Economy of Russia

Despite the downfall of commodity market prices from their 2022 peaks and the easing inflationary pressures, inflation in many countries remained above target. Central banks were compelled tightening monetary policies, leading to a significant increase in interest rates in many countries worldwide. As a result, inflation rate in the United States decreased from 6.4% year-over-year in January 2023 to 3.4% year-over-year in December 2023, and in the Eurozone, from 8.6% to 2.9%. The tightening of monetary policy and the fragmentation of commodity markets caused a slowdown in the global economy to 3.2% compared to 3.5% in 2022. This slowdown was primarily observed in the EU and the UK, as well as in some developing countries (South Africa, Turkey). Meanwhile, the US economy's growth accelerated (from 1.9% in 2022 to 2.5% in 2023) due to increased consumer demand. China's GDP growth also accelerated (from 3.0% in 2022 to 5.2% in 2023).

Financial markets in 2023, however, showed positive dynamics. The MSCI World Index rose by 17% since the beginning of the year (the US market grew by 23%, Japanese - by 28%, European - by 8%). At the same time, the Shanghai Composite Index fell by 6% in 2023 due to weak industrial production dynamics and stagnation in the real estate sector. The best performance in 2023 was demonstrated by IT companies. Performance of the banking sector was weaker due to the rising interest rates and the liquidation of several banks in the US and Switzerland at the beginning of the year.

Food prices decreased in 2023 due to increased supply from major food exporters. According to FAO-OECD forecasts, food prices are expected to decrease by an average of 3.6% by 2027. The energy market in 2023 was affected by the global economic slowdown, increased oil production, the development of renewable energy in the EU, and decarbonization policies in developed countries. Brent crude oil prices in 2023 decreased compared to 2022, averaging $82.6 per barrel. The average annual gas price also decreased, averaging $470 per thousand cubic meters, which is three times lower than in 2022. This happened because of reduced demand from the EU due to high gas storage levels and increased supply from the US.

Global economic performance continues to expand in 2024 amid adaptation to tight monetary policy in developed countries and expectations of its upcoming easing. International trade is also recovering due to increased exports from developing countries (e.g., China) and growing imports from the US. In April 2024, for the first time in the past two years, the PMI New Export Orders entered positive zone.

Gas prices remain low, but a rising trend began to form in April-May after the price decline since autumn 2023, partly due to the seasonal resumption of restoration of European underground storages. The oil market in 2024 is experiencing growth, with increased demand for Russian Urals crude oil, reducing its discount to minimal levels ($8/barrel) since 2022. Central banks of developed countries are maintaining high interest rates. It is expected that the ECB will be the first bank to lower rates in the summer of 2024, while the Fed will likely postpone its first rate cut decision until the autumn of 2024.

 

According to the IMF, global GDP is expected to grow by 3.2% in 2024, with the GDP of the United States is expected to increase by 2.7%, the Eurozone by 0.8%, China by 4.6%, and India by 6.8%. The OECD estimates that global growth in 2024 will be 3.1%, driven by a slowdown in output dynamics in emerging markets and moderate recovery in the Eurozone. The European Commission also forecasts global and EU economic growth at 3.1% in 2024. The main drivers of growth are the revival of manufacturing and a significant acceleration in international trade. Factors that could dampen growth include a potential rise in commodity prices due to escalation in the Middle East, which would sustain high inflation and necessitate the continuation of tight monetary policy, negatively impacting economic growth and financial stability; a reduction in capital inflows to emerging markets due to a narrowing interest rate spread with developed countries; and the possibility of a slowdown in China's economic growth given ongoing issues in the country's construction sector.

Regarding the Russian economy, the European Commission forecasts a growth rate of 2.9% in 2024 and 1.7% in 2025. Internal negative factors include insufficient supply of domestic products amid persistently high interest rate and labor market constraints. This will limit investments, and the growth in domestic consumption will be satisfied by imports, especially in sectors where demand and supply imbalances have already emerged.

 

The year 2023 was successful for the Russian economy. Despite sanctions and an unfavorable external economic condition, GDP growth reached 3.6%, the average annual inflation rate did not exceed 6%, real disposable income of the population increased by 5.4%, and investment growth was 9.8%. This was caused by increased government spending, military expenditures and rising demand for domestic products due to the higher cost or unavailability of imports. Consumer demand was also supported by rising wages due to the labor shortages.

Development programs and subsidiaries, amid increased demand for domestic products, stimulated investment growth. With restrictions on cross-border capital movement, a significant part of budget expenditures remained within the country, reducing the need to increase public debt and adding stability to the budget. The consolidated budget deficit remained moderate (2.2% of GDP in 2023).

In 2023, there was a recovery and leading dynamics across the main sectors of the real sector. The structure of economic growth changed, with a reduced output in mining and an increased contribution from the manufacturing industry.

From the perspective of GDP utilization (Table 1), the most significant growth was in the gross capital formation (15.8%). However, the growth rate of gross fixed capital formation was at 8.8%, which, considering the high growth rate of consumer spending from both households and the public sector, indicates recovering logistics chains and investments in inventories.

Table 1. Physical Volume Indices of Gross Domestic Product Utilization Components (percentage change from the previous year)

 

Source: Rosstat

 

Statistics on production capacity utilization (Figures 1, 2) and the condition of the labor market indicate supply-side constraints. These constraints caused import to increase and ruble to depreciate, as well as accelerated inflation due to consumer demand outpacing supply dynamics.

 

Figure 1. Capacity utilization rate for the economy as a whole, %

Source: Bank of Russia.

 

 

Figure 2. Capacity Utilization Rate by Industry, %

Source: Bank of Russia.

 

Industrial production, after slow growth in 2022, increased by 3.5% in 2023 and by 5.6% in January-March 2024 (Table 2). The mining sector experienced negative growth in 2023, however, with a 1.1% increase noted in January-March 2024. The total output of the manufacturing sectors, after weak growth in 2022, rose by 7.5% in 2023 and by 8.8% in January-March 2024.

The most significant output growth in 2023 and January-March 2024 was observed in the following sectors: production of leather and leather products, production of motor vehicles, trailers, and semi-trailers, production of electrical equipment, production of furniture, production of other transport equipment, production of metal products (excluding machinery and equipment), and production of computers, electronic and optical products. Moderate growth was also seen in the pharmaceutical sector, production of coke and petroleum products (with a 3.8% decline in the first quarter of 2024), production of machinery and equipment, production of chemicals and chemical products and production of rubber and plastic products.

 

 

Table 2. Production Indices by Specific Types of Economic Activity in the Russian Federation, % compared to the same period of the previous year.

Source: Rosstat.

 

Retail trade turnover increased by 6.4% in 2023 and by 10.5% in January-March 2024, while services grew by 4.4% in 2023 and by 5.8% in January-March 2024.  Construction work rose by 7.9% in 2023 and by 3.5% in January-March 2024.

Annual GDP growth in the first quarter was 5.4% and adjusting for the extra day in February 2024 - 4.5-4.8%. Quarterly GDP growth was higher than in the fourth quarter of 2023. April's survey data were less positive but still indicated continued growth of the Russian economy, both in consumer consumption and investment activity.

 

According to the Ministry of Finance of the Russian Federation, federal budget revenues for January-April 2024 amounted to 11,684 billion rubles (Table 3), with the budget being having a nominal deficit of 1,484 billion rubles. However, according to the Federal Treasury, budget revenues amounted to 8,867 billion rubles, with a deficit of 3,963 billion rubles. This discrepancy is explained by the shift in April tax payments, which were received not on April 28 (a public holiday) but only on May 2. A similar technical shortfall in non-oil and gas revenues was observed at the beginning of 2023, when the budget deficit amounted to 3,421 billion rubles.

Oil and gas revenues increased in January-April 2024. This trend began in the fourth quarter of last year due to rising oil prices and a reduction in the discount on Urals crude oil. The non-oil and gas budget deficit for January-April 2024 was at the same level as January-April 2023 and amounted to 5,641 billion rubles. 

 

Table 3. Federal Budget Execution (billion rubles, cumulative from the beginning of the year)

Sources: Ministry of Finance of Russian Federation.

As of May 1, 2024, the volume of the National Welfare Fund (NWF) amounted to 12,751 billion rubles, equivalent to 139 billion USD (or 7% of GDP). NWF’s liquid assets amounted to the equivalent of 5,172 billion rubles (or 2.9% of GDP) or 56.3 billion USD.

 

A slight reduction in exports compared to the same period last year can be explained by declining prices for natural gas and metals, as well as increased sanctions pressure on Russian exports, including quantitative and price restrictions. The reduction in imports is due to China's heightened concerns about secondary sanctions from the United States and difficulties with foreign trade settlements.

 

Table 4. Balance of payments of the Russian Federation, billion dollars

 

Source: Bank of Russia.

 

In March, China reduced deliveries of machinery, equipment, and electrical equipment to Russia by 15%, to $2.9 billion, compared to March 2023. The total export of Chinese goods to Russia in April 2024 decreased by 10.2% compared to April 2023, to 59 billion yuan. Chinese exports to Russia fell by 13%, to $8.3 billion, compared to the same month last year. For the period January-April 2024, Chinese exports to Russia decreased by 1.9%, amounting to $32.73 billion. Nevertheless, China is increasingly using Central Asian countries to export its goods to Russia, so the statistics on Russian imports may not be fully representative.

Russia's trade balance increased to $43.7 billion in January-April 2024 (Table 4), and the current account balance doubled compared to the same period last year. If the trade balance and current account continue to expand, this will contribute to the strengthening of the ruble. It can become possible to see the situation from 2022 again, when due to the import restrictions, dollar exchange rate was about 60 rubles per dollar.

The services balance deficit decreased to $6.5 billion from $10.1 billion in January-April 2023, due to both a reduction in the import of services of the "Travel" category and an increase in the export of other services. The total deficit of primary and secondary income amounted to $5.5 billion (compared to $11.5 billion a year earlier), due to a decrease in foreign investors’ presence on Russian market, as well as a reduction in the volume of dividends accrued in favor of non-residents. Foreign assets (excluding reserve assets) increased by $32.2 billion (compared to $9.5 billion a year earlier), partly because now it takes more time to complete an international settlement. 

 

According to the Bank of Russia, as of mid-May, the maximum deposit rate was 14.92%. Currently, restrictions on cash withdrawals from foreign currency accounts by individuals, limited to no more than $10,000 in cash (with the remaining funds issued in rubles at the market rate on the day of withdrawal), remain in effect and have been extended until September 9, 2024. These restrictions were initially introduced by the Bank of Russia on March 9, 2022.

At the latest meeting of the Board of Directors of the Bank of Russia, held on April 26, 2024, it was decided to keep the key rate unchanged at 16.00% per annum. It is known that the rate was actively raised in the second half of 2023 in response to accelerating inflation and inflationary expectations. The Bank of Russia notes that "current inflationary pressure is gradually weakening but remains high." Inflation expectations in May increased for the first time in 2024 (Figure 3).

 

Figure 3. Direct Inflation Estimates by the Population: Median Values, % per Annum

Source: LLC "inFOM".

 

According to the Bank of Russia, demand still exceeds supply. Thus, the dynamics of consumer sectors are excessively active (Figure 4).

 

Figure 4. Dynamics of Retail Trade, Food Service, and Paid Services Turnover

Source: Bank of Russia

 

But the output of investment sectors and intermediate sectors shows more moderate dynamics (Figure 5).

 

Figure 5. Output of Manufacturing Industry Groups (2014 = 100%). The “heaviest” industries refer to the production of "fabricated metal products, except machinery and equipment" and "other transport equipment," which have the greatest weight in the value-added structure of the investment group.

Source: Bank of Russia.

 

According to the Bank of Russia, the growth of retail lending accelerated to 1.7% MoM in April from 1.6% MoM, with the average monthly growth for January-April being 1.3% MoM, comparable to the average for the same period in 2023 (1.4% MoM) when market rates were significantly lower. Despite the slowdown in the growth of ruble loans to non-financial organizations to 1.3% MoM in April from 1.6% MoM in March, the overall growth of lending (including retail and financial organization lending) remains the main source of active expansion of the money supply after the reduction in the budget's contribution (Figure 6).

 

Figure 6. Factors Contributing to the Formation of Broad Money, percentage points.

Source: Bank of Russia.

 

Therefore, the Bank of Russia assesses the current situation as overheating, and at the next Board of Directors meeting on June 7, 2024, there is a high probability of raising the key rate by 0.5-1 percentage points. The Bank of Russia forecasts a decline in inflation to 4.3-4.8% in 2024 and a return to 4.0% in 2025.

 

Since the beginning of military actions between Russia and Ukraine in February 2022, Western countries implemented several sanctions packages. After February 2022, the volume of sanctions increased 6.1 times, reaching a total of 16,587 (Figure 7). Russia became the most sanctioned country among those under sanctions.

 

Figure 7. Number of Sanctions Before and After February 2022 by Country.

 

Source: Based on data from: https://www.castellum.ai/russia-sanctions-dashboard

 

The countries that imposed sanctions against Russia include the USA, Canada, Switzerland, the EU, the UK, France, Australia, and Japan. The largest share among these countries belongs to the USA—22%, and the EU—11%.

Sanctions can be divided into trade, financial, personal, and informal categories. Trade sanctions include restrictions on export and import operations, both quantitative and price-related, such as price caps on Russian oil, bans on the purchase of Russian goods important for Russia's revenue (e.g., metals, diamonds, etc.), and bans on the import of dual-use products into Russia, which encompasses a broad range of items. Financial sanctions include disconnecting major Russian banks from SWIFT, banning reserves and other assets, both private and state-owned, and the inability to raise capital in international financial markets. However, there is no complete ban on trading in dollars and euros. Sanctions also impacted the logistics sphere—banning Russian ships from entering European ports, transit through EU territory, and closing airspace for Russian aircraft. Informal sanctions include the withdrawal of companies from Russia, extended visa processing times, visa restrictions, and more.

As for June of 2024 the main sanctions that can be applied, considering their negative impact on the sanctioning countries themselves and the global economy, have already been implemented. Future actions and packages will primarily focus on addressing vulnerabilities in the sanctions and exerting pressure on third countries to enforce sanctions (e.g., banning parallel imports, etc.). For example, the 12th package includes measures such as the "No Russia" clause in contracts with importers from third countries. Another example is the pressure on banks in third countries to limit or completely cease operations with the Russian payment system "MIR." According to Bloomberg, the 14th package is expected to introduce a ban on political parties, think tanks, and other organizations from receiving funding from Russia to prevent Russian influence on European Parliament elections. Additionally, the EU is discussing a ban on importing Russian helium, tightening restrictions on exporting manganese ore and other rare earth components. The EU may also ban the use of the Russian Central Bank's Financial Messaging System (SPFS). New export restrictions against companies, including those from China, Turkey, and the UAE, which are believed to help Russia circumvent sanctions, are being discussed. New sanctions may affect the re-export of Russian liquefied natural gas (LNG) to third countries. A complete ban on importing Russian LNG into the EU is also under discussion. However, Greece, Cyprus, and Malta oppose any restrictions against Russian tankers. The EU may tighten export rules for dual-use goods to Belarus. The import of diamonds from Belarus will also fall under sanctions, as Belarus is considered a transit point for selling diamonds of Russian origin. Additional sanctions may include restrictions on the supply of cars and car parts to Belarus.

To circumvent sanctions, Russia uses several tools, the main ones being the "shadow" fleet, creating intermediary chains for importing and exporting goods, and importing individual components instead of finished products. In response to the price cap on oil and oil products, Russia and associated agents have started buying old tankers, and currently, the shadow fleet exceeds the combined shadow fleets of Iran and Venezuela. According to various estimates, this includes over 600 ships. The "shadow fleet" masks the ultimate beneficiaries of the tankers or cargo, hides the source of oil, etc., using methods such as turning off the ship's identification system, falsifying location information, and short-term flag changes. Thus, the origin of the oil becomes difficult to determine. It is sold at a discount but above the price cap. Along with the price cap, a ban was introduced on insurance by companies from price cap coalition countries for transporting Russian oil if purchased at or above the set level. Therefore, traders working with the shadow fleet use insurers from Russia and other countries. As a result, there are savings on freight costs, but logistics have lengthened. Currently, Russia mainly focuses on Asian markets, while the UAE has replaced Russia in European markets. Russian oil and oil products (diesel) are re-exported, for example, by India to EU countries. Despite redirecting exports to the East, the growth in Asian countries was not significant enough to compensate for the sharp decline in exports to European countries (Figure 8).

 

Figure 8. Dynamics of Russian Exports to European and Asian Countries for 2022–2023, in billion USD.

The Russian economy is dependent on Western technologies. The group of goods including machinery, equipment, and vehicles holds a significant weight in Russian imports. There is a high share of foreign added value in the production of electrical equipment, textiles, pharmaceuticals, computers, etc., with 30% to 50% in the metallurgical and chemical industries. While the oil embargo, price cap, and other restrictions on Russian exports have significant but predominantly short-term effects, the ban on the supply of technologies, equipment, etc., to Russia will reduce the productivity of the economy and its growth potential. To circumvent sanctions on importing goods into Russia, intermediary chains are also being established, making it extremely difficult to trace the final buyer.