is an amalgamation of “Brazil, Russia, India and China.”  Although these countries have had strong rates of economic growth from 2001 to the recession of 2009-2009, the pace of growth has meaningfully declined since.  India and Brazil are currently experiencing a version of stagflation, and China is slowing as they try to shift the components of economic growth from one that is export dominated to one more evenly balanced between exports and domestic consumption.  The biggest wild card among the four is Russia, whose growth was predominantly based on oil exports.  For the last few years, overall annual GDP has continued to slow.  And now with trade sanctions lowering imports, increasing inflation and a sharply declining currency, the economy faces additional hurdles which may prove recession-invoking.

     Although Russia emerged from the recession growing at a fairly robust rate, it has slowed for the last two years.

Form 2010-to mid-2012, the Russian economy grew between 4%-5%.  But since mid-2012, the pace of overall annual growth has declined to between 1%-2%.

     Growth components have narrowed as well. 

In 2011, growth came from inventory stockpiling, domestic consumption and capital formation, while the mix changed in 2012 to consumption, capital formation and government spending.  The components of growth narrowed in 2013 to consumer spending with a small contribution from exports.  Exports will slow as a direct result of international trade sanctions imposed as a result of the Ukraine situation.

     And consumer spending may start to decline thanks to the following developments.  First, unemployment is increasing:

Notice the seasonally-adjusted and non-seasonally adjusted charts moved in parallel trends until the beginning of 2012.  Since then, the unadjusted level as increased, currently standing at about 6.5%.  Prudence demands using the unadjusted measure

     And wages have been declining:

The year-over-year rate of wage growth has been steadily declining since 2012, steadily dropping from the 10%-12% pace to their current level of around 2%.  And as wages have dropped, we’ve also seen a corresponding decrease in retail sales, where the drop has been from a year over year rate of about 8% to just above 1%.  This drop is caused by a combination of rising unemployment and higher inflation.

     Business investment won’t be rebounding either:

Business sentiment for both mining and non-mining industry has been decreasing for the last few years.  Mining sentiment starting dropping mid-2012.  It was fairly steady in 2013 but has dropped precipitously in 2013.  Non-mining sentiment has been dropping steadily since the beginning of 2013.

     As a result, fixed capital investment has been declining:

 Although it increased at strong rates in 2012, it is now contracting.

     And making matters worse is the rise in inflation.


Prices started to rise in 2012, when they rose to 7%.  They decreased a bit heading into 2014, but thanks to a declining ruble and trade sanctions, prices have again increased, this time rising to just below 8%.  And inflation is bleeding into core inflation (brown line, right chart) which has risen from 6% to 8% since the first of the year. 

     To curb inflationary pressure, the Russian Central Bank has raised rates from 5.5% at the beginning of the year to their current level of 8%. 

     And finally is the drop in the ruble:


Above is a chart of the Bank of International Settlements ruble valuation level, which has dropped ~15% since early 2013.  While higher interest rates will help to defend the currency, the Russian Central Bank is also actively buying the ruble in the open market to halt its decline. 

     To conclude, Russian growth is slowing.  The two sectors most responsible for growth over the last 4-5 quarters – exports and consumer spending – are facing strong headwinds in the form of lower wages, rising unemployment and trade sanctions.  Business sentiment is depressed which will hurt capital investment.  And the declining ruble and rising inflation will force the Russian Central Bank to keep rates high, further dampening economic growth.  The sum total of these events is slower growth at a minimum with a recession a good possibility.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer




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