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5 August 2015

The end of the consumer economy

The way the Kremlin has destroyed one of the foundations of ‘Putin’s stability’

Over the years, the development of the Russian economy was based on the inflow of ‘petrodollars’ into the country which, distributed among the population, enabled the steady growth of domestic consumer demand. Between 2000 and 2008 – during the period when the rate of the ruble against the dollar even rose slightly (28.1 versus 24.9 ruble/dollar – the annual average for the respective years) – retail trade turnover in Russia snowballed, growing by a factor of 5.9 (for example, its increase amounted to 48.3% over the same period in the USA). This sharp upswing in consumer demand gave rise to a situation which radically differentiates Russia from any other ‘catch up’ economy: the spheres of services, construction and trade were growing faster than GDP for all these years, whereas the manufacturing industry was lagging behind considerably (in China, the growth of manufacturing in 2000-2012 outpaced the GDP growth by almost 35%). As a matter of fact, the Russian economy started to resemble a dumbbell: the materials sector was concentrated on the one side whereas the sphere of services and consumer goods manufacturing – on the other – while key sectors of the processing industry continued their demise and infrastructure was in decline.

Consumer demand was stimulated by two factors: on the one hand, an increase in the population’s income which significantly outstripped growth of productivity and all other performance indicators as well as an increase of retirement pensions, benefits and other welfare payments. In the same period of 2000-2008, the average wage in the economy grew 7.75-fold whereas old-age pensions – 8.24-fold. On the other hand, citizens’ confidence in the stable outlook for the economy tempted them to take out credits and loans, which became rather prevalent with the growth of large retail chains and the decrease in mortgage interest rates. During these years, the level of indebtedness of natural persons in terms of bank loans (not counting micro-credit organizations) increased 30-fold, reaching 12.5% of GDP. On the eve of the 2008 crisis, 40% of cars and nearly 45% of apartments in new buildings were purchased using credit.

The state closely followed the process of improving the well-being of citizens – it is even widely accepted that the so-called ‘Putin consensus’ was built on the guarantee of this well-being. In 2009, Russia became the only one of the countries with large economies in which, against the backdrop of the crisis, indicators of real income of the population grew (by 0.7%) and retail trade turnover increased (by 4.8%) at current prices. However, the situation changed during the next crisis which started because of the drop in oil prices and sanctions introduced in response to the annexation of Crimea and the onset of war in the east of Ukraine.

It was a ‘triple’ blow for consumption. On the one hand, reduced proceeds from exports as such led to a rethink of business strategy by many large companies which considered optimization of costs, freezing wages and reducing staff. At the same time, the state started to increase taxes and levies, also incentivizing businesses to save money (or close down). On the other hand, a sharp decrease in budget revenues (‘oil-and-gas’ revenues amounted to 51.8% of the budget as of the end of 2014,) generated lower expenditure (a decline from 1.59 trillion rubles in January 2015 to… 865 billion rubles in May). And, with that, hopes for an increase in wages for public sector employees or retirement pensions for elderly residents have been destroyed. Finally, against the backdrop of both processes, the financial sector has experienced a serious shock: banks have lost a considerable amount of the resources of large companies which have been forced to pay off external loans; inflation has sharply increased interest rates; the jump in exchange rates inflated prices on import goods which constituted an important (if not decisive) share in the consumer market.

The results are in. Compared to last year’s indicators, the real income of the population decreased by 4.7% during the first half of 2015, retail turnover dropped by 9.4%, whereas total issued consumer credit – by more than one third. The growth of sectors which produce durables and have been oriented towards bank financing while selling their produce has slumped: in the first half of the year, sales of passenger cars plummeted by 36% and new housing – by 48%. And now, the main question for the Russian economy lies in whether it can ‘find the ground beneath its feet’ and push consumer demand up.

Today, one cannot tell for sure what the second half of the year 2015 will look like. However, it is clear that it is going to unfold in the midst of confrontation between two polar trends.

On the one hand, the reduction in consumption has created preconditions for the reversal of the trend for many months in a row – over the course of all this time, people have reduced their spending by even more than their incomes have been falling: the feeling of uncertainty is having its effect. Besides, the halt of the growth in prices (according to the data of the Rosstat, in June, prices increased by as little as 0.2%) and the relative stabilization of the rate of ruble has played a positive role. The Central Bank has lowered the base rate several times and that is why rates on consumer credit have also dropped (for example, mortgage interest rates fell from an average of 22-24% in January to 12.5-15% today). Many apocalyptic predictions about unemployment and declining living standards have not yet come true – and this, too, creates a certain positive attitude in society.

On the other hand, one should bear in mind that the economy responds slowly to impulses from the budgetary sphere as well as from external factors. From May to July the price of Brent crude oil dropped by 14%: from $65-67 to $56-57 a barrel. Cumulative expenditure from the federal budget in the 2nd quarter turned out to be 23.3% lower than the 1st quarter. The outflow of capital continues, and it reached $52.5 billion during the first half of the year. The real sector will respond to the reduction in budgetary spending with a lag of 6-7 months, that is in September-October; the inflow of foreign currency from commodity sales will de facto decrease earlier; from early fall, companies will start drawing up plans and budgets for the following year, cutting costs. Besides, many experts predict a rise in the dollar rate which may lead to some of the population converting money into foreign currencies and postponing a number of purchases for several months. Shrinking investment observed over the course of the last 11 months will also contribute to the slowdown in growth.

What comes out of it? As it happens, quite obvious things.

First of all, it is necessary to stress once again that consumption is the key source of growth for the Russian economy (although not so huge compared to the USA): cumulative wages constitute 53% of GDP whereas exports in the first half of 2015 — as little as 13% while, for example budgetary investment in infrastructure comprised as little as 1.7% of GDP. There is no compensation for the decrease in consumer spending. That is why the government needs the population to continue buying. If the authorities in Russia were capable of using the experience of leading countries during the 2008-2009 crisis, they would have long ago suggested aggressive measures for demand activation: they would have renewed the program for scrappage of motor vehicles, introduced bonuses for the purchase of new housing, subsidized the purchase of building materials for individual construction, abolished the maximum possible number of levies imposed on small businesses in the area of services and trade. All of this could become an incentive for the enhancement of consumer spending which is extremely vital today as is a reduction of pressure on the labor market and a reduction in unemployment, which would support demand in the more distant future. State-owned banks could purchase portfolios of consumer credit from private banks and lower interest rates, thus, partially freeing up the money of borrowers which can be allocated to increase consumption. Finally, the authorities could stop limiting indexation on retirement pensions since pensioners spend practically all of their resources on current consumption. They could also refrain from abolishing, for example, fringe benefits on public transportation or raising rates for housing and public utilities. In other words, if the leadership in Russia were wiser, they would cut spending which practically does not give a 'multiplier effect' (like, for example, investments in the construction of the Vostochny Cosmodrome or the road infrastructure) and earmark the funds saved for social programs which could help to hinder the reduction in consumer spending.

Unfortunately, such a scenario seems unlikely. Firstly, the government has convinced itself that economic growth will 'pick up in the 3rd and 4th quarters' and has subsequently started to squander money on projects with a more than dubious economic impact. Russian entrepreneurs who met Putin 'on the sidelines' of the economic forum in Saint Petersburg were unanimous in their view that the President is practically not interested in the economy. And, judging by what is happening, this is seemingly true – the authorities take no strides to help stabilize the situation at least in regard to the support of consumer spending. This is largely clear – Russia has always been focused on 'big projects' – but, in the current situation, success depends solely on these 'small things' which it should have learned how to deal with long ago.

This is why our forecast looks pessimistic: the economic downturn will accelerate in mid-3rd quarter and will exceed 5% at the end of the year. Consumer spending will decrease by 12-13% against the backdrop of the decrease in real income by 8-10%. This will have a catastrophic effect, primarily because citizens will come to understand that: recession is here to stay for a long time, and spending will further reduce in 2016. Russia will fall outside the limits of the 'consumer economy' which used to be the most essential foundation for Putin's stability. The opposite will come in its place as a foundation for the system, as a parody of the mobilization economy which requires limitations on well-being for the sake of 'the struggle against external threats'. Such a replacement will not threaten the stability of the regime in the coming years but it will create preconditions for the gradual exit of Russia from the circle of 'economically advanced' countries. 

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