Wishful and real: how would Russian economy evolve in 2017

The main issue in the prospects for 2017 is whether the Russian government would be capable of unleashing, at least in part, the potential for economic growth? Any estimated outlook at Russia’s economy in 2017 would start off with a snapshot of the current state of affairs, and the challenges that the economic system is facing.

Year 2016 results

On the one hand, the outcome of 2016 looks significantly better than that of the previous year: the recession is over, inflation is steadily declining, the Rouble exchange rate demonstrates a certain stability. On the other hand, one shouldn’t be overoptimistic. The end of recession does not necessarily mean a transition to growth. Several one-off factors played a immense role during the third trimester: a record harvest, the sharp increase in consumption of the Russian gas by Europe, the surge in world coal prices, which led to an increased production and export of the coal from Russia... These factors can not be seen as long-term and thus do not ensure a sustainable growth.

Inflation is still at a level perceived as very high all over the world. The head of Russia’s Central Bank believes that even with a 4-% inflation rate the country will only rank 124–128 among 182 countries. As the revenues stagnate, the state is forced to freeze its expenditure through reduced investment and cuts in the social programmes.

At the same time, it is increasingly difficult to adequately assess the real situation in the Russian economy given that the degree of confidence in Russia’s statistical services keeps falling. On top of this, last May, the Rosstat public monitoring agency stopped publishing the monthly data on the dynamics of investments into the Russian economy. At the very end of 2016, Rosstat reviewed the data on the dynamics of manufacturing during the last two years. For a few months now no one would be able to assess the state of affairs in Russian industry. Once you learn that the stats on personal revenues of Russians always remained a big controversy for Rosstat, systematically criticised by the expert community, the picture grows even sadder. By and large, the government is not capable of defining neither the direction in which the Russian economy shifts today, nor the well-being of its elements.

The potential

Potential growth is a natural characteristic of any economy as well as an apparent objective to be pursued. Experts agree, that the growth potential of the Russian economy today is at 3.5–4% annually. Therefore, the main issue in the prospects for 2017 is whether the Russian government would be willing to unleash this potential or, at least, some significant part of it.

There is no doubt, that in the absence of new external impacts, such as a sharp drop in oil prices or a new set of stringent sanctions against Russia by the West, the Russian economy is destined for a weak growth within 1%, in the coming year. This certainty is based on the market nature of the Russian economy with the equilibrium reached via market based prices and free fluctuation of the Rouble. By mid-2016 the Russian economy came to an equilibrium by ingesting the drop in oil prices and the financial sanctions by the West. So far, President Putin refrained from taking any steps or making statements that would push the country’s economy towards a Zimbabwe- or Venezuela-type scenario, i. e. a galloping inflation, price fixing by the state and general supply shortages. Should he stick to this line, the Russian economy will only have one direction: that of growth.

Over the last quarter of a century one could count on one hand the cases, when an economy would shrink for more than two years in a row. This is not taking into account periods at war or the transition between the state-managed and the market economy in the Eastern bloc in early 1990s. So there is no reason to believe that in this respect the economy of Russia is something fundamentally different from those of other countries.

Potential for growth

Russian economy paid a high price for this newly acquired equilibrium: internal consumption fell by some 15% over two years, while the investments went down by 10%. This highlights the two components of domestic market as the ’growth potential’ for the near future.

As of spring 2016, the statistical monitoring services point out growth, albeit very slow, in the real wages, still not sufficient to underpin the growth of consumption. Wealthier classes of Russians (about 20% of the population) prefer storing up on financial assets, mainly through bank deposits. They are still reluctant to resume the purchase of cars with the sales sliced by half compared to 2013. The real estate market is also rather sluggish. Should the government discover new resources to stimulate consumption in these two segments, this would inevitably give the economy a significant boost.

Investments

Investments prospects are less bright. Although Russia is steadily rising in the international rankings this does not translate into investments, thus preventing a sustainable growth.

There are two major obstacles on the way to the investment activity picking up pace in the private sector: the economic sanctions of the West, that sharply increase political risks of doing business in Russia, on the one hand, and the continuing distrust in the judicial and law enforcement systems, incapable of providing protection for business ownership, on the other.

Should there be any indications of significant progress in either of the two issues during the first half of 2017, this might take effect in the second half of the year on the country’s economic growth. If, however, there will be no developments in these fields, it would be hardly possible for the Russian economy to exceed the 1-% growth. The real economic outlook for 2017 is therefore crucially dependant upon the domestic and foreign policies that the Russian authorities adopt, as well as on the set of priorities chosen while planning the budget expenditures.

Ministry of finance: the new Russian tax system outline

In the end of 2016, Russian President Vladimir Putin instructed his cabinet to develop a new tax system. The new system might include a reduction in social insurance premiums, growth of VAT and a revision of the regressive wage taxation.

At the last congress of the Russian Union of Industrialists and Entrepreneurs the head of the Finance Ministry Anton Siluanov spoke of several measures to be undertaken in preparation for the new tax system.

«We need to adjust the tax system in a way, as to encourage those evading taxes, that is first of all. We’re talking of reducing the tax burden for the honest taxpayers, thus aligning the terms of market competition, that is the second issue», Siluanov itemised. He added that the common taxes in Russia are really high, levied in the form of social insurance premiums, while lowering them would require a change in the indirect taxation. An example might be observed in the luxury market, or the consumption of harmful products, the minister explained.

«In addition, we believe it would be useful to consider a regressive system for wage taxation», affirmed the minister. He explained that such system would relate to the social insurance premiums.

Another issue for revision is the tax incentives. These are quite numerous today, and the authorities are reviewing their effectiveness, confirmed the head of the Finance Ministry.

The tax policy in Russia is closely linked to the budget policy. The government sees its current priority in reducing the economic susceptibility in the face of the ever-changing external factors, the minister observed. There is a fiscal rule to achieve this, explained Siluanov: when the oil prices rise the state may be tempted to spend the surplus; this, however, would strengthen the Rouble, which is bad for the industry. The budget deficit should be minimal, so that it does not exhort pressure on taxes. At USD 40 per barrel taxes provide 32% of the GDP, this is sufficient for the authorities to fulfil their obligations, Siluanov added.

At the end of last year, during the annual address to the Federal Assembly, President Putin suggested considering «the plan for tuning up of the tax system» in the course of 2017. Putin insisted for different business associations to be involved. According to the president, it is necessary to adopt appropriate amendments to the Tax Code in 2017, and implement them as of 2019.

Russia is among the most investor-attractive countries

Large foreign companies take charge investing in the Russian economy. According to the rating agencies, Russia will be one of the most popular emerging markets in 2017. «The Russian Rouble is the main instrument for investors who tend to in the countries with low interest rates and purchase higher-yielding options,» emphasized one of the agencies. According to the Swiss bank UBS Group AG, ROI on the operations in Russian Rouble will stand at 26%. Other attractive markets are those of South Africa, Brazil, Mexico, Chile, India and Indonesia. The reason is always the same: the improvement of political climate in these countries.

Since the collapse of the oil prices in 2014, Russian economy began recovering, albeit slowly. The decrease in GDP slowed down, so did the inflation which kept climbing up, while the Rouble gained a good potential to strengthen positions. Moreover, capital flight was reduced by almost 5 times in the first 10 months of 2016, down to USD 10 billion. Last time similar results were recorded in 2008. According to the FX experts, foreign investors start returning slowly to Russia. In the first 9 months of 2016, foreign investment has grown up to USD 8.3 billion. For comparison, a year earlier this figure was only USD 5.9 billion. In 2017 this figure might well get improved, as Russia is on the list of the most investor-attractive markets, in the year to come.

«As we look at the situation with foreign investment, one should keep in mind that the foreign players often evaluate a country in its totality, looking mostly at the geopolitical risks that might lead to loss of funds. Teething troubles in the eurozone and uncertainty in the United States push investors to look for other way to place their assets, with Russia presenting a good opportunity. For the last few years, Russia faced an economic disaster under the Western sanctions, domestic counter-sanctions, and facing the collapse of the oil market.

The situation, however, might evolve in the near future. Thus, one of the main incentives for foreign companies to invest in the Russian economy is the appointment as a Head of the White House of the US president-elect Donald Trump, which so far «gives hope for the normalisation of relations between the two countries, and the removal of the geopolitical risks from the fair valuation of Russian assets,» analysts affirm. According to the expert community, it is now time to start investing in financial sector and in the real economy. «Now is the right time. Many large companies see new opportunities in the Russian market with good growth prospects. Giants focused on the mass market (such as IKEA, Leroy Merlin and many others) gear up to extend their presence in Russia.

It is now a very important period to create the right conditions for the increasing purchasing power, it is vital to make the necessary funding available to both producers and consumers. This can be done, for example, by lowering the CBR base rate, a policy that might attract investors, reignite domestic production and raise the quality of life. «Otherwise there is a risk for the investment attractiveness to be preserved only for short-term currency speculations with Rouble», analysts reckon.

Shanghai in 2016: USD 18.5 BLN in FDI

The volume of foreign direct investment pulled in by Shanghai in 2016 exceeded USD 18.5 billion. The FDI growth trend was observed in Shanghai for the last 17 years, although last year, it slowed down to 0.3%, compared to 1.6% in 2015. «We have observed a relatively stable growth of FDI in Shanghai. More importantly, the quality of investments and the sectors of interest exceed our expectations,» the city authorities commented in a statement.

Some USD 16.3 billion of the total FDI came into the urban utilities sector, about USD 2.2 billion went into manufacturing. The total volume of investment sealed by contracts amounted to USD 51 billion.

Foreign investment remains a powerful driving force behind the growth of Shanghai’s economy, which is perceived as one of the largest financial hubs in the country and the biggest platform for the companies geared by the foreign capital. By the end of 2016, some 580 global multinational companies opened their offices this Chinese metropolis. Shanghai also boasts 411 R&D and scientific centres with foreign capital.

China leaves behind the economic contestants as the us loses its leadership

China is recurrently mentioned in the analytical reports as a kind of ’future geopolitical centre’ of the planet. According to the IMF, the Red Dragon’s GDP reached USD 19.3 bln in 2015, or 17% of the global GDP. For a reference, the US economy constitutes 15.7%, the EU — 14.8% and the Russian — 3.2% of the global figure.

Today, China boasts one fifth of the world’s total production capacity with 17.5% of the global population. Every year, China constructs new ships worth 766 mln tons of combined tonnage, or 45.1% of the global production in this sector. Furthermore, China makes up for some 46% of the global aluminium production, 47% of coal production, 49% of steel, 60% of cement, 50% of iron ore and 54% of cast iron. China holds the leading positions in many sectors of economy: 7 out of 10 smartphones, for instance, are manufactured annually in China, along with 9 out of 10 PCs.

Once this country was perceived as a great, although primitive, factory with millions of low-cost workers stamping technically backwards, though very inexpensive, copies of the European and the American flagship products. These days, however, are long gone. On August 16 last year China launched the world’s first quantum communication satellite, with no analogues in the world. This relates not only to the satellite itself but also to the very principle of quantum communication.

Preserving the rigid system of the official 5-year plans, combined with a wide range of private ventures present in the economically open sectors allowed the country to nurture a sustainable multi-sector economy during the last six 5-year periods (as of the VI period from 1981 to 1985 through to the XII period from 2011 to 2015).

Over 48% of the industrial production in China is realised today by public enterprises, 38% by collective ventures and 13.5% by the private sector, including JVs with the foreign capital. In retail sector the state is responsible for 41% of the turnover, the collective ventures for 28%, while private sector accounts for 31%. The share of goods under direct price control by the state fell from 95% to 6%.

The current state of affairs in China, therefore, only appears as a free market to an external viewer, with a touch of general political leadership by the Communist party. In fact, however, the country is big enough to make the 30-% share of private capital seem vast. It is in fact a powerful state system with a highly centralised controlled economy, under a single national political and economic plan, with the combined benefits of planned and free market economy.