Russia's economic prognosis: a laggard, not a leader, in global recovery

Manufacturing output is rising around the world, with bullish reports from the United States, Europe and Asia.  The global purchasing managers index reached 55.9 in December: anything over 50 indicates an expansion in output.

But not Russia.  In fact, Russia's PMI fell further in December, to 48.8 from 49.1 in November.  This indicates an accelerating decline in Russian industrial activity.  From Bloomberg:

The decline in new orders led to another round of inventories depletion that also contributed negatively to the PMI in December," Dmitry Fedotkin, an economist at VTB Capital in Moscow, said in the statement.

Manufacturers including OAO Novolipetsk Steel are trying to adjust to smaller markets, with Deputy Industry Minister Andrei Dementiev projecting a 7 percent decline in the country's steel industry in 2009, Interfax said on Nov. 10. Sluggish bank lending and gains in the ruble threaten to hamper a recovery led by last year's 84 percent gain in Urals crude, Russia's key export. The ruble gained 13 percent against the dollar in the last three quarters of last year, a trend the central bank has said it wants to curb.

The government has forecast a rebound from Russia's 10.9 percent annual contraction in the second quarter, the steepest drop since at least 1995. Output fell a further 8.9 percent in the third quarter and will contract about 8.5 percent for all of 2009, Prime Minister Vladimir Putin said on Dec. 30.

. . . .

Exports "remained a key source of weakness" as new orders from abroad fell for a 15th month, VTB said. The work backlog contracted at the sharpest pace since April and inventories of finished goods continued to decrease "at a strong rate," the bank said. Employment in manufacturing fell in December, extending a string of declines that started in May 2008, VTB's gauge showed.

Earlier signs of recovery in manufacturing may have been caused by one-time effects. While industrial output expanded in November for the first time in more than a year, a six-fold jump in the production of hydraulic turbines accounted for much of the increase, Raiffeisen International Bank-Holding AG's Russian unit said in a Dec. 22 research note. Chinese imports of raw materials failed to recover in November, "raising doubts that external demand will stimulate the growth of Russian industry," according to the note.

Rising joblessness and a drop in retail sales in November indicate economic growth last quarter was close to zero, according to Raiffeisen. The unemployment rate jumped in November to a four-month high of 8.1 percent from 7.7 percent in October.

This contradicts Russian government happy talk:

The gloomier manufacturing outlook contrasts with a brighter picture presented by the government, which said on its Web site on Dec. 30 that the economy grew a seasonally adjusted 1.9 percent in the fourth quarter, citing preliminary figures. Putin predicted on Dec. 30 that the economy will expand about 3 percent in 2010.

Russia will post "steady" growth this year after domestic producers regained access to external financing and prices for oil, gas and metals picked up on improved prospects for a global economic recovery, central bank Chairman Sergey Ignatiev said on Dec. 22, forecasting an expansion of 5 percent or more.

The Bloomberg article mentions the unemployment rate.  Even the higher 8.1 percent rate seems very low, given the cratering of Russian manufacturing, and the lack of any appreciable rebound.  I've conjectured that most unemployment is masked, by companies either retaining and paying idle employees under pressure from the government, thereby weakening their financial condition and limiting their ability to expand later, or as a result of government support of some kind.

This article in SeekingAlpha (H/T LR) provides some color regarding how the government provides this support:

For those interested in where Russian deficit spending is going, much of it has been used to cushion the effect of what one former senior Putin advisor has called the most precipitous decline in Russian industrial output since the Axis invasion of 1941.

Furloughed Russian workers have been paid by regional authorities to re-paint and polish-up their inactive factories for limited periods of time. Government orders have been placed for unneeded equipment, just to keep people working. Make-work retraining and adult internship programs have been instituted. And last but not least, the automotive sector has been bailed out.

This deficit spending on bailouts and social programs is rapidly draining the country's reserve funds:

Interfax reported Monday that in a meeting with President Medvedev, Finance Minister Kudrin claimed that the Reserve Fund of the Russian Federation--one of the two components of the Stabilization Fund set up in 2004 to serve as a rainy-day repository for oil superprofits--will be fully liquidated in 2010 in order to support government deficit spending.

The fund's prognosis seems to be growing bleaker by the hour. In an interview earlier in the day with the news channel Vesti, Kudrin had said that total liquidation would only occur in the event that oil falls below $70 dollars per barrel for any substantial length of time, thereby depressing tax revenues and forcing Moscow to dip further into its reserves.

In that interview, the minister had also stated that Russia would start rebuilding the Reserve Fund no earlier than 2013.

The fund is currently invested in dollar-, euro-, and sterling-denominated sovereign debt. According to the Finance Ministry's website, the fund's value has dipped from $142.6 billion in September 2008 to $75 billion at present--a decline of over 47 percent, attributable largely to asset liquidation to cover Russian deficit spending of roughly 6.3 percent of GDP in 2009.

Putting this altogether provides some insight onto the mixed blessing that an increase in oil prices (courtesy of Helicopter Ben and his Chinese counterpart) is for Russia.  The higher price has eased somewhat the pressure on the reserve funds and helped the government's fiscal situation, but at the same time it has provided support to the ruble.  This has harmed industrial exports (n.b., a "key source of weakness" per the Bloomberg article), and thus manufacturing.

Moreover, although Goldman Sachs continues to be bullish on Russia, and the Russian equity market has rebounded, foreign direct investment has not kept pace.  This reflects myriad factors, not the least of which is the growing realization (hey, it's never to late to learn!) that investing in Russia under the shadow of expropriation is a mug's game:

Foreign investors in Russia are playing a game that Nathan Detroit, the host in "Guys and Dolls" of "the oldest established permanent floating crap game in New York," found unwinnable. On a losing streak, the gun-toting thug, Big Julie from Chicago, forced use of his own dice-- which had no spots ("I know where they are," Big Julie assured the players)--and proceeded to roll only winners.

The modern version of Lenin's famous prediction that "the capitalists will sell us the rope with which to hang them," might be that they will provide the capital to develop Russia's natural resources so the regime can dominate its "near-abroad" and increase Western Europe's dependence on it for supplies of natural gas. But investing in a nation in which there is no established rule of law is to shoot craps with Big Vladimir of Leningrad.

One reasonable conclusion to draw from all this is that Russia is likely to be a laggard, rather than a leader, in the world recovery.  Yes, a recovering world will boost oil prices and generate some tax revenues-but it will also boost the ruble, thereby impeding a recovery in manufacturing, which will be a drain on the fisc.  Investors are still relatively cautious around the world, and hot money aside, Russia offers a lot of dangers that they are quite happy to avoid, thank you.

The result?  A familiar one: purgatory.

In (somewhat) better news, Russia's population didn't decline in 2009:

Despite Russia's natural population decline, immigrants ensure the country's overall growth, the health and social development minister said on Thursday.

Tatyana Golikova said as of November 1, Russia's population was 141.9 million and that by January 1, 2010, it would be 15,000 to 25,000 more than for the same period in 2009.

She said although natural decline continued, the birth rate was 3-3.5% higher than a year ago and that 1.76-1.78 million babies were expected to be born this year.

Mortality was also down 3.-3.5% on last year, but still rather high - a total of 1,985,000.

According to the Russian Federal Migration Service, 333,474 foreign nationals and stateless individuals received Russian citizenship in January through November 2009.

Something of a mixed bag: more immigration, a slight decline in mortality, a slight increase in the birth rate, but still a natural decline (a "symbolic" in the words of one official increase in total population of about 20K, with immigration of 333K implies a natural decline).

It would be interesting to know whether the increase in the birth rate is more than one would have expected, conditional on the fact that women born during the last Soviet baby boomlet are at their years of peak fertility.  I'm sure somebody will answer that question for me.