Economic Outlook Russia: how to sustain growth

By Scott Hazelton14 November 2012

Construction forecasts for Russia. SOURCE: IHS Global Insight

Construction forecasts for Russia. SOURCE: IHS Global Insight

High energy prices have improved the recent performance of the Russian economy, but this growth is something of a double-edged sword – an over dependence on developments in world energy markets also make it vulnerable to price shocks.

Indeed, while oil prices have regained much of their lost ground since their 2008 peak, they will fall a little in the second half of 2012 and stay lower into 2015. Any gains after that are expected to be modest.

Another problem for Russia is that physical volumes of its energy products will rise only slowly. Older deposits are being depleted and remaining reserves tend to be in more challenging geographic and climatic conditions, making them difficult to extract.

This means Russian GDP growth will moderate from +4.9% growth in the first quarter of 2012 to less than +3% in the second half of the year. The forecast for the year as a whole is GDP growth of +3.6%, sliding to +3.5% in 2013 and then picking up once more to +4% in 2014.

Russia’s non-energy industries face competitive challenges because of a long period of insufficient investment as well as over-aged and over-burdened infrastructure. Much of the productive capacity of the manufacturing sector is also sorely in need of modernisation and expansion.

Accelerated investment is the key to diversifying the Russian economy and sustaining robust growth. However, generating and attracting that investment will require further structural and institutional reforms to improve the business environment.

Corruption

The degree of corruption in Russia’s bureaucratic system has increased in the past few years. Investors are certain to seek high premiums for investing in economies where private-property rights are not universally secure and macroeconomic stability is fragile.

The problem is compounded by turmoil in financial markets due to the Euro crisis, which has caused investors to move capital from perceived risky economies in a flight to safety. Capital flight from

Russia in the first half of 2012 has been put at US$ 43.4 billion.
While Russian credit markets have thawed considerably, banks remain concerned about a potential new wave of loan defaults and remain hesitant to lend, keeping the spread between commercial lending rates and the monetary policy rate quite wide.

The first chart puts the Russian construction market in size, growth and risk perspective compared to its neighbours and the global average. While the largest market in the region, and offering above-average growth over the next five years, it is clearly perceived as high risk with only the Czech Republic viewed less favourably in that regard.

Despite the risk, Russia does offer near or above the global average for construction growth. The near term impetus comes from infrastructure spending, much of it already budgeted. From 2010 to 2015, the government plans to spend RUB 13 trillion (US$ 413 billion) on the development of transportation infrastructure. Spending includes the construction or updating of 17,000 km of roads and 100 runways.

The plan also includes the expansion of seaports and the construction of 3,000 km of railways, in addition to a high-speed rail line. Other government spending plans include the US$ 800 million Vostochny Kosmodrome spaceport, which recently began construction and is set for completion in 2020.

Energy needs

Russia also has plans to build some 26 nuclear power plants to increase electricity production levels by two thirds by 2020 in order to address the country’s expected electricity supply shortage. In order to meet a more than a +50% expected rise in energy demand by 2030, Russia will have to spend US$ 25 billion on the energy sector annually.

Additionally, in terms of communications, while the mobile sector of the country’s telecommunications network is already well developed, the broadband sector is experiencing rapid growth.
On the residential side, the government plans to spend RUR 600 billion (US$ 19 billion) from 2010 to 2015 to increase yearly housing construction from 58 million m2 per year to 90 million m2 per year. The programme has a 2020 goal of construction of 142 million m2 of housing floor space annually.

To put this in perspective, in 2011, there was an estimated 3.272 billion m2 of residential floor space in Russia, with an estimated 22.8 m2 per inhabitant. However, with a shrinking and aging population, there is no true residential boom in the offing. A gradually improving economy should create a more confident consumer to spend on renovation activity, but a strong growth in residential activity is unlikely.

Meanwhile, spending on non-residential structures will gradually improve over the next several years, driven largely by the commercial sector. Russian industry needs modernisation, but it also suffers from excess capacity, lower cost competitors around the world and high unemployment.

Russia’s services sector, on the other hand, has been developing rapidly, which will drive a better outlook for office and other commercial structures. A return to stronger economic growth in 2014 will provide the boost to consumer spending necessary for retail expansion, and Russia’s hotel industry is already underserved.

Russia offers potential, particularly with its energy reserves, but the financial and political risks are clearly evident, particularly regarding the availability of capital. If the government implements reforms to improve business confidence – both inside and outside the country – the outlook could get much better.

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