At the start of the year the prospect of a rapidly appreciating rouble and higher than expected inflation were seen as the biggest dangers facing Russia’s economy. Both have come to pass but the economy continues to roar ahead regardless. The combination of cheap money from abroad and rising productivity has offset these dangers and is driving Russia’s impressive growth.
Russia’s first strong growth after a 1998 devaluation was fuelled by the cheap rouble, which lost 75% of its value against the dollar in a day. Economists worried that an appreciating rouble would kill the first green shoots of growth as the devaluation fillip was eaten away. The rouble has already clawed back 80% of the value against the dollar it lost.
Investment on the increase
| Inflation versus exchange rate |
| Source: Aton, Goskomstat |
It appears that rising competition has already led factories to invest in boosting productivity – investment that is being facilitated by the cheap money coming from abroad. The Russian economic development and trade ministry began the year with a 4.3% GDP growth estimate, but the economy put in 6.6% of growth (annualized) over the first four months of the year, compared with 3.7% over the same period in 2002.
Al Breach, chief economist with Brunswick UBS Warburg, says: “There are two things going on at the same time. Emerging markets as a whole are benefiting from the low interest rates in the US, and the perceived credit risk in Russia has improved dramatically thanks to the Kremlin’s solid macroeconomic policies and an economy that has put in five years of 5%-plus growth.”
Breach say that productivity gains between 2000 and 2001 were made simply by filling empty seats on production lines. Now they are coming from making existing workers work harder or by buying more efficient equipment.
Over the first quarter of this year productivity in Russian factories rose by between 10% and 13% against the 5% gains made three years ago.
Low interest rates in the US are also fuelling a boom in Russian borrowing. For example, last year Russians issued $1 billion-worth of corporate Eurobonds; over the first three months of this year they have issued about $4 billion-worth. Likewise Citigroup reports that its Russian syndicated loan business is exploding.
The other macroeconomic bugbear is Russia’s rising inflation. The economic development & trade ministry has already admitted that it is likely to miss this year’s 12% inflation target: over the first four months of this year inflation was 14.8%, compared with 15% at the end of 2002.
Inflation is a problem when companies are weak, but impetus is being added to Russian growth by the growing number of small and medium-size enterprises (SMEs), and in particular the rapidly expanding service sector.
“If inflation rates climb above about 22% then we should get nervous,” says Peter Westin, an economist with the Aton brokerage in Moscow, “but thanks to the momentum among the SMEs we can cope quite comfortably with inflation in the range of 12% to 15%. Looking at Central Europe’s experience, their economies grew strongly with much higher inflation, thanks to the SMEs.”
Russia has also had some luck. The appreciation of the rouble and higher than expected inflation has been offset by the recent appreciation of the euro. Although most of Russia’s exports are dollar-denominated, half of its total trade is with the eurozone and paid for in euros.
Since the start of 2003 the rouble has lost almost 10% against the euro in nominal terms and 4% in real terms, while the rouble has appreciated by 3% against the dollar in nominal terms and by 9% in real terms.
“Import growth has risen by 18% since the start of the year,” says Westin, “but if you strip out the exchange rate effect – the state committee for statistics calculates all imports in terms of dollars – then the real imports have only risen by 10%. The rising euro is depressing imports and has given Russia extra breathing space.”
Until the start of this year the government could not decide what would be better for the long-term health of the country: faster rouble appreciation which would make it easier to keep inflation in the ministry’s 10% to 12% inflation target band or controls on this.
However, in February the Central Bank of Russia (CBR) caved into the fact that high international oil prices were going to push up the rouble’s value and said it would reduce its efforts to manage the currency.
Economists are divided on the wisdom of making inflation the priority, but with economic growth running well ahead of expectations no-one says that the Central Bank of Russia’s monetary policies are wrong.
“The argument over which is better – low inflation or a strong rouble – have become academic,” says Christof Ruehl, the World Bank’s chief Russia economist. “More important is to increase the number of monetary tools at the CBR’s disposal as its main instrument remains buying and selling dollars.”
